Raymond James turns bullish on Cronos Group

The advent of biosynthetic cannabis will be a boost for Canadian licensed producer Cronos Group (Cronos Group Stock Quote, Chart, News TSX:CRON), says Raymond James analyst Rahul Sarugaser who raised his target price for the stock from $6.50 to $10.00 in an update to clients Tuesday.

Biosynthetically-generated cannabis foregoes the expensive and unwieldy process of growing plants either outdoors or in greenhouses and uses lab-derived engineering to generate cannabinoids. The process also has the benefit of producing purer compounds that are more attractive for the pharma industry as well as the derivatives market.

Cronos Group signed a partnership deal in 2018 with genetic engineering firm Ginkgo Bioworks to produce a spectrum of cannabinoids, a process that will reach fruition in 12 to 18 months by Sarugaser’s estimate.

Sarugaser said production costs for biosynthetically-generated cannabinoids could range from $2,000 per kg down to as low as $100 per kg once engineering optimization and scale come into effect.

All that entails a re-valuation of Cronos’ worth, Sarugaser said, based on a new assessment of the global market for biosynthetically-generated cannabis compounds.

“To value CRON's biosynthesis partnership with Ginkgo Bioworks, we previously used a comparables-based analysis, which—given the market's early, limited understanding of cannabinoid biosynthesis' disruptive potential—we now discard. Here, we have developed a novel, robust, defensible, top-down valuation methodology specific to cannabinoid biosynthesis,” Sarugaser wrote.

The analyst used a probability-adjusted scenario analysis of the potential penetration of biosynthesis technology into the cannabis CPG and Pharma markets and then estimated the global market for products derived by cannabinoid biosynthesis to be growing from C$10 billion in 2025 to C$115 billion by 2040, in effect calculating the present value of the global cannabinoid biosynthesis opportunity at about C$40 billion.

“From this $40 billion global cannabinoid biosynthesis opportunity, we undertook a probability-adjusted calculation of the opportunity attributable to CRON, estimating its current value at $1.54 billion, or $4.10/share. Adding this value to our DCF analysis (10 per cent discount, two per cent terminal rates) of CRON's revenues—unchanged from our previous estimates—we derive a per share value of $10.09, which we round to $10.00,” Sarugaser wrote. (All figures in US dollars unless where noted otherwise.)

With his estimate that biosynthesis will be yielding revenues for Cronos in 12 to 18 months, Sarugaser has changed his rating from “Market Perform 3” to “Outperform 2.”

At press time, the analyst’s new $10.00 target represented a projected 12-month return of 60.8 per cent.

By the numbers, Sarugaser thinks CRON will generate fiscal 2020 revenue and EBITDA of $44 million and negative $81 million, respectively, and fiscal 2021 revenue and EBITDA of $100 million and negative $70 million, respectively.

Toronto-based Cronos Group last reported earnings on May 8, where the company posted first-quarter consolidated revenue of $8.4 million, up from $3.0 million year-over-year, and an adjusted loss of $40.7 million versus a loss of $10.1 million a year earlier. Cronos reported an inventory writedown of $8 million due to pricing pressures in the marketplace, according to management.