It sounds heartless to say, but successful investing is largely about exploiting the emotions of others.
The two biggest emotions to exploit in the market are obviously fear and greed. When investors are too fearful, it pays to exploit that emotion by betting the other way. And vice versa for greed.
Another common emotion to exploit is impatience.
Back on January 31, I suggested it made little sense to chase cannabis stocks in the strong rally at the time. I suggested waiting for declines of 2%-4% to start buying.
Now, impatience with the lack of news flow on the next expected catalyst has brought substantial declines in cannabis stocks that are buyable.
Since January 31, the AdvisorShares Pure U.S. Cannabis (MSOS) has fallen by over 9%. The AdvisorShares MSOS 2X Daily (MSOX) is down by over 20%. The rest of our portfolio names of the best cannabis stocks (see below) have made similar moves.
I’ve been adding to positions this week in the weakness, and I suggest you consider doing the same. I won’t be able to call the exact bottom in this pullback. Or if I do it will only be by sheer luck. No one can precisely call bottoms or tops in sectors or stocks on any regular basis. You should run away from anyone who claims to have a system that can do this. The way I manage this challenge is to buy in stages and average in.
Buying now means buying ahead of a major potential catalyst that has not gone away. The precise timing is unknown. My guess is that it could hit between now and the end of April. It will come in the form of a proposed rule from the federal government on rescheduling cannabis under the Controlled Substances Act (CSA).
The background here is that the Health and Human Services Department (HHS) has asked the Drug Enforcement Agency (DEA) to soften its stance on cannabis by downgrading it to Schedule III from Schedule I under the CSA. The change would help cannabis companies by boosting cash flow enormously.
The reform would boost cannabis company cash flow by exempting companies from an Internal Revenue Service rule (called 280E). This bars the deduction of operating expenses against Schedule I drug revenue.
Now, the next step in rescheduling will come in the form of a proposed rescheduling rule from the DEA. The timing is critical, from the all-important political perspective. The proposed rule has to drop by March or April for the Biden administration to reap election-year boasting rights – obviously part of the plan here. When the DEA drops the proposed rule, that will be another sign of rescheduling progress, and so it will be another cannabis sector group catalyst. But the rule needs to come out by March or April to allow enough time for comments and hearings needed to approve rescheduling before election day, or at least inside the current administration.
Some recent poll results suggest the Biden administration is likely to press hard for progress on cannabis rescheduling as an election tactic. The two key polling insights for cannabis investors are: 1) A vast majority of voters back cannabis reform, and 2) Cannabis reform is an even more salient issue for young voters who are defecting from Biden.
The bottom line: Given the way younger voters are defecting from Biden, you can imagine the Biden camp may be pushing hard for timely progress on cannabis rescheduling. The poll results and simple logic on the possible timing suggest a DEA proposed rule could drop soon, catalyzing the cannabis sector once again.
What to Do Now
Cannabis stocks have fallen enough to consider adding to positions again. Consider buying in stages. Preserve some buying power for further pullbacks. The key takeaway is that in a volatile sector like this, I prefer to add on weakness rather than strength.
Consider any of our portfolio names. 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.
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. It is important to catalogue evidence of this cultural momentum so that does not happen to you. That is the purpose of this section of Cabot Cannabis Investor.
* In a campaign move that confirms the importance of cannabis in the presidential election, Vice President Kamala Harris touted Biden administration progress on reforming federal marijuana law in a video aimed at young voters. Evidence of the prioritization of cannabis reform in the election is bullish for the sector because it confirms we may soon see progress on rescheduling under the Controlled Substances Act. The next step in this process should be Drug Enforcement Administration publication of a proposed rescheduling rule. This would need to happen by the middle of April to allow time for further substantial progress ahead of the November elections. A recent poll found that young voters were substantially more favorable towards President Joe Biden after being informed of his rescheduling efforts.
* The vast majority of North Carolinians want cannabis legalized for medical use. A recent Meredith Poll found that 78% of people support the state’s Compassionate Care Act, which would do this. North Carolina’s Senate approved it last year, but the House of Representatives did not get to vote on it. Lawmakers could reconsider the bill this year.
* The U.S. Navy now grants more waivers to recruits who test positive for cannabis, instead of simply rejecting them. Confirming my cultural momentum thesis, a Navy official said the change was made to better reflect the reality that the majority of states have legalized cannabis use. The change is also part of an attempt to deal with an ongoing shortage of recruits. The Air Force has made a similar change in its recruitment standards. Cannabis is the most common substance found in military drug tests.
* Virginia’s House of Delegates has approved a bill that would legalize recreational-use cannabis sales. A rec-use sale legalization measure is also making progress in the Senate. Recreational use is legal in the state, but rec-sales remain prohibited.
* Pennsylvania Gov. Josh Shapiro (D) says his state’s lawmakers have no choice but to advance legislation legalizing recreational-use sales, citing an estimated $250 million a year in tax revenue lost to neighboring states which have made the policy change.
“This really comes down to an issue of competitiveness,” he said in an interview on WILK News Radio. “The reality is we are leaving all that money on the table. We are falling behind other states. We can’t let Ohio and the other states around us keep eating our lunch on this.” Pennsylvania is virtually surrounded by states that have legalized rec use, or Ohio, New York, New Jersey, Delaware and Maryland. Only neighboring West Virginia has not done so.
Besides lost tax revenue, Shapiro cited the ongoing momentum behind cannabis law reform nationwide. “I actually think we don’t even have a choice anymore given the way this is moving so quickly across our region and across the country. It’s obviously wildly popular across the country and certainly in polling regionally.” The upshot: State lawmakers who continue to oppose rec-use legalization are going to have to “justify that to their constituents,” he said.
