Cronos Group is undervalued, says Raymond James

Cronos Group (Cronos Group Stock Quote, Chart, News, Analysts, Financials TSX:CRON) saw its share price spike earlier this year, but the stock has now been on a prolonged slide since mid-February. Is there upside from here? Likely, says Raymond James analyst Rahul Sarugaser, who in a Friday client report previewed the company’s upcoming quarterly release, saying Cronos’ cannabinoid biosynthesis investments are about to pay off.

Cronos Group is a Canadian licensed producer of cannabis with an established partnership with tobacco company Altria and a brand portfolio which includes health and wellness platform PEACE NATURALS, adult-use brands COVE and Spinach and hemp-derived CBD brands Lord Jones, Happy Dance and PEACE+.

After a disappointing 2019 when the cannabis sector experienced heavy losses, CRON had a better 2020, rallying over the final quarter to end the year down 11 per cent. Again a sector-wide movement, Cronos’ share price more than doubled from November 2020 to early February 2021, but the stock and sector have witnessed a pullback more recently, bringing CRON down to $10.27 as of Friday’s close for a year-to-date return of 16 per cent.

But Sarugaser sees more upside to the name, saying in his report that Cronos’ partnership with bioengineering company Ginkgo Bioworks deserves special attention.

“CRON is one of the companies we believe will change the cannabinoid product landscape through its longstanding commitment to innovation—evidenced by its investment in biosynthesis and its appointment of CPG product innovation legends like Todd Abraham to its executive team —paired with its (and Altria’s) significant resources,” Sarugaser wrote.

The Boston-based Ginkgo Bioworks, with which Cronos established a partnership in 2018, has developed a platform to synthesize cultured cannabinoids identical to compounds more traditionally extracted from plants, where the biosynthesis method avoids the impurities and crop costs involved in traditional production.

Sarugaser said on its own the Ginkgo partnership adds about $4.00 per share to CRON’s valuation.

“CRON has long been forecasting its cultured cannabinoid — pure, consistent cannabinoids produced via biosynthesis using engineered microorganisms like yeast, bacteria or algae — product launch for 3Q21. We understand that the company is on track to commercialize its first cannabinoid during that timeframe, likely launching with CBG as its first molecule and focusing on other rare cannabinoids next,” the analyst wrote.

“Since 4Q20, we’ve been awaiting news about CRON’s receipt of a Health Canada commercial processing license for its Cronos Fermentation manufacturing site before the company launches fermented CBG-incorporating products. We expect CRON’s 1Q21 conference call will shed some light on its process with Health Canada and tangible steps toward commercializing cannabinoids by biosynthesis ~3Q21. We believe CRON’s fully-licensed and fully-ramped biosynthesis operations would unleash ~US$1.5 billion of value,” he said.

Ahead of Cronos’ first quarter 2021 results due on May 7, Sarugaser said he is expecting Q1 revenue and EBITDA of $16.6 million and negative $37.8 million, respectively. He expects the company to have finished the quarter with $1.24 billion in cash and no debt. (All figures in Canadian dollars except where noted otherwise.)

Further ahead, Sarugaser thinks CRON will generate 2021 revenue and EBITDA of $89 million and negative $141 million, respectively, and 2022 revenue and EBITDA of $132 million and negative $79 million, respectively.

With the update, Sarugaser has maintained his “Outperform 2” rating and his $11.00 target price.

On his valuation, the analyst wrote, “We balance our DCF analysis against a comparables analysis of CRON versus its cannabis industry peers and extend this comparison to large, consistently +EBITDA consumer packaged goods (CPG) industry stalwarts with ~40 per cent gross margins. With this analysis we use a 2024 EV/ EBITDA multiple of 12x to derive an implied share price of $11.38. We round these two separately-derived implied valuations and maintain our target price of $11.00.”

“And so, while the market (and many of our peers) moderates their expectations of CRON’s stock performance, we see underappreciated value in CRON — and its partnership with Ginkgo Bioworks, in particular — so we maintain our Outperform (2) rating,” Sarugaser said.

Cronos published its full-year 2020 financials in February, where the company hit $46.7 million in consolidated net revenue compared to $23.8 million in 2019. Adjusted EBITDA went from negative $98.3 million to negative $147.3 million.

Cronos said the 2020 revenue growth was due primarily to growth in Canada’s adult-use cannabis market, along with growth in its US segment and sales in the Israeli medical market. At the same time, the company’s earnings losses for the year were driven by third-party purchased flower associated with adult-use products in Canada, a decline in wholesale sales, greater general and administrative expenses and higher sales and marketing costs related to brand development and R&D.

“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 Kurt Schmidt, President and CEO of Cronos, in a February 26 press release.