May the buyouts begin. Poor sentiment has pushed the values of cannabis companies so low, the strong are now buying the weak. Like the recent cannabis company insider buying, this is a signal that valuations may be close to bottoming here.
However, realistically, it could be a while before the sector recovers since we are dependent on politicians for progress.
The bottom line: You want to emphasize owning the financially strongest companies now, for two reasons.
1. Financially sound cannabis companies are the ones that can power through without having to do onerously dilutive financings at low stock valuations or high interest rates. The challenge here for the weak is that politicians hold the keys to all the important potential industry reforms: rescheduling, banking reform, and decriminalization or even legalization. And politicians are slow to act.
The good news is that cannabis reform does seem inevitable. There is strong cultural momentum towards cannabis reform because of popular support for this change. A majority of Americans favor cannabis reform and legalization even on both sides of the aisle. This suggests that sooner or later politicians will respond and make favorable changes. President-elect Donald Trump campaigned in support of all three of the key reforms. He likes to say, “Promises made, promises kept.” It’s showtime. I think reform will happen. But it is going to take a while.
2. Financially sound cannabis companies are the ones that have the capability to buy the weak. Astute purchases will position the stronger companies for better performance on the other side of the current dark times for cannabis.
Below, I offer detail on the significant cannabis sector buyout that just happened this week, in the
company update section.
But first, here are the two cannabis companies with the best financial strength in our portfolio. These are the names I’d suggest focusing on and averaging down in, at the moment.
Green Thumb Industries (GTBIF)
This is the blue-chip name in cannabis. Based in Chicago, Green Thumb has over a hundred stores and twenty production plants in fourteen states. It sells popular brands like Dogwalkers, and RHYTHM through its RISE dispensaries.
CEO Ben Kovler takes a conservative approach to capital allocation, growth and expenses. This is why Green Thumb is one of the few cannabis companies that actually makes money. It earned four cents a share in the third quarter.
It’s also growing revenue, despite industry headwinds. In the third quarter, it posted 4% sales growth to $28.8 million. In the first nine months of the year, the company posted $151.8 million in operating cash flow.
One way you can tell Kovler is a conservative manager is that unlike many of the larger cannabis companies, he’s continued to have his company pay its full share of federal taxes. Many competitors have started to ignore the IRS ban on expense deduction, hoping that the IRS policy gets changed by rescheduling. This is risky because, meanwhile, the IRS formally disagrees with this approach.
Here’s another way you can tell Kovler is a conservative manager. Green Thumb has enough financial strength to make it the rare cannabis company that can exploit the dramatic sector stock price declines by buying back shares. The company has a $50 million stock buyback plan in place.
In the third quarter, the company extended its debt maturities by inking a $150 million five-year credit facility. It negotiated an interest rate of 5% which is low for the sector – another sign of financial strength. Green Thumb ended the third quarter with cash of $174 million, against debt of $255.6 million. It has the financial strength to make it through the hard times while politicians dawdle, and prosper on the other side.
Cronos (CRON)
With its war chest of $862 million in cash, Cronos has the financial strength to make it through the long wait for politicians to enact reforms that help the sector.
That’s more than its market cap of $769 million, which means the company has negative enterprise value of around $91 million. In other words, buy the stock, and you are getting the business for free and then some.
This is quite a business to get for free. Cronos is one of the rare cannabis companies posting very robust growth, thanks to the quality of its product and the popularity of its brands. The company’s Spinach brand is the number one brand in Canada, according to Hifyre. Its PEACE NATURALS brand is a top brand in Israel, and it is popular in Europe, an emerging cannabis market.
Third-quarter net revenue grew almost 21% to $29.9 million, thanks to the popular demand for these brands. Cronos said it had so much demand that it could not keep up. That’s the kind of brand strength you want to see in an investment. Cronos saw strong demand in Canada and Israel. It also saw strength in Germany, Austria and the U.K., where it is starting to build market share. The company cites its proprietary plant genetics based on years of research.
Including the consolidation of its GrowCo cannabis supply company, which Cronos incorporated onto its balance sheet in the third quarter for the first time, sales grew 38% to $34.3 million. Cronos brought GrowCo onto the balance sheet because it got majority control of the board during the quarter. The company’s operating cash flow came in at $11.6 million, compared to a slight decline the year before.
“As international demand continues to rise, particularly in markets like Germany, the U.K., and Australia, the investments we’ve made in our infrastructure and global partnerships are paying off,” said Cronos CEO Gorenstein in the third quarter earnings call. “Thanks to our strong balance sheet, we are exceptionally well positioned to capitalize on future growth opportunities and enhance our position in the markets we operate in.”
A Rescheduling Update
Cannabis investors continue to wait for the rescheduling catalyst. Here is where we stand now. But first a quick primer.
Rescheduling refers to moving cannabis to Schedule III from Schedule I under the Controlled Substances Act. This will help cannabis companies by neutralizing IRS Rule 280E. This bars the deduction of operating expenses against revenue from the sale of Schedule I substances. The change would significantly boost cash flow at cannabis companies, and narrow losses or increase earnings. Rescheduling cannabis to Schedule III could boost sector cash flow by $2 billion to $3 billion a year, estimates the research group Leaflink.
