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Is Cronos Group a Buy on the Dip?

Cory Renauer, The Motley Fool

Cronos Group (NASDAQ: CRON) just can't seem to catch a break. Shares of the Canadian cannabis producer have tumbled about 33% since Altria Group (NYSE: MO) gave the company CA$2.4 billion just a couple of months ago.

Cronos Group's first-quarter performance was disappointing, but the period ended before Altria had a chance to make a difference. 

Did Altria make a huge mistake, or is Cronos stock a buy on the dip? Here's what you need to know about the path ahead of the tobacco giant's enormous investment. 

Cannabis and a stack of hundred dollar bills.

Image source: Getty Images.

Reasons to buy

Cronos Group gained a new chief financial officer in April, along with four new board members courtesy of Altria. Cronos Group's former CFO will remain as the company's first chief commercial officer. 

Cannabis investors across the board need to worry about corporate governance issues, but Cronos shareholders can probably expect fewer financial shenanigans than we've seen from its peers. Cronos' five-member board of directors is now a seven-member board, four of which Altria chose.

The market for legal cannabis in Canada and around the globe has a lot more room to grow. According to Statistics Canada, household spending on cannabis hit an annualized CA$5.9 billion during the fourth quarter of 2018, but just 21% of those sales went to licensed producers. Drawing a larger share of the overall market away from illicit mail order services and unlicensed dispensaries could send sales soaring.

At the moment, licensed retail outlets in Canada can only sell dry marijuana flower and concentrated oil extracted from those flowers to make tinctures and capsules that aren't nearly as easy to sell as oil-filled vaporizer cartridges. Later this year, Health Canada will allow the sale of edibles, which are popular, and beverages, which might become popular.

Extracts for vape pens have already become a symbol of middle-class cannabis use. Despite their popularity, vape cartridges containing THC, the psychoactive component of cannabis, still aren't available through legal means. With more of the products consumers want, Cronos and its peers have a chance to pull lots of customers away from a thriving illicit market.

Vaporizer cartridge filled with cannabis oil.

Image source: Getty Images.

Reasons to be nervous

Alcohol's pretty easy to regulate, because making your own costs a lot more than the stuff you can get at the store, even after taxes. Investors who dive into cannabis investing need to remember that this isn't the case with marijuana. Several hundred dollars of equipment and experience are all it takes to grow more top-quality cannabis than one person can consume, and competing with their surplus sales isn't going to be easy.

Canada charges producers a 10% excise tax on all cannabis sales, plus provinces add to the burden. That's a big reason legal cannabis in Canada costs 49% more per gram than illegal cannabis.

The eventual availability of edibles and vape pens probably won't lead to the sales growth investors are hoping for. Health Canada insists on THC concentrations far too low to have any effect on the 6% of Canadians who use cannabis daily.

Reasons to run

You'll have a hard time finding experienced consumers who think licensed cannabis products are worth any extra expense. Despite charging consumers prohibitively high prices for products of mediocre quality, Cronos Group is further away from profit town than ever before.

First-quarter revenue rose 120% year over year to CA$6.5 million, but sales, general, and administrative expenses grew 316% to CA$12.7 million. If sales don't rocket higher, this company will have to shutter buildings and send employees packing just to break even.

Unfortunately, it doesn't look like licensed cannabis sales are going to improve fast enough to avoid further losses. During the first three months of 2019, Cronos Group sold 1,111 kilograms of cannabis, which was just 7% more than in the previous quarter.

According to Statistics Canada, 18% of Canadians reported cannabis use during the first quarter of 2019, compared with 14% a year earlier, but the newbies are all casual users. Daily users who are responsible for a majority of overall sales remained steady at 6% of the population, and this figure isn't likely to change. 

A cannabis bud sits atop a small pile of U.S. currency.

Image source: Getty Images.

Not worth the risk

Building and staffing greenhouses in Israel, Australia, and Colombia could get a lot more expensive without any assurance that Cronos will be able to sell marijuana at a profit in those markets. After reviewing the company's performance in its domestic market, that doesn't seem likely. 

Thanks to Altria, Cronos Group finished March with CA$2.4 billion in cash on its balance sheet. That gives the company time to improve, but it isn't worth the risk.

Despite sliding recently, Cronos Group's enterprise value is still a whopping $4.6 billion in U.S. dollars. There's a chance Altria's presence will help rein in expenses, but this is still an insane valuation for a company with eight-figure annual sales and no clear path to profitability. This stock needs to dip much further before it reaches bargain territory.

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Cory Renauer 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.