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Morningstar | Initiating on Fast-Growing Cannabis Industry: We See Cronos as Overvalued. See Updated Analyst Note from 27 Jun 2019

We are initiating coverage of cannabis, an industry we forecast to grow by 9 times through 2030 amid widening legalization and increased participation for the Canadian, international, and U.S. markets.

For Canada, despite recent recreational legalization, cannabis has penetrated just 12% of our estimated market, setting the stage for 20% CAGR through 2030.

For the international market, we forecast market potential of nearly $43 billion and 23% CAGR through 2030 as more and more countries recognize the benefits of medical cannabis. However, increasing competition from other countries could limit the opportunity for Canadian producers to $20 billion.

For the U.S., recreational and medicinal cannabis has penetrated just 8% and 21% of their estimated markets, leading to 25% CAGR and 15% CAGR through 2030, respectively. We expect six more states to legalize recreational cannabis and three states to expand commercial distribution. Furthermore, we expect the federal government will recognize states’ right to decide legality.

We are initiating coverage of Cronos Group, which cultivates and sells cannabis predominantly in Canada and to a lesser extent, global markets. Our fair value estimates are $11 per share and CAD 14.50 per share, respectively. Our model uses a 10-year explicit forecast that assumes roughly 31% volume CAGR, 3% price CAGR, and a 2028 operating margin before plant adjustments of 35%. We assign Cronos a no-moat rating and stable moat trend, as it will struggle to earn economic profit as it spends on growth in the early-stage industry.

At today’s price, we see shares as overvalued. Cronos is expanding its capacity with plans to cultivate in Israel, Colombia, and Australia through joint ventures. Cronos also has limited U.S. exposure through a R&D partnership with Ginkgo Bioworks to produce cultured cannabinoids. In addition, Altria Group’s investment provides Cronos with an experienced partner to navigate strict regulatory environments.

For more details on the cannabis industry and our market forecasts, please see our observer, “Green Rush: Cannabis Market Will Grow by 9 Times by 2030 Amid Widening Legalization.”