Cabot Cannabis Investor Issue: April 24, 2024

Cannabis stocks have fallen sharply since the beginning of April. The AdvisorShares Pure U.S. Cannabis (MSOS) is down 15.4% since April 1. There are two reasons.

First, investor enthusiasm for stocks overall has waned, creating significant declines across indices. Because cannabis is perceived as a riskier sector, cannabis stocks decline more than most stocks when investors move into risk-off mode.

Second, many analysts and investors had hoped for visible progress on key catalysts by now – chiefly rescheduling and cannabis banking reform. They have been disappointed.

Those two catalysts are not off the table, however. This suggests cannabis stocks are a buy in the current bout of sector weakness.

Here’s some brief background on these two potential catalysts.

1. The U.S. Department of Health and Human Services (HHS) has recommended that the Drug Enforcement Administration (DEA) and the Department of Justic (DOJ) move marijuana to Schedule III from Schedule I of the Controlled Substances Act (CSA). We are now waiting for a proposed rule from the DEA, which will be a major catalyst for the group. This could land soon.

2. The Senate may soon rekindle efforts to approve cannabis banking law reform, known as the SAFER Banking Act. The change would allow banks to serve cannabis companies, which currently have to deal with the burden and safety issues of operating in cash only. As I outline below, lawmakers on both sides of the aisle have recently suggested we may see progress soon.

While federal bureaucrats and lawmakers toy with these reforms, at the local level consumers continue to vote with their wallets. States keep hitting record-high sales results. And polls continue to affirm that a majority of Americans want meaningful cannabis reform. Theoretically, politicians should respond and show progress on the two reforms I mentioned above.

The bottom line: Cannabis stocks are quite weak this month, but two potential catalysts remain on the near-term horizon. The proposed rule from the DEA would be the biggest one. This suggests cannabis stocks are a buy in the current weakness.

What to Do Now

Given the potential near-term catalysts, I suggest considering any of our portfolio names below, or the MSOS and AdvisorShares MSOS 2X Daily (MSOX) ETFs if you want to keep it simple.

Portfolio names are: Ayr Wellness (AYRWF), Cresco Labs (CRLBF), Curaleaf (CURLF), Cronos (CRON), AdvisorShares Pure U.S. Cannabis (MSOS), AdvisorShares MSOS 2X Daily (MSOX), ETFMG Alternative Harvest (MJ), Green Thumb (GTBIF), Organigram (OGI), Tilray Brands (TLRY), Trulieve (TCNNF) and Verano (VRNOF). For simplicity, consider getting exposure via MSOS or the leveraged version, MSOX.

In a volatile sector like this, I prefer to add on weakness rather than strength. When or if we do get major rescheduling news from the DEA (proposed rule publication), that will create a rally in which to trim positions and de-lever a bit. De-lever in this instance means trimming MSOX and putting the funds into cash or the MSOS.

One of the reasons we outperform so much is that on several occasions I have taken advantage of sector weakness to lever up the portfolio (shift from MSOS and some stocks to MSOX). Likewise, there will come a time to de-lever. I will let you know.

Cannabis News from Around the World

Part of my core thesis for being bullish on cannabis stocks is that there continues to be tremendous cultural momentum toward cannabis reform around the world. I’m convinced cannabis stocks will not remain ignored forever.

We see evidence of this powerful cultural momentum in the changes in laws to legalize cannabis, big tobacco investments in the space, robust cannabis sales growth in states that legalize, increased cultural acceptance in the form of relaxed drug testing standards in sports leagues and the workplace, and poll results that show a growing majority of people support legalization regardless of age and party affiliation.

These trends tell us cannabis stocks are a strong contrarian buy that will turn very profitable for patient investors with a medium-term horizon. The sector is so volatile it is easy to get shaken out of names by heightened emotional reaction to drawdowns. So, it is important to catalogue evidence of this cultural momentum. That is the purpose of this section of Cabot Cannabis Investor.

* We could see progress soon on two cannabis sector catalysts. A key cannabis reform proponent in the House of Representatives recently predicted this year’s “4/20” day will be the last one with marijuana designated as a Schedule I drug under federal law. “This is the year that I think we can break the federal logjam,” said Rep. Earl Blumenauer (D-OR) who is co-chair of the Congressional Cannabis Caucus.

