Steer clear of Cronos Group, says PI Financial

A big earnings miss in its latest quarterly numbers has PI Financial analyst Jason Zandberg staying on the sidelines with Cronos Group (Cronos Group Stock Quote, Chart, News, Analysts, Financials TSX:CRON). In an update to clients on Monday, Zandberg reiterated his “Neutral” rating while increasing his target price from $7.50 to $10.00.

Toronto-headquartered Cronos is a licensed cannabis producer in Canada with operations worldwide and a brand portfolio that includes health and wellness platform Peace Naturals, Cove, Spinach and hemp-derived CBD brands Lord Jones, Happy Dance and Peace+.

The company reported its fourth quarter and full-year 2020 results last Friday, hitting net revenue for the Q4 of $17.0 million compared with $7.3 million a year earlier and an adjusted EBITDA loss of $53.1 million compared to a loss of $51.7 million for Q4 2019. For the 2020 year, revenue was up 97 per cent year-over-year to $46.7 million and EBITDA was down 50 per cent to negative $147.3 million.

Management said Cronos incurred an inventory write-down of $15.0 million in the fourth quarter on dried cannabis and extracts due to price compression in the Canadian market and they warned that further write-downs could be expected if prices continue to be depressed. For the full year, Cronos’ inventory write-downs totalled $26.1 million.

Overall, the company said the larger year-over-year EBITDA loss was due to increases in G&A expenses and in R&D spend.

“We are poised to build upon the growth we experienced in 2020 as we continue to push cannabinoid innovation and differentiated product offerings under our portfolio of brands,” said newly appointed CEO Kurt Schmidt in a press release. “My goals this year will be to focus on building a winning team by fostering a collaborative, performance-driven culture; continue to focus on creating disruptive technology and innovation; grow and develop our brands and strengthen our ability to compete through R&D, strategic global infrastructure and engaging in the legislative process in key markets.”

Operationally, Cronos noted in the fourth quarter release that it secured its first major US retailer for its Happy Dance product line, with expectations to launch at over 550 ULTA Beauty stores across the country in upcoming weeks. Further abroad, Cronos obtained certification and licensing for cultivation, production and marketing of dried flower, pre-rolls and oils in Israel in 2020 and has its Peace Naturals line of flower and oils now on the market, having received a 2020 Innovation Award from the Israeli Marketing Association for its marketing strategy last year. Cronos said its Natuera Latin American joint venture continued to hit operational milestones, as well, completing its first CBD export to the United States.

From his perspective, Zandberg called the impact of Cronos’ fourth quarter a negative, saying,

“EBITDA losses during the quarter were far greater than expected. We are maintaining our Neutral rating on CRON and increasing our price target only because industry multiples have risen. With that being said, we recommend clients should avoid the stock until we have better clarity on how Cronos will invest their large cash position,” Zandberg wrote.

By the numbers, CRON’s fourth quarter revenue of $17.0 million was above Zandberg’s $14.3-million estimate as well as the consensus $13.3 million, while the $53.1-million EBITDA loss was greater than Zandberg’s call for a loss of $28.1 million and the Street’s negative $26.7-million estimate. Fully diluted EPS of negative $0.35 per share was below Zandberg’s negative $0.08 per share estimate and the consensus negative $0.06 per share.

Zandberg pointed out that Cronos’ Rest of the World sales grew by 193 per cent in the Q4 to $13.5 million, while Lord Jones sales in the US increased by 114 per cent to $3.5 million. Gross margins in its US business were 52 per cent but overall gross margins continued to be negative due to the inventory write-downs. Overall, Cronos’ US segment had an adjusted EBITDA of negative $11.8 million compared to negative $1.2 million a year earlier, with Zandberg relating that the bigger negative came from higher sales and marketing costs.

Looking ahead, Zandberg expects CRON to generate 2021 revenue and adjusted EBITDA of $86 million and negative $56 million, respectively, and 2022 revenue and EBITDA of $120 million and $6 million, respectively. The analyst’s new $10.00 target represented at press time a projected 12-month return of negative 24.8 per cent.

Cronos finished 2020 with its share price down 11.3 per cent for the year. So far in 2021 the stock is up 58 per cent. Cronos’s share price hit a high of $30 in early 2019 at the height of the cannabis bubble but spent most of last year in the $8-$10 range.

On the path ahead for Cronos, executive chairman Mike Gorenstein said in the fourth quarter press release, “We look forward to continuing to launch innovative cannabinoid products in Canada and to expand our portfolio of U.S. hemp-derived CBD brands. Internationally, we’re pleased with the progress we have made in Israel and as regulations continue to evolve, we will look to establish ourselves as a leader in the markets in which we operate.”