Cannabis Industry: The Potential is Big

Cannabis is not just hype. It has the potential to be big, big enough to be a multi-hundred-billion-dollar industry. With time, even more of already existing beverages, alcohol, and pharmaceutical companies will tap into it to create differentiated and defensible consumer and medical brands. However, it is essential to identify winning cannabis companies from losing ones.

Cannabis Growth
Photo by Matthew Brodeur on Unsplash

Cronos Group: Growth Driven By Strategic Deals

In December 2018, Cronos secured a C$2.4 billion investment from Altria. The deal gave Altria 45% ownership in Cronos with the potential to increase it to 55% if Altria chooses to exercise additional warrants. The investment which came at a time Cronos was low on cash furnished the company with enough for expansion to stave off aggressive competition.

Furthermore, perhaps, the most strategic deal for Cronos is the supply JV with Ginkgo Bioworks. As part of the conditions of the agreement, Ginkgo Bioworks will provide high-quality cannabinoid extracts. Moreover, Cronos will have exclusive, royalty-free access to the critical technology for the production and commercialization of the target cannabinoids.

Cronos has a wholesale and retail presence in both global medical brands and Canadian recreational brands. The company has significant operations in Australia, Latin America, and Europe — from Germany to Poland and Israel — and a strong potential for increased production capacity.

Cronos: Revenue Projected To Increase But Enterprise Value/Sales Expected To Fall

Revenue is expected to increase from roughly C$20 million for FY2018 to approximately C$150 million for 2019, representing more than a 600% rise. The EPS is also projected to rise from the C$0.06 for 2018 to at least C$0.14 for 2019.

However, despite a potential increase in volume of products sold, the EPS and Adjusted Operational Profit, analysts believe, will decline in the medium term. Moreover, in the long term, the market capitalization and the share price are expected to be reasonably constant as the company faces the prospect of stalled growth and growing debt.

Cronos is maintained at an average neutral rating. Its high EV/Sales ratio (suggesting it is overvalued) of 248.4× for 2018 is expected to witness a downturn by FY2019 while its net cash (debt)  is forecasted to be on the rise. Also, apart from general industry risks such as legalization or restriction risk, Cronos’ specific risks include the possibility of a market developing soon enough for other cannabinoids.

Tilray, Inc. (NASDAQ: TLRY): Incremental Risks Could Impede Long Term Growth

Tilray, being controlled by Privateer Holdings which owns all of its Class 1 voting shares and about 76% of the class 2 shares, is highly vulnerable to dilution. Also, from 2023, Tilray may have to be paying more in renewals on its brand value it would have built with some intellectual property licensed to it by Privateer. This situation will negatively impact its costs.

Tilray’s strategy is similar to others in the industry. Being aggressive in making deals also, it has acquired Manitoba Harvest, the largest hemp food industry, and has also established a partnership with Ab In Bev, a global beer leader. The Ab In Bev deal into which Tilray invested close to US $50 million is vague and not direct thereby making it a big risk.

By virtue of its strategic acquisitions and partnerships, Tilray now has extensive operations in Europe, Latin America, New Zealand, the U.S., and Africa. It has an increasing list of products marketed under global medical, global hemp/hemp-CBD, and Canadian recreational brands. Also, the company has been making efforts to increase its extraction capacity.

Tilray: High Risks But The Rewards Could Be Big

Analysts currently rate Tilray as underweight. Its 5-year price target is $48, implying an expected 39% fall from its current price.  With a forecasted fall in the Adjusted Operational Profit, EBITDA, and EPS, this may not be a surprise. Therefore, the stock has a significant downside potential.

The projected increase in the volume of products sold for the next five business years may do little to influence the net cash (debt) which has been forecasted to continue in the red. The EV/Sales is expected to be on a long-term steady decline amidst an increasing revenue during the same period, however. But for now, it is better to either stay away or reduce its holding.