The U.S. Department of Health and Human Services (HHS) has recommended that the Drug Enforcement Administration (DEA) move marijuana to Schedule III from Schedule I of the Controlled Substances Act (CSA). We are now waiting for a proposed rule from the DEA, which will be a major catalyst for the group.

Blumenauer was also positive on the potential for progress on cannabis banking reform. He predicted the Republican-controlled House would take up the Secure and Fair Enforcement Regulation (SAFER) Banking Act if the Senate gives it a thumbs up. Senate Majority Leader Chuck Schumer (D-NY) recently reiterated that SAFER Banking Act remains a priority. Some political analysts speculate bank reform proponents may try to put cannabis banking reform in a Federal Aviation Administration (FAA) funding bill. Current FAA funding is set to expire on May 10th.

“Every day we’re closer on SAFE Banking,” said Blumenauer. “Negotiations are ongoing in the House and Senate, and we are, in fact, making progress. I’m quite confident that if we’re able to break this loose in the Senate, which looks increasingly likely, it won’t be a problem in terms of ultimate consideration in the House,” he said. Rep. Nancy Mace (R-SC) recently said Republicans in the House should approve the bill if they want to remain in control of the chamber. Mace has long urged Republicans to use cannabis as a wedge issue to attract voters from the left. She says she has used cannabis in the past to help manage stress from trauma earlier in her life.

* A flurry of new polls find that most people support cannabis legalization and rescheduling, and a substantial portion of Americans are regular users. Here is a roundup.

A Data for Progress poll recently found that the majority of voters, including Republicans, support cannabis legalization. The survey found that 75% of Democrats, 54% of Republicans and 67% of Independents favor legalization. The Data for Progress poll confirms the results of a recent Pew Research Center poll which found 90% of people in the U.S. think cannabis should be legal for recreational or medical purposes.

The new Data for Progress poll also found that 59% of voters support rescheduling cannabis under the Controlled Substances Act. It says 60% of Democrats support the change, as do 52% of Republicans.

The context here is that the Department of Health and Human Services has recommended to the Department of Justice (DOJ) that cannabis be moved down to Schedule III from Schedule I. We now await publication of a proposed rule from the Drug Enforcement Agency (DEA), which is part of the DOJ. If the DEA goes along and publishes the rule, which is expected soon, it will provide a major catalyst to cannabis stocks. Rescheduling would exempt our cannabis companies from Internal Revenue Service rule 280E which bars the deduction of operating expenses against sales of Schedule I drugs. This change would boost cash flow at our companies tremendously.

* About 40% of Americans use cannabis, according to a new Harris Poll. About 25% of people use it at least once a week. And 64% of Americans say cannabis no longer has the negative stigma it used to have. “With 4 in 10 Americans using marijuana, it’s not a trend it’s a cultural shift,” said Harris Poll’s Libby Rodney. “What was once taboo is now mainstream, reflecting changing attitudes and norms.” Nearly 60% of people in the poll said they were surprised cannabis has not yet been legalized nationwide.

* Cannabis legalization does not increase usage, according to a new survey. The poll found that cannabis use is about the same in states that have legalized and those that prohibit cannabis use. “Criminalization does little to curtail its use,” concluded Gallup, which did the survey. The poll found that one in ten people used cannabis ten or more times in the past month, and one in five had used cannabis at least once in the past month.

* About 64% of Americans think alcohol and tobacco are more dangerous than cannabis, according to a recent YouGov survey. On legalization, the poll also found that 71%of Democrats, 67% of independents and 46% of Republicans support the change.

* A dozen years into cannabis legalization, the majority of Colorado voters have no regrets. A recent Colorado Polling Institute poll found that 67% of people in Colorado think legalization has been a positive for the state. That’s up from 55% who approved the change in 2012. Coloradoans have purchased over $15 billion worth of cannabis since the reform happened. Colorado now generates more tax revenue from cannabis than alcohol or cigarettes.

