Back on December 27 I suggested holding off on cannabis sector purchases given the group strength at the time. We had realized nice gains, and it did not make sense to chase the stocks. “I prefer to add on weakness rather than strength,” I wrote. I recommended adding on weakness of 2% to 4% or more in any of our portfolio names.
The AdvisorShares Pure US Cannabis (MSOS) and AdvisorShares MSOS 2X Daily (MSOX) exchange traded funds (ETFs) closed that day at 6.93 and 3.60, respectively, and went on to fall 4.5% to 9% over the next few trading days.
Buying those dips was a good idea because the MSOS and MSOX then advanced 20% to 38% or more over in just a few trading days in the new year.
This early-2024 rally was suspect because it was sparked by non-news. It was triggered by the publication of a letter from the Drug Enforcement Agency (DEA) to a representative in Congress. It mentioned the DEA is reviewing a proposed rescheduling of cannabis to Schedule III from Schedule I under the Controlled Substances Act.
Of course, this was not news at all. We already knew this. This week, the market is figuring that out and sobering up. The ETFs MSOS and MSOX are weakening.
What to Do Now
Aggressive traders may want to take profits, with the hope of buying the volatile group back at lower prices. After all, the recent move was sparked by insignificant news, the DEA letter to Rep. Earl Blumenauer (D-OR) confirming that the agency is conducting a rescheduling review.
I suggest caution on selling aggressively at this point because much of the early-2024 false rally has reversed. Plus, the problem with selling the cannabis group strength caused by the DEA letter non-news (or any big rally) is that real news on rescheduling can land at any time.
The bottom line: So, I suggest staying long, and accumulating again on 5% to 10% weakness from here. When I personally sell strength, I keep the sales limited to just a few percentage points of my overall cannabis position. If you have no exposure to the volatile cannabis group, I suggest starting entries here, and then adding on further weakness. If you already have a position, I suggest adding on any further weakness of 5% to 10%. As a general guideline, let’s use MSOS and MSOX as proxies for the cannabis group. I suggest getting more aggressive in adding these ETFs and portfolio names; for example, when MSOS falls into the 6.70 to 7.10 range, and when MSOS falls to the 3.10 to 3.50 range. This conclusion is based on where the group has found support recently.
A Looming Catalyst
The next big step that will really get the group moving higher will be DEA publication of a proposed rescheduling rule. Our problem is that it is impossible to know when this will land.
Big picture, though, several cannabis experts expect significant – if not complete – progress on rescheduling before the November 2024 presidential election. The logic here is compelling: President Joe Biden wants to post a rescheduling win to attract votes.
For those just getting up to speed on cannabis, the history here is that in October 2022 Biden told various administrative agencies to reform federal cannabis laws. Last summer the Department of Health and Human Services (HHS) sent the DEA a letter suggesting cannabis should move to Schedule III from Schedule I. This change would be big news for the cannabis group. It boosts cash flow for cannabis companies by allowing them to deduct operating expenses on federal tax forms. Currently, an IRS rule called 280E prohibits this. But this provision’s application to cannabis would be voided by a move to Schedule III.
Based on a review of history, the Congressional Research Service concludes the DEA will go along with the HHS recommendation. The timing of rescheduling reform remains in question. Predictions are all over the map.
One cannabis regulatory expert, attorney Howard Sklamberg who is a partner at Arnold & Porter, thinks full rescheduling (not just DEA publication of a rescheduling rule) will happen by the summer. That would give Biden plenty of time to tout the victory. Sklamberg is worth listening to because he was the chair of the Food and Drug Administration’s Marijuana Working Group for several years.
However, another cannabis regulatory expert I talk with, Shane Pennington, who is a partner in the Porter Wright Morris & Arthur, is skeptical of the fast timeline scenario. He notes that rescheduling typically takes a long time, as many as nine years.
Who is right? Given the cultural momentum behind cannabis law normalization and political exigencies due to the extent to which Biden is behind in the polls, I’m leaning towards Sklamberg’s expectation of rescheduling before the November election.
Rescheduling is not the only potential cannabis catalyst. Several big states are moving towards recreational use legalization (Pennsylvania and Florida) and European countries are, too. But rescheduling would be a big catalyst since it would improve cannabis company cash flow so much, and probably clear the way for institutional investor participation in the space.
