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3 Things Cronos Group Needs to Do to Catch Its Competitors

Sean Williams, The Motley Fool

Since the beginning of the year, most marijuana stocks have been on fire. Through this past weekend, the Horizons Marijuana Life Sciences ETF, the first-ever tradable cannabis exchange-traded fund, had gained 49%, year-to-date, compared with "only" 16% for the broad-based S&P 500.

The impetus for this rally is Canada's legalization of recreational marijuana in October, as well as continued legalizations in the United States and around the world. Today, more than 40 countries worldwide have given the green light to cannabis in some capacity, and the sky appears to be the limit for marijuana stocks.

An up-close view of a flowering cannabis plant growing in a hybrid greenhouse.

Image source: Getty Images.

Cronos Group has been "smoking" hot this year

Among the top-performers since the beginning of the year is Ontario-based Cronos Group (NASDAQ: CRON), the first pot stock to ever uplist from the over-the-counter exchange to a more reputable U.S. exchange. Year-to-date, Cronos Group's stock has gained 64%, and was up nearly 125% as of early February. The catalyst? Thank tobacco giant Altria (NYSE: MO).

In early December, Altria announced that it would be investing $1.8 billion into Cronos Group for a non-diluted 45% equity stake. Furthermore, Altria received warrants that, if exercised in the future, could boost its equity stake to 55%. Essentially, it gave Cronos Group an established partner with which to develop new products (e.g., vapes), as well as a real shot at being bought out down the line. Not to mention, the $1.8 billion in cash gives Cronos the ability to execute on its long-term strategy.

But there's quite the bifurcation between how Cronos Group's shareholders view their company and how outsiders (i.e., non-shareholders) see this stock. Taking an objective step back as someone with no monetary interest in Cronos Group, the company isn't able to hold a candle to its larger peers at the moment. It's just inside the top 10 in terms of production potential among Canadian growers, and delivered a meager $4.2 million in fourth-quarter sales, despite Canada's legalization.

If Cronos Group is to maintain its lofty $5.7 billion market cap, it'll need to do three things to catch up to its peers.

An up-close view of a flowering cannabis plant growing indoors.

Image source: Getty Images.

1. Increase production capacity

Arguably the most glaring deficiency between Cronos Group and other growers is Cronos Group's lack of production capacity. The company's 850,000-square-foot joint venture grow farm (Cronos GrowCo) will be complete by midyear and is capable of 70,000 kilos of annual output at full capacity. Combined with Peace Naturals (40,000 kilos at its peak) and its relatively small overseas growing operations, the company might have a shot to squeeze blood from a turnip and reach 120,000 kilos of peak output. That may only be good enough for eighth or ninth on the list of Canada's major growers, and it already trails Aurora Cannabis' annual run-rate of 150,000 kilos, as of the end of March 2019.

If Cronos Group wants to be taken seriously as the third-largest marijuana stock by market cap, it's going to need to beef up its production potential, and relatively quickly. Tacking on additional output organically would probably take too long, especially with so much market share up for grabs in the early going. Rather, Cronos Group may want to go shopping for added production capacity. Either way, it needs more output if it wants to be considered a major player.

2. Push into overseas markets

Cronos Group has also done a reasonably poor job of moving into international markets. Aside from nascent grow operations in Australia and Israel, and distribution partnerships in Poland and Germany, Cronos has very little overseas presence.

The concern is that without ample international sales channels, Cronos Group could fall victim to the oversupply and commoditization of dried cannabis flower by as soon as 2021. In select U.S. states that've legalized recreational weed, oversupply and commoditization of cannabis flower have led to a precipitous decline in per-gram pot prices. Domestic producers that don't have diverse overseas sales channels may have to reduce the price of their product and crush their margins in order to move it. This is Cronos Group's likely fate if it doesn't seriously land distribution or production agreements in international markets.

A handful of dried cannabis buds next to an index card that says yes that's lying atop dozens of miniature Canadian flags.

Image source: Getty Images.

3. Secure additional domestic supply deals

Thirdly, Cronos Group's ability to land domestic supply deals hasn't been anything to write home about. Things looked promising when the company announced supply agreements with Ontario and British Columbia on August 21, 2018, but Cronos has struggled to move its product into additional Canadian provinces and territories. 

Comparatively, a handful of Cronos Group's peers have supply deals in each and every one of Canada's provinces and territories. Perhaps no company has done a better job of landing domestic deals than Canopy Growth, the largest pot stock in the world. As of its most recent quarter, Canopy had secured more than 70,000 kilos in annual domestic supply deals, which is more than half of Cronos Group's peak production capacity, for those of you keeping score at home.

This is a company that has a lot work to do if it's going to keep up with its similarly sized peers.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.