* Not all the polling news is positive for cannabis investors. A new poll in Florida found that fewer than half of voters will support a referendum on the November ballot calling for recreational-use legalization. The Florida Atlantic University (FAU) and Mainstreet Research poll found that a 47% of voters back the referendum, while 35% oppose it an 18% are undecided. The referendum needs at least 60% voter support to become law. Earlier polls had found adequate support exists to clear the 60% threshold.

Major cannabis companies in the state like Trulieve (TCNNF) are funding a marketing campaign to drum up support for the reform. Florida Gov. Ron DeSantis’s (R) thinks voters will reject the cannabis referendum. He’s argued recreational-use approval would reduce the quality of life in Florida, in part by increasing the prevalence of the aroma cannabis in public places. But Trulieve CEO Kim Rivers predicts Floridians will approve the rec-use legalization referendum.

* Nevada continues to pave the way in cannabis consumption lounges. A company called Planet 13 recently opened a new cannabis lounge near the Las Vegas Strip called the Dazed Consumption Lounge at Planet 13. Thrive Dispensary opened the Smoke & Mirrors lounge in February, and one called the Sky High Lounge launched in 2019 on tribal land. Nevada legalized recreational use in 2016, but state law prohibits consumption in public and in hotel rooms, which limits options for tourists who want to follow the law.

* Massachusetts cannabis stores in March sold $154 million worth of product, including $136.8 million in recreational cannabis and another $17.2 million in medical products. That’s up from $150.5 million in March 2023, for 2.3% growth. The state launched recreational use sales in late 2018.

* Michigan cannabis sales hit a monthly record in March when retailers sold nearly $289 million worth of product.

* Missouri cannabis sales hit a new record of $125 million in March. The state launched recreational cannabis sales in February last year.

* Illinois cannabis sales hit near record levels in March at $174.8 million, up almost 10% from February.

* The legalization of recreational use of cannabis does not increase teen cannabis use, says a new study from the American Medical Association (AMA). The study polled high school students on their cannabis use. It found that recreational-use approval and the launch of retail sales were “not associated with adolescents’ likelihood or frequency of cannabis use.” Instead, legalization “was associated with modest decreases in cannabis, alcohol, and e-cigarette use.”

But the study also found that teens who already use cannabis do so more frequently after the rec-use legalization. The study was published in the AMA’s journal JAMA Pediatrics.

* New York Governor Kathy Hochul wants to crack down on illicit cannabis stores to support dispensaries conducting legal cannabis sales. The state has been a great case study in how not to roll out legal recreational-use sales. Illicit shops abound, undercutting legally licensed stores including those run by publicly traded cannabis companies. Hochul recently announced a plan to “finally put an end to the chaos” of unlicensed shops. The Office of Cannabis Management will have the authority to padlock businesses caught selling illicit cannabis. The plan also sets hefty fines for landlords who don’t start eviction proceedings against tenants violating the law by operating illicit shops.

* Cannabis activists in North Dakota have filed to put a rec-use legalization initiative on the state’s 2024 ballot. Now they have to round up at least 15,582 signatures supporting the referendum by July 8. The state has already approved medical use sales.

* The U.S. cannabis industry supports 440,445 full-time-equivalent jobs, a 5.4% increase from 2023, says Vangst, an industry jobs platform. Annual sales of legal product increased 10.3% to $28.8 billion last year, it says. California has the most cannabis sector jobs at 78,618. Michigan comes in next at 46,746 and Florida has 30,238 jobs.

Company News

This section offers a roundup of developments at portfolio companies since the last Cabot Cannabis Investor issue was published. One of the key trends to note is that our companies continue to open stores in states that recently legalized recreational use, or are about to make this change. You want to own shares of companies that are doing this.

Curaleaf (CURLF)

Curaleaf on April 22 acquired the cannabis producer Northern Green Canada, whose product is certified for sale in Europe where Curaleaf has been expanding aggressively in Germany, Poland and the United Kingdom.

“This is an incredibly important deal for our international expansion strategy,” said Curaleaf founder and executive chair Boris Jordan. “We’ll be able to bolster our supply of high-quality EU-GMP certified flower immediately to key European markets as well as enter the fast-growing markets of Australia and New Zealand.”