We will see some progress on rescheduling during late January through early March, in the form of a packed schedule of hearings on the matter by administrative law judge (ALJ) John Mulrooney inside the Department of Justice (DOJ). An ALJ presides over a kind of tribunal inside an executive branch agency, like the DOJ, to offer opinions on matters like new rules.
While the hearings may serve as a catalyst, depending on the headlines, actual rescheduling probably remains far in the future. It may not happen for a year or two at least, one attorney close to the process tells me. Cronos (CRON) CEO Michael Gorenstein predicts rescheduling will happen in a year and a half at the earliest.
But at least rescheduling seems likely to happen. During his campaign, President-elect Donald Trump promised several times he wants to see rescheduling, favorable banking reform that opens the banking system to cannabis companies, and at least decriminalization if not outright legalization. Trump expressly favored legalization by supporting the Florida referendum that would have accomplished this.
That measure got 56% of the vote. It fell short of the 60% needed to pass. But 56% support in a conservative state like Florida confirms polling which consistently shows a majority of Americans on both sides of the aisle favor cannabis reform. Theoretically, politicians should respond to this signal.
Trump will have a busy agenda at the start of his administration, taking on issues like immigration and federal spending. But he also campaigned on the dictum “promises made, promises kept.” So, it is not irrational to think his administration will follow through on cannabis reform promises at some point.
His administration will face “deep state” challenges. Despite President Joe Biden’s express desire to see rescheduling, the reform has come up against resistance inside the DOJ, at the Drug Enforcement Administration (DEA), an insider tells me. The DEA gets a lot of its budget from drug-related property confiscation. This may explain its resistance to cannabis reform. Rescheduling would not halt this, because cannabis would still be illegal. But any movement in the direction of reform threatens the DEA’s budget. So, resistance seems natural.
Parties close to the ALJ hearing process express frustration that the DEA is playing such a prominent role in the procedures, given its apparent bias against reform. They also believe the ALJ seems to be stacking the deck against reform, by scheduling witnesses who are generally opposed to change. An innocent explanation could be that the ALJ wants to hear an opposing point of view capable of providing the other side of the story in the hefty Health and Human Services 254-page document outlining research that supports moving cannabis to Schedule III.
After the ALJ hearings are complete, the ALJ will make findings of facts and conclusion of law on matters like cannabis abuse and addiction potential and currently accepted medical use. It will make a recommendation on moving cannabis to Schedule III and cite its reasonings.
Then it will be up to the DOJ and the attorney general to decide. The DOJ’s notice of proposed rulemaking, which promulgated rescheduling, expressly stated that the DOJ will have the final say. So, a lot is riding on who becomes attorney general.
If anyone is up to the task of taking on “deep state” opposition to reform, it would be a Trump administration. Trump campaigned as a Washington, D.C. outsider prioritizing challenges to embedded bureaucrats who make policy even though they are unelected.
Deep state, or DEA, opposition to rescheduling also goes up against public opinion which favors cannabis reform, even on the right. Recall that the DOJ and its Office of Legal Counsel both have concluded the HHS rescheduling proposal makes sense. Meanwhile, near term, the first and probably final round of ALJ hearings will take place from January 21 through March 3. Expect lots of headlines but no overt progress on rescheduling. That will come later, and it is hard to predict when at this point.
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 institutional investors will not ignore cannabis stocks 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.
* U.S. legal-market cannabis sales will exceed $32 billion in 2024, according to the research group Leaflink. Annual sales will grow 72% to hit $55 billion by 2030, it predicts.
Leaflink says the sector currently supports 500,000 jobs and over 25,000 businesses in 41 states. Cannabis sales generated $457.6 million in tax revenue in 2023. The research group said Michigan and Alaska rank highest for per capita use.
Flower is the most popular form of the product, representing 40% of retail sales, followed by cartridges (22%), edibles (14%), pre-rolls (13%), and concentrates (12%).
Price compression as more stores open continues to be a challenge for companies in the space. Nationally, cannabis flower prices have declined by 7% year over year, says Leaflink.
* The National Football League (NFL) has reduced fines for positive cannabis tests and increased the allowable THC limits for players. The continuing liberalization of cannabis rules among major sports leagues confirms the cultural momentum towards accepting cannabis and cannabis reform that favors companies in the sector.
In 2023 the National Basketball Association removed cannabis from its list of banned substances list and set up rules that allow players to invest in and promote cannabis brands. The National Collegiate Athletic Association recently voted to remove cannabis from its banned substances list for Division I players. The Ultimate Fighting Championship last December removed cannabis from its banned substances list.
Four years ago, the NFL stopped suspending players for testing positive for cannabis.
* In a sign that legal cannabis sales will continue to expand in Europe, Denmark will likely expand its medical cannabis pilot program into a fully legal market, say government officials.
