Cronos Stock Shrugs Off Negative Analyst Report

April may bring spring showers, but it still feels like winter for marijuana stock investors. This month has rained almost entirely bad news down on the cannabis sector, and investors haven’t spared Cronos Group (NASDAQ:CRON) from the selling deluge.

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Aphria’s (NASDAQ:APHA) dour earnings report further damaged the mood, casting a wide shadow over other industry players. Companies like Tilray (NASDAQ:TLRY) and Canopy Growth (NYSE:CGC) saw their share prices wilt as people began to adjust their outlook for this earnings season downward. And there was the latest short seller target as well, with Village Farms (NASDAQ:VFF) losing as much as 15% of its value following a negative report from Citron.

On Wednesday, all signs pointed to even more trouble for CRON stock in particular. That’s because BofA/Merrill Lynch launched coverage of several leading marijuana stocks. It gave favorable coverage to two, while slapping CRON stock with an underperform rating. Normally, you’d expect CRON stock to slump on the news. Instead, shares dipped a bit and then rallied, actually closing the day in the green. It could be a positive sign for the company going forward that it could rebound following bad news.

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Worried About Valuation for CRON Stock

BofA’s report was hardly all that negative on Cronos as a company. They like its prospects, but the share price is a hang-up. They wrote: “We initiate coverage of Cronos, a Canada based cannabis company, with an Underperform rating and […] $13 price objective”.

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They arrived at this price target in large part on an enterprise value to sales metric. They plugged in their 2020 estimate for sales and slapped a 23x multiple on said figure, which worked out to a $13 price target.

As I said, BofA isn’t down on the company. Their analysts added that, “Cronos is a compelling fundamental value in our view, but we are unable to get comfortable with the valuation.” That’s fair. The marijuana stocks are all highly valued and require some faith in the overall cannabis story to get behind.

On the other hand, it’s not like BofA views the whole sector as overvalued. At the same time that it panned Cronos on valuation, it gave a buy rating to Aurora Cannabis (NYSE:ACB) suggesting that it will be one of the “few truly global” companies in pot. Interestingly, even using just a 17x EV/sales multiple, they got to an $11 price target for ACB stock. BofA was even more optimistic for Canopy Growth, suggesting it is worth 24x EV/sales, which gets to a price objective of $52. So, for as fundamentally bullish as BofA may be on Cronos, they like some of its competition a whole lot more.

Need A Better Earnings Report

CRON stock owners come into this earnings season with an extra dose of trepidation. That’s because, arguably, Cronos delivered the single worst earnings report of all the marijuana majors during the last quarterly earnings report cycle. Given that APHA stock is now down 25% in recent days following its clunker of an earnings release, the market is saying companies need to shape up or their share prices will get leveled.

Turning back to Cronos, its last report showed some flaws in the business model. Remember that Citron Research had previously blasted Cronos for having tiny distribution deals compared to rivals. Cronos’ last earnings showed minimal recreational marijuana revenues. While overall revenues grew sharply, it appears that Cronos is still reliant on medicinal for the time being. Anyone who was thinking Cronos would see business results soar on Canada’s legalization has been disappointed — at least for the time being.

Cronos also appears to be suffering from the same margin compression that has hit its rivals. Over the past three quarters, its gross margin has fallen from 63% to 55% and now just 45% during the most recent one. As the flood of marijuana supply comes online, they will have to demonstrate that they can keep their profit margins up. Otherwise, it could be rough days ahead for CRON stock.