Cronos or Altria: Which is the Better Buy?

It’s been almost two months since Altria (NYSE:MO) closed its deal to buy 45% of Cronos Group (NASDAQ:CRON) for C$2.4 billion. And the cigarette maker’s latest earnings disappointment would suggest Cronos Group stock is the better buy of the two if you’re looking to make a play on marijuana stocks.

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However, before you jump on your discount broker’s website to buy some CRON stock, you might want to consider the argument for considering MO instead.

Earnings in Transition

In my opinion, free cash flow is the metric that rules most, if not all, investment decisions. That’s because if you’re a company with minimal debt and growing free cash flow, it’s pretty hard to get into too much trouble in an economic downturn.

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And while an economic downturn doesn’t appear to be imminent here in the U.S., economies have a way of turning sour in a hurry. Donald Trump’s economic policies are all the rage right now with (a whopping 56% of ) Americans, but when the benefits of his tax cuts wear off and the country’s debt problem worsens, you better own companies whose financials are rock solid.

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Altria reported Q1 2019 results April 25. On the top line, revenues net of excise taxes fell 6.0% year over year to $4.4 billion. On the bottom line, adjusted earnings per share decreased 5.3% to $0.90.

As if that wasn’t bad enough, Altria missed the analyst estimate for earnings by two cents and revenues by $200 million.

Ouch.

Free Cash Flow Set to Grow

However, the company is in the early stages of a cost reduction program that should generate significant savings over the next year. In addition, investments such as Cronos and Juul should change the company’s growth trajectory in the years to come. A short-term decline in earnings isn’t a big deal.

From a free cash flow perspective, despite the downturn in earnings, Altria still managed to generate $2.25 billion in the first quarter. On a trailing 12-month basis, it’s free cash flow is $7.6 billion providing CEO Howard Willard with plenty of cash to pay down the $16.3 billion in 4.1% unsecured debt it issued in February to pay for Juul and Cronos along with general corporate purposes.

As long as it can commit to paying down a billion a year over the next five years, the increased cash flow from Juul along with gains from its Cronos investment should bring the total debt down to close to two times EBITDA from 2.8 after the first quarter.

Willard put it best in the company’s Q1 2019 press release

“After taking steps to position Altria for long-term success at the end of 2018, we entered 2019 with an evolved business platform that includes our strong core tobacco businesses and new strategic investments with tremendous potential for growth,” Willard stated.

With 2019 adjusted earnings expected to grow by 4%-7%, there’s an excellent possibility that free cash flow could surprise in 2019.

Cronos Stake Worth Less

Since Altria closed its deal in early March, Cronos Group stock has fallen in value by 23%. That’s prompted InvestorPlace contributor Luce Emerson to suggest Altria overpaid.

“With CGC and TLRY already off the market, Altria jumped for CRON,” Emerson wrote April 11. “There are certainly synergies across Altria’s core business with cannabis than with beer. Still, it is hard to justify paying a price to sales multiple of 267x (compare that to CGC’s 86x).

She goes on to suggest that if you compare Canopy Growth’s (NYSE:CGC) market cap to kilograms sold with Cronos Group’s, you’ll see that Altria paid approximately $1.8 million per kilogram of cannabis sold or three times as much as investors pay for Canopy Growth.

I’m as big a fan of unconventional metrics as anyone. However, in this case, I don’t think we’re talking about an apples-to-apples comparison.

The fact is, we’re not talking about mature companies here, such as Altria or Philip Morris International (NYSE:PM), where the price-to-sales comparison is a perfectly logical metric. Comparing P/S ratios at this point in the game when it comes to cannabis makes less sense than it did during the dot.com boom.