Rapid Reaction: Cronos guides larger EBITDA losses to grow US CBD market

Guidance for larger EBITDA losses – and it makes sense

Cronos Group on Thursday reported strong Q2 results through the end of June with revenue of CA$10.8 million, well ahead of consensus estimates of CA$7.3 million, and inline gross margin of 53.5%.

The Toronto company’s adjusted EBITDA loss of CA$17.8 million was larger than the expected CA$9.9 million.

During the call, Chief Financial Officer Jerry Barbato provided qualitative guidance that the “adjusted EBITDA loss will increase in the second half compared to the first half.”

Given that Cronos’ first-half 2019 adjusted EBITDA loss was CA$26.7 million, this implies at least a CA$26.7 million adjusted EBITDA loss in the second half of 2019.

Consensus expectations were for Cronos’ adjusted EBITDA loss to be only CA$17.6 million and remain flat with the prior first-half 2019 expectations.

Why Cronos guided down adjusted EBITDA by CA$24 million

It’s typically a negative for a company to guide to larger EBITDA losses.

And, indeed, Cronos shares closed down 4% on the Toronto Stock Exchange on Thursday.

However, factoring in the CA$2.3 billion investment by Altria Group in December, it should be expected that Cronos would invest that capital to expand its business. Specifically, Cronos is planning to target the American CBD, Canadian vapor and biosynthesis markets.

The larger-than-expected EBITDA losses are a sensible discretionary investment to grow new markets for a company with a big infusion of capital trying to capture a huge opportunity.

The increased EBITDA losses for the second half of 2019 are driven by investment in sales and marketing, research and development, as well as hiring more staff.

It would be worrisome if Cronos’ surprise losses were the result of gross margin compression due to price or cost pressure (which management controls less and usually results in lower valuation multiples), but this is active investment in an opportunity.

Cronos’ investment plans for US CBD

Last week, Cronos announced it will spend $225 million (CA$297 million) in cash and another $75 million in stock to acquire Redwood Holdings, providing Cronos with a platform to build out a CBD business in the U.S.

On Thursday’s Q2 call, CEO Michael Gorenstein confirmed Cronos’ plans, saying that “it’s fair to estimate that the U.S. CBD market will likely be the largest contributor over the next year or two.”

Another growth initiative for the company is the commercial launch in Canada of a vaporizing device and product contingent upon approval by Health Canada. Cronos expects to get the OK in late December or early January.

Cronos is also investing in researching biosynthesis via its joint venture with Gingko Bioworks.

Perhaps sell-side analysts did not include the additional investment for CBD or Redwood in their estimates, but when a massive strategic partner hands you $2 billion and tells you to go get the U.S. CBD market, you don’t worry about an extra CA$20 million in the next few months.

Investors should focus on the opportunity for Cronos in the American CBD market, not the lack of profit thereof in the six months.