A Franklin & Marshall College poll recently found that 63% of registered voters in Pennsylvania think rec use should be legalized.
* In another sign of the broadening cultural acceptance of cannabis use, the Colorado Tourism Office (CTO) now includes cannabis-related activities in its marketing material, like cannabis-friendly tours, a cannabis lounge and accommodations that allow cannabis use. CTO-funded research has found that 6% of tourists said legal pot was one of the main reasons to visit the state and over 15% said they planned to visit a dispensary during their visit. Colorado became the first state to legalize recreational-use cannabis in 2012. The CTO has listed breweries, wine events and gaming activities for years.
* U.S. citizens reporting regular cannabis use has more than doubled since 2013 to hit 17% last year, according to Gallup. In 2013 7% reported use. The poll found that 26% of people aged 18-34 say they use cannabis, compared to 18% among those aged 35-54, and 11% of people 55 and older. Males are more likely to use than females (19% vs. 14%). Democrats are more likely to use cannabis than Republicans (22% vs. 12%). College grads are less likely to do so. Gallup has also found that half of Americans say they have tried cannabis and 70% support legalization.
Cannabis Portfolio Company News
This section offers a roundup of developments at portfolio companies since the last Cabot Cannabis Investor update was published.
Curaleaf (CURLF)
Our Curaleaf continues its expansion in Europe, one of the main reasons I keep this name in our portfolio.
Curaleaf in early February purchased Can4Med, a pharmaceutical wholesaler specializing in cannabinoid products in Poland.
“Poland boasts one of Europe’s largest patient populations seeking medical cannabis,” said Curaleaf CEO Matt Darin. “By joining forces with Can4Med, Curaleaf International gains a strong foothold in this dynamic market. Poland’s medical cannabis market is expanding rapidly.” The country has “an extensive network of medical professionals authorized to prescribe cannabis,” says Darin. Curaleaf was already in Poland. Curaleaf’s Four 20 Pharma subsidiary is one of the only licensed producers in the country. Poland has a population of 38 million.
Organigram (OGI)
Organigram shares fell 17% this week after the company announced a sharp decline in fourth-quarter sales and wider losses. However, the stock is still up 43% this year because of several potentially bullish developments, which also explain why I keep the company in our portfolio despite the recent sales setback.
First, the bad news. Fourth-quarter net sales fell 16% compared to last year because of declines in international sales and medical-use sales. Organigram cut its cost of sales by 14%, and gross margins grew slightly to 31% from 30%. But losses still widened substantially to net income of $15.8 million from $5.3 million in the same quarter a year before, in part because of an asset write down. On the bright side, operating cash grew to $7.7 million from $3.5 million because of improvements in working capital and accounts payable.
Why keep this name in our portfolio? I think it’s worth keeping a small exposure (5% of our holdings) for three reasons.
1. First, Organigram is backed by tobacco giant British American Tobacco (BTI). The tobacco company, known as BAT for short, recently agreed to put another $124.6 million into Organigram, on the heels of an investment of over $200 million a few years ago.
Organigram already had a strong balance sheet, with cash of $54.6 million at the end of the year. In January it got $41.5 million of the BAT funds, which will make the balance sheet even stronger. Half of that amount will go towards operating cash. The other half will go into a venture capital division called Project Jupiter, which is exploring ways for Canada-based Organigram to invest and grow abroad.
2. This international growth is the second reason to own Organigram. The company already supplies Israel and Germany from its Moncton and Lac-Supérieur facilities in Canada. Organigram is in the process of getting its Moncton plant certified as a supplier by Europe. This should improve sales into Germany. Approval would also allow the company to sell higher-margin finished and packaged product into Australia rather than bulk product. The company is also about to start shipping to the U.K. and announce partnerships in other countries.
Meanwhile, two-thirds of the fresh infusion of $124.6 million from BAT will go to Organigram’s Project Jupiter, which is exploring international growth. “We have seen tremendous interest from cannabis companies looking for partnership opportunities and growth capital. Organigram is now uniquely positioned to take advantage of these opportunities,” says CEO Beena Goldenberg.
3. The oversupplied and troubled Canadian cannabis market may be hitting an inflection point, foreshadowing better times ahead. Organigram has been complaining for months that competitors engage in “THC inflation,” or the deceptive overstatement of product strength. It says the Canadian government is finally starting to crack down on this. Next, Canada is starting to go after competitors who have survived by holding back on paying taxes to stay solvent. If the crackdown continues, it might shut down cannabis companies and pull supply off the market, favoring survivors like Organigram. Organigram could benefit nicely given its position as the number two supplier in Canada, and its number one position in milled flower and concentrates. Organigram is trying to grow share in vapes by investing in a vape product technology company Green Tank Technologies in exchange for exclusive access to its products.
Cannabis Plus Insider Portfolio News
This portfolio invests in companies that have exposure to cannabis trends but do not touch the plant. Names must also have to have the right kind of bullish insider buying, according to my system of insider purchasing analysis.
AFC Gamma (AFCG)
The cannabis sector real estate lender AFC Gamma recently closed on two commercial real estate loans for $56.4 million. The loans should offer yields in the mid- to high-teen percent range, and thus support AFC Gamma’s hefty 17% dividend yield.
AFC Gamma funded a $28.2 million loan to DC Partners to build a mixed-used project in Houston, Texas. It will include luxury residential condominiums, a Hyatt hotel, restaurants and retail. The second loan for $28.2 million went to Belpointe PREP to fund a multi-family development with retail space in downtown Sarasota, Florida. AFC Gamma plans to continue to offer loans to fund cannabis-related real estate. But it has also expanded its business to invest outside of cannabis, as these two loans demonstrate. As long as they produce the expected rich yield and don’t go into default, that’s fine with me.
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