The only 5 things in Cronos Group’s Q3 earnings update that really matter

This article was originally published on Fool.com

Even with all of the excitement leading up to the launch of Canada’s recreational marijuana market, Cronos Group (NASDAQ:CRON) still had its day-to-day business to run. The cannabis producer enjoyed a strong second quarter, with revenue skyrocketing and earnings soaring. But when Cronos reported its third-quarter results on Tuesday, there were a few chinks in the armor.

The company continued to experience solid sales momentum in Q3, with revenue jumping 186% year over year and nearly 11% higher than the second quarter. However, Cronos Group posted a net loss of 7.27 million Canadian dollars (about $5.5 million), compared to positive earnings in the prior-year period and in the previous quarter.

These numbers weren’t the important takeaways from Cronos Group’s Q3 earnings report, though. Here are the five things in the company’s quarterly update that really matter.

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1. The loss should be temporary

If Cronos Group’s big loss in the third quarter was a sign of things to come, investors would have a good reason to be concerned. But the loss should only be temporary.

Total operating expenses increased by a whopping 242% year over year. And the spending increases occurred in every area of the business. However, this higher spending was to be expected as Cronos ramped up for the opening of the recreational marijuana market in Canada. You can think of the spending increases — and the associated net loss — as an investment that should generate a solid return in the not-too-distant future.

2. Higher capacity is coming

One major reason for the increased spending was Cronos Group’s production capacity expansion. Perhaps the best news for the company in the third quarter was the completion of Building 4 at its Peace Naturals facility in Stayner, Ontario. This building adds another 286,000 square feet of indoor growing space. The first harvest is expected by the end of 2018.

Once Building 4 is operating at its peak, Cronos Group should be able to produce around 40,000 kilograms (just over 88,000 pounds) of cannabis per year. The company’s other expansion initiatives are projected to boost annual production capacity to over 117,000 kilograms within the next couple of years.

3. Cronos should be able to sell all it produces

Here’s the really important thing to know about Cronos Group’s added capacity: The company should be able to sell its entire production for a while. Cronos secured supply agreements for the recreational marijuana market with Ontario, British Columbia, Nova Scotia, and Prince Edward Island. These provinces have over half of Canada’s total population.

Cronos Group also entered into a supply agreement earlier this year with Cura Cannabis Solutions. This deal requires Cura to purchase a minimum of 20,000 kilograms of cannabis each year over a five-year period.

4. Partnerships could pay off in a big way

It’s quite possible that the partnerships Cronos Group formed during the third quarter will mean a lot more to the company over the long run than its Q3 financial results. One of those partnerships focused on adding production capacity — a joint venture with a group of investors led by greenhouse operator Bert Mucci. However, the other two deals could also be key for Cronos Group’s future success.

In September, Cronos announced a partnership with Ginkgo Bioworks to produce cultured high-purity cannabinoids from engineered strains of yeast. If successful, this effort would enable Cronos to produce cannabinoids at a dramatically lower price than current methods allow. In August, Cronos teamed up with Colombian agricultural company Agroidea SAS in a deal that opens more doors in the Latin American cannabis market.

5. More dilution is likely on the way

So far, everything that really matters with Cronos Group’s Q3 update has been positive. There is one glaring potential negative development that could be on the way, though. Cronos Group reported cash of CA$43.8 million. This total, combined with the company’s CA$28.7 million construction loan, should fund operations at least through the next 12 months. But it seems likely that Cronos will need to raise more cash at least by sometime in 2020.

Based on the company’s history, this additional capital will probably come from issuing new shares. Although Cronos Group shouldn’t have a problem generating all the money it needs, doing so comes at a price for shareholders: The value of all existing shares will be diluted.

The big picture

The common thread throughout all five of these key items from Cronos Group’s Q3 update is that there’s a bigger picture for the company than just one quarter. What really matters for Cronos — and investors — is how the company grows over the long term.

Cronos Group’s long-term prospects hinge on its capacity, its distribution channels (both in Canada and in international markets), and its innovation. The company’s advances on these fronts during the third quarter will matter a lot more a few years from now than its Q3 revenue increase and net loss.

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Keith Speights has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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