Why Merrill Lynch Has High Hopes for Cronos

Cronos Group Inc. (NASDAQ: CRON) shares popped on Wednesday after Merrill Lynch released a very positive report. This is not something that happens every day, but the brokerage firm issued a double upgrade with very significant upside.

Merrill upgraded Cronos to a Buy rating from Underperform and raised the price objective to $27 from $13, implying an upside of 87.2% from the most recent closing price of $14.42.

The firm estimates the U.S. cannabinoid (CBD) market at roughly $2 billion currently, potentially growing to $11.5 billion in 2032. Although this may prove conservative, assuming 1% prevalence despite recent studies cited in CBD hearings on May 31 (FDA on CBD) suggesting about one-fourth of U.S. consumers have tried CBD.

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Merrill detailed in its report:

While clearly a high multiple even vs peers, following recent mgmt comments, we have improved confidence Cronos is near announcing its launch, in our view a significant catalyst: (1) improving near-term visibility in the largest market for cannabisderived compounds in the world, (2) Cronos beginning to flex its near group-leading balance sheet (C$2.4 billion cash) and partnerships (Altria, MO) to begin a transformation we see creating a vastly different co. in the years ahead. As this process accelerates, the near-term bear thesis, one to which we ascribed (initiation), becomes increasingly untenable, especially with Cronos value fractions peers despite more cash and similar market opportunity.

The firm was sure to note that it does not see Cronos entering the United States by acquiring a cannabis retailer (like CGC-Acreage), but rather see it leveraging Altria Group Inc.’s (NYSE: MO | MO Price Prediction) distribution (a presence in 230,000 stores) to launch its own products.

The potential to scale distribution nationally via Altria separates Cronos from its peers, especially those unable to access frequented channels.

While nonintoxicating beverages (think post-workout drinks) seem a natural fit at corner stores, Altria’s main channel, with FDA stating CBD in food additives is still prohibited for interstate commerce. Merrill thinks Cronos will focus on creams, tinctures and vapes/sprays for the United States.

Merrill gave its investment rationale as follows:

We see Cronos as one of the more compelling fundamental stories in cannabis, reflecting the second strongest balance sheet in the sector (post Altria investment) and a forward-thinking strategy (cannabinoid development platform). While the stock is expensive on near-term valuation vs peers, we think use of balance sheet will transform the organization, bringing valuation closer to peers over time.

Shares of Cronos traded up about 9% Wednesday to $15.70, in a 52-week range of $5.61 to $25.10.

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