For simplicity, consider owning MSOS and the leveraged version MSOX as proxies for the group. Also consider our portfolio names, which I believe are some of the best publicly traded companies in the cannabis space. They are: Ayr Wellness (AYRWF), Cresco Labs (CRLBF), Curaleaf (CURLF), Cronos (CRON), AdvisorShares Pure US Cannabis (MSOS), AdvisorShares MSOS 2X Daily (MSOX), ETFMG Alternative Harvest (MJ), Green Thumb (GTBIF), Organigram (OGI), Tilray Brands (TLRY), Trulieve (TCNNF) and Verano (VRNOF).
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 easy to be afraid to buy when the group falls a lot, and down into my suggested buy ranges. So, it is important to catalogue evidence of this cultural momentum.
That is the purpose of this section of Cabot Cannabis Investor. Let’s take a look at recent developments driving the cannabis normalization cultural momentum.
* Cannabis is the most popular drug on the planet, says the United Nations. It estimates 219 million people have used cannabis in the prior 12 months, or 4.3% of the global adult population. The United Nations published its conclusions in its annual “World Drug Report” for 2023. The estimates are for 2021.
* The global recreational-use market will nearly double over the next four years to almost $50 billion by 2027. So says the U.K.-based cannabis data company Prohibition Partners.
Sales growth will be driven by ongoing legalization in the U.S. and Europe according to the group’s
Global Cannabis Report. It says annual sales will hit $49.7 billion by 2027, nearly double the current $24.9 billion. The group forecasts $33 billion in rec and medical uses sales in the U.S. by 2027, up from
$26 billion in 2022. Including illicit sales, the tally could hit $100 billion for the U.S.
In Europe, Malta has legalized rec use. Switzerland and Holland are researching legalization in pilot programs, and Germany is liberalizing medical use rules and considering rec use legalization.
* Wisconsin may soon join the ranks of states that offer legal cannabis sales in some form. Conservative lawmakers in Wisconsin on January 8 offered the broad outlines of a medical cannabis proposal. It would set up the distribution of smokeless, medical-use cannabis via state-run dispensaries run by state pharmacists.
Rep. Jon Plumer (R) and Rep. Tony Kurtz (R) offered the outlines of this plan in a press conference. Note that they are Republicans. Conservatives are generally less favorable to normalization of cannabis laws.
The proposal would make Wisconsin the first state to set up state-run dispensaries. They would distribute products like gummies and oils. Kurtz said the medical cannabis program would “help a tremendous number of people,” including “people that I personally know that will benefit from this very much-needed program.”
Kurtz said state Republicans are leading the way and have a “great opportunity to introduce a much-needed program with medical cannabis with controls.” Gov. Tony Evers (D) wants to go even further and permit legal recreational use sales, but has also said he’d go along with the more limited medical use proposal.
Wisconsin is bordered by states that allow legal cannabis sales in some form. People from Wisconsin spent more than $121 million on cannabis in Illinois last year, forking over $36 million in tax revenue to the state, according to one study.
Plumer said medical-use legislation will be unveiled and go to committee soon. A bipartisan group of lawmakers also introduced a bill to decriminalize cannabis possession last month.
* Cannabis sales in New Mexico hit an all-time high of $50.5 million in December. Recreational use sales came in at $37.5 million, and medical sales were $13 million. Dispensaries sold more than a half billion dollars of cannabis in 2023, the first full year that rec use sales were legal. Rec use sales started in April 2022.
Sales hit record levels in at least a half a dozen states last year including Illinois, Michigan, Connecticut, Maryland, Rhode Island, Montana, and Maine. New Jersey cannabis sales will hit $1 billion this year, predicts Jeff Brown, director of the state’s Cannabis Regulatory Commission. Sales were $578 million in the first three quarters of 2023. Full-year 2023 data will come out soon.
* The Ultimate Fighting Championship (UFC) announced it is taking cannabis off its banned substances list for athletes. With the late-December policy change, UFC joins the National Basketball Association (NBA) which removed cannabis from the league’s banned substances list last year. A National Collegiate Athletic Association (NCAA) committee recommended last September that its divisional governing bodies remove cannabis from the list of banned substances for college athletes.
* Kentucky Gov. Andy Beshear (D) is urging state lawmakers to broadly expand the number of health conditions allowing residents to purchase medical marijuana once it becomes legal in 2025.
Beshear drew on guidance from two advisory groups he created. The Team Kentucky Medical Cannabis Workgroup and Board of Physicians and Advisors have recommended adding ALS, Parkinson’s disease, Crohn’s disease, sickle cell anemia, neuropathies, severe arthritis, fibromyalgia, muscular dystrophy, Huntington’s disease, HIV/AIDS, glaucoma and terminal illness.
The current list of qualifying conditions includes cancer, post-traumatic stress disorder (PTSD), multiple sclerosis, chronic pain, epilepsy, chronic nausea and muscle spasms.