Curaleaf says annual global cannabis sales will hit $55 billion by 2027. Emerging markets beyond the United States and Canada, including Germany, Australia and New Zealand, will contribute $6.3 billion of the $55 billion, it says.

Trulieve Cannabis (TCNNF)

Trulieve continues its Florida expansion ahead of the possible approval of recreational use in November with the opening of a medical cannabis shop in North Palm Beach. Voters will weigh in on a referendum in November which would legalize rec-use sales, if approved. Polls show mixed results on whether more than 60% of voters will approve, the needed minimum. Trulieve would be the biggest winner, since it dominates the Florida medical cannabis market.

Sector Performance

Our main cannabis portfolio continues to outperform the New Cannabis Ventures Global Cannabis Stock Index. Our Cabot Cannabis Investor portfolio cannabis portfolio was up 23.8% this year as of the April 23 close. That was 2.6 percentage points better than the 21.2% gain for the New Cannabis Ventures Global Cannabis Stock Index. We’ve done 16.9 percentage points better than the 6.9% gains this year in the S&P 500.

We achieved this outperformance by being in the right stocks and using leverage. Our portfolio is leveraged because of the large position in AdvisorShares MSOS 2X Daily (MSOX). It is a top-five position. The leverage helps capture more upside as we see progress on rescheduling cannabis, and progress towards approval of recreational use in more large states like Pennsylvania and Florida.

Once a few of these pieces of the puzzle are firmly in place, I will roll back leverage by trimming MSOX in favor of cannabis stocks or the AdvisorShares Pure U.S. Cannabis (MSOS) ETF. If you are a highly active trader, it would make sense to deleverage into rallies in the same manner along the way and then hope for a pullback to re-lever.

Our Cabot Cannabis Plus Insider Portfolio is up 40% since I launched it on March 29 last year. That’s more than three times the 13% gain in the Russell 2000 index over the same time.

The portfolio is well positioned to outperform because investments in Chicago Atlantic Real Estate Finance (REFI) and AFC Gamma (AFCG) pay attractive yields of 12% and 16.2%. The dividends were recently confirmed even though they look suspiciously high. Portfolio prices are as of the close, April 23.

Portfolio

Canna Plus Insider Portfolio

*Includes dividends by adjusting down the entry price to incorporate dividend payouts

Company Profiles

Ayr Wellness (AYRWF) This is a vertically integrated multistate operator based in Miami. It has over 90 dispensaries. It operates in Florida, Illinois, Massachusetts, Pennsylvania, New Jersey, Nevada, Ohio, and Connecticut. Ayr has 18 grow and production sites, around a dozen national brands, and a proprietary library of over 160 cannabis strains. Like many names in our portfolio, Ayr is strategically positioned in states that look poised to approve recreational-use sales. It has over 60 stores in Florida, for example.

Ayr has built out its brand development strength with the appointment of David Goubert as president and CEO. Goubert previously served as president and chief customer officer at Neiman Marcus Group, and he was at LVMH for 20 years before that.

Ayr is currently launching brands from its national portfolio in New Jersey, including Ayr’s Lost in Translation flower, Kynd flower, Road Tripper flower, STIX pre-rolls, Entourage vapes, Secret Orchard vapes, and Wicked soft lozenges.

Ayr reports $50 million in cash and $635 million in net debt. This debt overhang is one reason why Ayr trades at 0.38 times sales. The company is founder-run, which can be a plus in investing. BUY

Cresco Labs (CRLBF) Chicago-based Cresco has the #1 market share position in Illinois, Pennsylvania and Massachusetts. The company has the top-selling branded portfolio of cannabis products in the industry. It has the top of branded flower and branded concentrates, and the third best portfolio of branded vapes.

Cresco offers exposure to many attractive U.S. markets with an emphasis on Illinois. It is also in Pennsylvania, Ohio, New York, Massachusetts, Michigan, Florida, Missouri, and Maryland. Most of those are states that recently expanded into recreational use sales, or are expected to over the next two years.

The company is founder-run, which can be a plus in investing. Cresco Labs has a price to sales ratio of 0.83. BUY

Cronos Group (CRON) Cronos is mainly a foreign operator with exposure to Canada, Germany, Australia and Israel.