* A Nebraska judge recently dismissed a lawsuit that challenged two medical cannabis legalization referenda approved by voters in November. The changes should take effect this month, but challenges remain. John Kuehn, a former state senator and former member of the State Board of Health, filed an appeal to the ruling. Kuehn says not enough valid petition signatures were collected. About 71% of Nebraskans voted to legalize cannabis.
* The global war on drugs has “completely and utterly” failed, says the United Nations (UN) High Commissioner for Human Rights, Volker Türk. He thinks drug policy should emphasize treatment, not punishment.
“The so-called war on drugs has destroyed countless lives and damaged entire communities,” said Türk in a video statement. “Criminalization and prohibition have failed to reduce drug use and failed to deter drug-related crime. These policies are simply not working, and we are failing some of the most vulnerable groups in our societies. The evidence is clear. The so-called war on drugs has failed, completely and utterly.”
Meanwhile, the Global Commission on Drug Policy in early December published a report also saying the global war on drugs has failed. It says the U.S. should decriminalize drug use and focus on treatment rather than double down on a “failed” drug war. The report is called “Beyond Punishment: From Criminal Justice Responses to Drug Policy Reform.”
* Illinois recreational-use cannabis sales in October were up 4.2% sequentially to $142.3 million. The year-over-year growth was 2.5%. Year-to-date sales are up 5.8% $1.14 billion, following 5% growth in 2023, and 13% growth in 2022.
* Idaho officials in late November gave the green light to cannabis activists to start collecting signatures to put cannabis legalization on the ballot in 2026. Organizers will have to gather 70,725 voter signatures, or 6% of voters. Idaho is one of the few states where both medical and rec-use remain illegal. Idaho is losing tax revenue because residents travel to nearby Oregon to purchase supply.
* A recent Ball State University found that 62% of Indiana residents support legalizing medical and recreational-use cannabis, and 25% support medical-use legalization. “It’s probably time for it to have found its way to Indiana on the medical side,” Gov.-elect Mike Braun (R) recently told reporters. Indiana is losing tax revenue to neighboring states, where Hoosiers go to purchase cannabis. Medical cannabis is legal in the four states bordering Indiana: Michigan, Illinois, Ohio and Kentucky. All but Kentucky have also legalized rec-use.
* Cannabis prices have fallen sharply in Ohio since it legalized recreational-use sales last summer. The average cost of one-tenth ounce of cannabis was recently $21.72 down from $26.59 last August, says the Ohio Division of Cannabis Control. Ohio is unusual in that its stores sell flower by the tenth of an ounce. Stores in most states sell one-eighth-ounce measures. Cannabis price compression has continued to be a challenge for cannabis companies for two years.
* New York legal-market cannabis sales should hit $1 billion this year, says the New York Cannabis Control Board (CCB).
* Senate Majority Leader Chuck Schumer (D-NY) this week tried to include cannabis banking reform in a government funding bill. But Republican leadership in the Senate and House blocked the move, according to media reports. This means the Secure and Fair Enforcement Regulation (SAFER) Banking Act is unlikely to pass during the lame-duck session. Incoming Senate majority leader John Thune (R-SD) opposes cannabis banking reform, though President-elect Donald Trump supports the change.
Company Updates
OrganiGram (OGI)
Canadian cannabis company OrganiGram on December 6 announced the purchase of competitor Motif Labs. The combination turns OrganiGram into the leading company in the Canadian recreational cannabis market by market share. It also makes OrganiGram the number one company in vapes in Canada. Together, the companies will have a market share of 12.4%.
Motif controls popular brands called Boxhot and Debunk, and it is strong in vapes (21% share) and infused pre-rolls (9.4% share). By market share, Motif is #1 in vapes and #3 in infused pre-rolls. Motif posted $79 million in sales last year, up from $35 million in 2022.
Motif has expertise in CO2 and hydrocarbon extraction of psychoactive cannabis distillates for use in vapes. Organigram says the purchase means it can expand Motif’s distribution to new markets in Quebec and along the Atlantic coast of Canada. Organigram says the purchase gives it a strategically located distribution hub in Southwestern Ontario. The company expects about $10 million in cost cutting over the next two years. Organigram is paying $90 million for Motif, or $50 million in cash and $40 million in stock.
Trulieve Cannabis (TCNNF)
Trulieve on December 9 announced it is opening a new store in Tampa, Florida. Trulieve continues to build its medical-use store presence in the state, even though voters rejected legalization of recreational-use sales in November. Trulieve CEO Kim Rivers has suggested cannabis advocates may next try to use the legislative process to legalize rec-use.
What to Do Now
Stay the course. This is not the time to give up in frustration. The best time to buy stocks is when they are widely hated, but plausible catalysts lie on the horizon. That is the case with cannabis stocks now. But this is also the hardest time to buy cannabis stocks. That psychological dynamic may also be a signal to buy, in the contrarian sense. As a general rule, some of your best stock purchase decisions will be the ones that are the hardest to make.
Consider taking both trading positions and multiyear positions in portfolio names now, or averaging down. I am personally averaging down in the current weakness. Favor the financially sound, like Cronos (CRON), and Green Thumb (GTBIF).
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.
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