Cronos Group is an overlooked gem in the cannabis sector: Raymond James

The recent gloomy news from Canada’s cannabis sector should be steering investors toward one name that will continue to shine brightly: Cronos Group (Cronos Group Stock Quote, Chart, News TSX:CRON) according to Raymond James analyst Rahul Sarugaser.

In an update to clients on Friday, Sarugaser said licensed producer Cronos Group has more going for it than investors have been giving it credit, including its partnership with tobacco company Altria and potential for penetration into the US CBD market.

News came from Nanaimo, BC’s Tilray on Tuesday that the company would be cutting ten per cent of its workforce, while on Thursday, Edmonton-based Aurora Cannabis announced a similar ten-per-cent cut in its
workforce along with $1.0 billion in impairment and goodwill writedowns.

It’s the latest from a reeling cannabis sector which saw huge chops in valuations over the second half of 2019 as the fledgeling industry in Canada attempted to deal with a slower than expected rollout of cannabis retail across the country and a glut of product.

Sarugaser says the market dynamics that drove poor performances for cannabis companies in their reported second and third quarters of last year are to be repeated in Q4 results currently coming in.

The analyst thinks that so-called Cannabis 2.0 sales of edibles and other derivatives will likely push revenues to growth rather than declines only in the second and third quarters of 2020, with much of the carnage running its course by Q4 2020 with a wide gulf by then separating the well-run and well-capitalized operations from those that will continue to struggle.

“We expect these continuing sector headwinds to drive the second bottom we predicted would occur in February or March 2020. We predict a rebound among strong, fiscally prudent operators beginning ~May 2020, materializing more fully in 2H20 with the realization of Cannabis 2.0 sales and, perhaps, the expansion of retail cannabis store footprint across Canada, particularly in Ontario, driving accelerated sell-through,” wrote Sarugaser.

On Cronos, the analyst points to the company’s roughly $2.0 billion in cash, $27 million in quarterly SG&A and quarterly cash burn of $30 million, indicating fiscal discipline and management’s strategy (which now appears prescient) to remain asset light in not building massive cultivation facilities or making splashy acquisitions and thereby exposing it, in the current climate, to big write-downs.

And while Cronos is still revenue-light at $13 million in its last quarter, Sarugaser said focusing on CRON’s current Canadian revenues would be a mistake.

“This misplaced focus —rather than understanding the potential of CRON's Altria-powered distribution network and its fundamentally disruptive biosynthesis partnership with Ginkgo Bioworks —is playing a role, we expect, in restricting its valuation to levels similar to that of ACB, presently,” wrote Sarugaser.

“CRON continues to gain market share in Canada, but, more importantly, the company has its gaze fixed upon the US CBD market. Unlike every other cannabis company —including its largest competitor, Canopy Growth (TSX:WEED): similar cash pile of $2.7-billion, yet a market cap 3x larger than CRON’s at $9.8 billion — CRON has the ability to plug into its partner Altria's ~250,000 points of distribution through convenience stores across the US (WEED is pursuing online-only sales of its First & Free CBD brand),” he wrote.

With the update, Sarugaser has reaffirmed his “Outperform 2” rating. For fiscal 2020 he is calling for revenue of $166-million and EBITDA of negative $7 million.