Cronos has respectable brand strength in Canada. It sells gummies, infused pre-rolls and vapes under the Spinach, Blue-Raspberry Watermelon and Tropical Diesel brands. Spinach products command 15.3% market share in the Canadian edibles category, and 19.8% share in gummies, according to Hifyre.

In Israel, Cronos sells dried flower, pre-rolls and cannabis oils in the medical market. The company has a partnership with Cansativa Group which allows Cronos to sell its Peace Naturals brand in Germany, where the cannabis market should grow dramatically over the next several years because of liberalization of restrictions on sales. Cronos has a 10% stake in Cronos Australia, a publicly traded company.

Cronos has $862 million in cash, or about $2.26 per share, against minimal debt of $2.5 million. Some of that cash could be deployed in acquisitions, possibly to expand in the U.S. adult-use market.

Cronos trades at 0.82 times book value. BUY

Curaleaf (CURLF) Massachusetts-based Curaleaf was the industry leader last year. It operates 145 dispensaries and several grow sites in 17 states and its European operations. It has one of the strongest brand portfolios in the U.S. led by Select, the number one selling vape brand in its markets. Here are three factors that support growth.

1. Curaleaf is an R&D powerhouse. A team of scientists is currently developing about 180 products.

2. Like many of the names in our portfolio, Curaleaf is well positioned to benefit from the opening up of rec-use sales in New York, Ohio, Florida, Pennsylvania near term.

3. Curaleaf will benefit from progress on liberalization of cannabis laws in Germany and elsewhere in Europe. It has a majority stake in Germany’s Four 20 Pharma, a licensed producer and distributor of medical cannabis that has more than 15%-20% market share in Germany. Curaleaf International is the largest vertically integrated cannabis company in Europe. It has a lot of room to expand production, and it boasts import and distribution in the U.K., Germany, Italy, Switzerland, and Portugal. Recreational use legalization in Germany is advancing, and it could open the floodgates to further legalization throughout Europe. Curaleaf has a 50% market share in the U.K.

The company is founder-run, which can be a plus in investing. Curaleaf has a price/sales ratio of 2.59. BUY

AdvisorShares Pure U.S. Cannabis ETF (MSOS) This exchange-traded fund (ETF) has large exposure to most of our portfolio names so it may seem redundant. However, I want to put it on your radar as a liquid trading vehicle for getting in and out of the group without having to make a lot of individual stock sales, and as way to get exposure to many of our names with one purchase. It also gives us diversification beyond our names, to positions like Jushi Holdings (JUSHF) and Innovative Industrial Properties (IIPR), among others. Consider accumulating this ETF on weakness of 2% or more. BUY

AdvisorShares MSOS 2x Daily ETF (MSOX) This is the leveraged version of the ETF MSOS. It theoretically goes up (and down) by twice as much as MSOS, though the relationship does not always hold exactly. Consider accumulating on weakness of 2%-4% or more. BUY

ETFMG Alternative Harvest (MJ) This ETF has outsized foreign exposure, which means it could benefit more than other marijuana exchange traded funds if we see progress on legalization in Germany and Europe. That could happen in the form of draft legislation and decriminalization of recreational use in 2023. “Legalization in Germany could be a tipping point for global expansion,” according to cannabis experts at ETFMG. This would put additional pressure on other European Union members to move forward with legalization. It could also encourage reform of the 1961 U.N. Single Convention on Narcotics which prohibits the cultivation and sale of recreational cannabis. “Such a result would be momentous and would open the doors to a global market,” says ETFMG. Owning this ETF broadens our industry exposure to names outside our portfolio, like Canopy Growth (CGC; WEED.TO), SNDL (SNDL), and GrowGeneration (GRWG), among others. BUY

Green Thumb (GTBIF) Chicago-based Green Thumb is our portfolio’s largest position. It has been the most profitable multistate operator of all the big ones – a sign of good management.