The expanded list would make medical cannabis available to nearly a half million more Kentuckians.
* South Dakota has given the green light to cannabis advocates who want to pay workers to collect signatures to support a 2024 recreational-use legalization ballot initiative. Volunteers have already been collecting signatures. The campaign is led by the South Dakotans for Better Marijuana Laws (SDBML).
* Nevada recently increased the legal limit for cannabis possession to 2.5 ounces, up from one ounce. The state will also allow recreational-use dispensaries to sell medical cannabis without the need for a separate license. The changes are part of a cannabis reform that Gov. Joe Lombardo (R) signed into law in June, which will also make it easier for convicted felons to run dispensaries. The state will also soon roll out cannabis consumption lounges.
Portfolio Company News
Cronos (CRON)
Cronos is expanding its international reach. The company just made its first shipment into the high-growth Australian market. Cronos sold cannabis flower to the Australian medical cannabis supplier Vitura Health. Cronos owns a 10% stake in the company.
Through June last year from the start of 2023, the number of medical cannabis patients in Australia grew 124% to 307,846. Cannabis sales there probably grew 9.4% last year to $186 million, estimates BDS Analytics. Besides the Canadian market, Cronos sells into Israel and Germany.
Curaleaf (CURA)
Curaleaf in early January launched a fast-acting THC beverage mix called Stir. Stir packets contain liquid with 5mg of THC designed to be mixed with drinks like sparkling water. Stir joins Curaleaf’s Zero Proof line of THC mixes. The company says the product uses nanotechnology to help it provide an effect in 15 to 30 minutes. Edibles often take twice as long. “Stir by Zero Proof is the next step in expanding our portfolio of THC-infused drinkables, a category which we believe will ultimately redefine how people socialize,” said CEO Matt Darin. Stir is available in Illinois.
Tilray Brands (TLRY)
Tilray on January 9 reported record sales of $194 million for the fourth quarter, an increase of 34% over the prior year, driven by strong cannabis sales growth and acquisitions.
The company posted 31% cannabis sales growth in Canada, and 55% medical cannabis sales growth in Europe. It finished the quarter that ended November 30 as the largest cannabis company in Canada by market share. The company has the #1 share in cannabis flower, oils, concentrates and THC beverages. Tilray is also the largest medical cannabis distributor in Europe, and the fifth largest craft beer company in the U.S.
Overall cannabis revenue increased 35% to $67 million. Cannabis gross margin was 31%. Alcoholic beverage revenue increased 117% to $47 million driven by brand acquisitions. Alcohol beverage gross margin was 34%. Medical cannabis distribution net revenue increased 12% to $67 million. Distribution gross margin was 11%.
Net losses decreased to $46 million in the quarter from a loss of $62 million in the prior year quarter. Net loss per share narrowed to seven cents a share from 11 cents a share. Gross profit increased 11% to $47 million, on 24% gross margins.
Operating cash flow was a negative $30 million compared to $29 million in cash flow the prior year. Operating cash flow was hit by expenses related to the acquisition of the Canadian cannabis company HEXO. Tilray realized $22 million in annualized run-rate savings as part of the $30 million savings target related to the HEXO acquisition. Tilray reduced its convertible debt by $127 million and another $18 million after the quarter closed. The company finished the quarter with $261 million in cash.
CEO Irwin Simon reminded investors in the earnings call that Tilray, a Canadian company, stands poised to enter the U.S. cannabis market if the Biden administration clears the way for this by rescheduling cannabis down to Schedule III from Schedule I under the Controlled Substances Act.
Trulieve Cannabis (TCNNF)
Trulieve opened two new dispensaries in Florida in late December in Crawfordville and Crestview in the Big Bend and Panhandle regions. The Crawfordville dispensary will only fulfill pickup orders placed online, a first for Trulieve. The Crestview dispensary offers walk-in and pickup service. Trulieve, the biggest cannabis company in Florida, continues to expand there ahead of potential recreational-use legalization this year. Florida voters may get to weigh in on the legalization of rec use in the 2024 election, if the state’s Supreme Court approves the language in a Trulieve-funded referendum on the topic. The court is expected to decide by early April.
Verano (VRNOF)
Verano expanded its Florida presence in early January by opening a MÜV dispensary in Yulee, near Jacksonville. That takes its Florida tally to 74 dispensaries. It has 137 dispensaries and 14 cultivation and processing facilities in 13 states. The company opened 12 dispensaries in Florida last year. It is positioning to benefit from potential legalization of recreational use in Florida, where voters are likely to weigh in on the topic in this fall’s election.
