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Vape pens key to Cronos Group's success, but the pot producer is 'testing investor patience'

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A warning from Cronos Group Inc. (CRON.TO) that adjusted earnings are set to decline in 2019 sent shares tumbling on Thursday as the Toronto-based company reported first-quarter results. The comment has analysts tweaking their outlooks while holding their breath for a cannabis vape pen breakthrough.

Chief financial officer Jerry Barbato said he expects EBITDA will decline in the coming quarters as Cronos makes investments in brands and research that will position the company for “accelerated growth in 2020.”

Shares sank eight per cent on the Toronto Stock Exchange, and 8.9 per cent on the NASDAQ, at Thursday’s close.

Cronos’ TSX-listed shares climbed 1.99 per cent to $19.43 at 11:56 a.m. ET. NASDAQ-listed shares added 3.26 per cent to $14.55.

Cronos' Toronto-listed shares as of 11:58am ET on Friday, May 10 (Yahoo Finance Canada)

The pot producer is in the midst of ramping up its growing facilities to boost supply while working to resolve processing and packaging bottlenecks. Chief executive Mike Gorenstein told analysts on Thursday’s call that he expects these issues to be resolved over the next few quarters.

GMP Securities analyst Martin Landry maintained his “hold” rating on Cronos while lowering his price target to $21 from $23. He cut his second-quarter revenue forecast to $6.7 million from $9.4 million, and lowered his expectations for sales volume to 10 tonnes in 2019 from 13 previously.

“Cronos is testing investor patience,” he wrote in a note to clients on Friday.

BMO Capital Markets analyst Tammy Chen pared back her 2019 and 2020 estimates based on Thursday’s results. She dropped her price target to $17 from $19. Chen has an “underperform” rating on Cronos shares.

The company reported first-quarter revenue of $6.5 million. Analysts surveyed by Zacks Investment Research expected first-quarter revenue of $4.9 million. The company reported net income of $427,812, or 48 cents per share, in the first quarter after reporting a loss of $1,085, or one cent, a year ago. Analysts expected a loss of two cents per share.

Landry and Chen hope to see the company leverage its relationship with Marlboro cigarette-maker Altria Group Inc. (MO) to secure a strong position in vapable cannabis.

Cronos recently established Cronos Device Labs in Israel, with a focus on developing vape products for cannabis applications. Select assets were purchased from a subsidiary of Altria. The 23-member team is comprised of product designers, engineers and formulation scientists with extensive experience in vaporizer technology.

“We know that the vaporizer space is one of the fastest growing and evolving categories with many consumers migrating to this convenient, non-combustible consumption method,” Gorenstein said on Thursday’s call. “The category is very important to us, and making sure we're able to launch with significant inventory is something that we are continuing to prioritize.”

Altria acquired a 35 per cent stake in Juul late last year to counter declining U.S. tobacco sales. The company’s line of electronic cigarettes saw a 154 per cent increase in sales between 2017 and 2018, according to Nielsen data.

“We expect there have been significant R&D conducted by Altria on vape technologies that could be transferable to cannabis,” Chen wrote in a research note on Thursday.

“We believe the partnership with Altria provides Cronos with capital for intellectual property and product development, and Cronos should benefit from Altria’s global distribution and branding strategies.”

Canada is set to legalize cannabis vape, drink and edible products in the fall. Landry expects the vape pen category will be Cronos’ main focus as it brings extract-based products to market.

“Cronos, with Altria’s expertise, could be a leader in the vape pen category at the onset of cannabis 2.0 products,” he wrote.

Yahoo Finance Canada Morning Brief