Green Thumb branded cannabis products include &Shine, Beboe, Dogwalkers, Doctor Solomon’s, Good Green, incredibles and RYTHM. The company operates a national retail cannabis stores called RISE. Green Thumb has 91 dispensaries across fourteen states. Green Thumb continued to strategically position itself in markets that look poised to expand to recreational uses sales, like Florida and Pennsylvania.

Founder Ben Kovler is chairman and CEO. Research shows that founder-run companies often outperform. Kovler has a 26% stake in the business and holds nearly 59% of voting power. Green Thumb trades at a price to sales ratio of 2.73. BUY

Organigram (OGI) Organigram holds the #2 position among Canadian licensed producers. It also sells high-margin flower in Israel, Australia and Germany. Germany should see robust growth over the next few years as it loosens rules on medical cannabis use. The CEO has alluded to “creative ways” to get into the U.S. cannabis market, but does not offer details.

The company has the #1 market share position in hash globally driven by popular products like Tremblant, Holy Mountain and SHRED. It has the #1 market share position in gummies.

British American Tobacco (BTI) is a big investor in Organigram, an endorsement of its potential. The two companies collaborate to develop cannabis products. The price to sales ratio is 1.31. BUY

Tilray Brands (TLRY) Tilray is a cannabis and consumer packaged goods company with one of the biggest global footprints in the industry. CEO Irwin Simon founded The Hain Celestial Group, a natural food company, which is in the business of brand development. This is a key factor for cannabis companies, too. So, the Hain Celestial experience may bode well for shareholders.

Tilray is a big recreational and medicinal cannabis supplier in Canada. It is ranked #1 there by sales for cannabis flower, oils, concentrates, and THC beverages; #2 in pre-rolls, #4 in vape, and among the top 10 in all other categories. It also offers medical cannabis in 20 countries on five continents through its subsidiaries and agreements with pharma distributors. It has operations in Canada, the United States, Europe, Australia and Latin America. It sells craft beer and CBD products in the United States.

Tilray seems like a good play on expected legalization of recreational use in Europe over the next few years, because it has been making significant investments there. It has a medicinal marijuana distribution network in Germany. It has production facilities in Portugal and Germany, the largest medical cannabis market in Europe.

Tilray sells hemp food products through its Fresh Hemp Foods division, and it has a craft alcohol business called SW Brewing, the tenth-largest craft brewery in the United States. The price to sales ratio is 1.66. BUY

Trulieve (TCNNF) Trulieve has long been the biggest medicinal marijuana vendor in Florida, where it has 50% market share. It has over 190 dispensaries and two thirds are in Florida. Cannabis activists are trying to get recreational use on the Florida ballot in November 2024. A win would be huge for Trulieve. Approval could make Florida the largest legal U.S. cannabis market with 22 million residents and 138 million tourists a year.

Meanwhile, Trulieve has been expanding across the country. It is diversifying its presence into Pennsylvania, Maryland, Georgia, Ohio and Massachusetts, among other states.

The company reports $201 million in cash against $795 million in debt. “U.S. cannabis has significant white space ahead, with many states yet to implement medical or adult-use programs, and the growing appetite for substantive federal reform,” says CEO Kim Rivers. It has a price to sales ratio of 1.77. BUY

Verano (VRNOF) Chicago-based Verano is one of the top five publicly traded multi-state operators in the U.S. by sales. Verano has nearly 140 dispensaries and 14 production facilities in 13 states. One of the most attractive qualities of this company is that it has a big presence in high-growth markets like New Jersey, Illinois, Florida and Connecticut, and states that may soon legalize recreational like Florida and Pennsylvania. The company’s strategy has been to position with medical dispensaries in states most likely to soon go recreational.

The company’s portfolio of brands includes Encore, Avexia, MÜV and its signature Verano line of product. To capitalize on the consumer’s trading down to value brands, Verano moved up the rollout of a new budget line called Savvy last year. It operates dispensary concepts called Zen Leaf and MÜV. It also has a licensing agreement with Mike Tyson’s Tyson 2.0 cannabis company.

The company reports cash of $175 million against debt of $542 million.

Verano is founder-run, which can be a plus in investing. Verano has a price to sales ratio of 1.75. BUY

The next Cabot Cannabis Investor Issue will be published on May 29, 2024.

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