Old-school value managers like Benjamin Graham and Warren Buffett used to have a funny way of describing their investing style.
They said value stocks were like cigar butts on the sidewalk that had a few puffs left in them.
I’d like to offer an updated version of this metaphor. I think cannabis stocks have a few more puffs left in them between now and the end of the year.
Cannabis names are thoroughly unloved and abandoned once again.
But that will change quickly, and in a big way, if any of the potential big catalysts hit between now and the end of the year. No guarantees, but this is likely.
The main ones are:
- Progress on rescheduling;
- The November vote in Florida and other states on legalizing recreational use;
- Progress on SAFER banking reform in Washington, D.C.;
- A possible U.S. attorney general memo clarifying a hands-off enforcement policy in states that have legalized.
The last two are wild cards now. They could happen by surprise any time between now and the end of the year. The Florida vote and other state votes (see below) have the well-defined timeline of election day, November 5. Or the day after if vote counts drag out.
A Rescheduling Timeline
So, let’s consider the possible timeline for the biggest potential catalyst of them all, which is rescheduling. As you know, the setup here is that the Drug Enforcement Administration (DEA) and its parent the Department of Justice (DOJ) have filed a proposed rule that would move cannabis to Schedule III from Scheule I under the Controlled Substances Act (CSA).
The jackpot for our cannabis companies would be the big cash windfall. The change would neutralize an IRS rule called 280E, which bars companies from deducting operating expenses against revenue from Schedule I substances. The bigger cannabis companies, like the ones in our portfolio, would see cash infusions of $50 million to $100 million. Rescheduling would be a huge catalyst.
Predicting when, or even if, this will happen is tricky. Below, I piece together my best guesses based on my own thinking and input from Shane Pennington and Boris Jordan. Pennington is one of the leading experts on federal cannabis regulatory law. He is a partner at Porter, Wright, Morris, and Arthur. Jordan is the chairman of our Curaleaf (CURLF). His company is one of the heavyweights in Washington, D.C. cannabis lobbying.
Here are the highlights of the next steps along the way in rescheduling, and the potential pitfalls.
- The next step in this process will be the close of comments on July 22. This event won’t be much of a catalyst.
- The significant step after that will simply be publication of the final rule. To get this done, the DOJ and DEA have to respond to substantial comments from the public. The most complicated and nuanced comments from both opponents and supporters will come during the last day or two of the comment period that ends July 22. They want to drop their comments at the last minute to limit the amount of time adversaries have to respond. In other words, once comments close on July 22, the DEA and DOJ will still have a lot of work to do.
This suggests final rule publication could take a long time.
However, that might not be the case. There’s a major political angle here in that President Joe Biden wants to use cannabis reform to attract voters, especially following the debate debacle. This means publication of a final rule could well happen before the election. Jordan, at Curaleaf, says publication of a final rule by October is “very possible.” This would be a huge catalyst for cannabis stocks, especially considering how negative sentiment is at the moment.
Potential Pitfalls
- Along the way, the whole rescheduling timeline could get thrown into turmoil if the DEA and DOJ decide to hold an internal administrative law judge hearing on the matter. This could easily add years to the process. A tricky angle here is that there’s no deadline for the agencies to tell us whether they want to hold hearings or not. “If there is a final rule, then you know there will be no hearing,” says Pennington.
Both Jordan and Pennington downplay the odds of a hearing. Pennington points out that hearings are generally the exception, not the rule. Next, in recommending rescheduling to the DEA, he says, the Department of Health and Human Services did a thorough job of presenting supporting science and sound legal logic under rescheduling guidelines set up by the CSA and various court interpretations of those rules. “The amount of process this has been through is extraordinary,” he says. “This has been extremely well vetted.”
Then there is the political angle, again. “They will not have an administrative law judge hearing if the goal of the administration is to get this done before the election,” says Jordan. “There is a political angle to this, not just a science angle.”
- After a final rule is published, opponents of rescheduling have thirty days to file a petition for review in an appeals court. This will happen. While this is widely expected, it could produce a cannabis stock retreat, given the bipolar nature of investors in the space.
- The appeals court could issue a stay order which would suspend rescheduling. This would be another negative for cannabis stocks. Though it’s impossible to know, especially without seeing the arguments in any appeal, a stay seems unlikely, says Pennington. With no stay, rescheduling would still be on the books, but it would be litigated in an appeals court or higher, possibly for a long time.
What to Do Now
Because cannabis stocks are so hated and it is reasonable to expect catalysts ahead, I believe it makes sense to accumulate cannabis stocks here and then patiently wait for catalysts to hit in the September-November timeframe, or earlier. Consider taking both trading positions and multiyear positions now.
Then if a catalyst creates a 15%-40% kind of rally, consider exiting trading positions and selling covered calls against multiyear positions. Consider selling calls about a month out in time and starting at two to three points above the current price and up.
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 a catalyst, 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.
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.
- A new Supreme Court ruling marginally increases the odds that opponents of cannabis rescheduling could win a court challenge to the reform, if it happens. The ruling basically puts more power into the hands of judges to dismantle agency actions, like rescheduling. It reverses a 1984 legal doctrine called Chevron deference, which gave executive branch agencies like the Department of Health and Human Services (HHS), the Department of Justice (DOJ) and others wide latitude in implementing laws passed by Congress.
This is a classic separation of powers issue. It addresses the constitutional dispersion of power to Congress, the executive branch, and the Supreme Court. High level, the new ruling states that when laws assigning powers to executive agencies are ambiguous, courts have to clarify the ambiguities, not agencies.
All laws contain language and concepts that are ambiguous. To the extent that the Controlled Substances Act (CSA) is ambiguous in how it assigns rescheduling responsibilities to agencies like the HHS and DOJ, courts now have more power to reverse agency actions like rescheduling.
On the bright side for rescheduling advocates and cannabis investors, the decision emphasizes the respect courts should show when Congress has overtly delegated power to an agency, which is the case with HHS and the CSA. The case is called Loper Bright Enterprises v. Raimondo.
“I remain confident that Schedule III will happen and that it will survive judicial review under Loper Bright just as surely as it would have under Chevron,” says Shane Pennington, a regulatory expert and partner at Porter, Wright, Morris, and Arthur LLP.
- North Dakota cannabis activists say they have turned in more than enough signatures to put a recreational-use legalization initiative on the ballot in November. The activist group, called New Economic, says it submitted 22,444 signatures. They needed around 15,500. A recent poll, however, found that 57% of North Dakota voters oppose rec-use cannabis legalization. North Dakota voters rejected rec-use cannabis legalization two years ago. Medical cannabis is permitted in the state.
- Texas cannabis activists say they have turned in enough signatures to put a marijuana decriminalization initiative on the ballot in the town of Bastrop in November. Ground Game Texas says activist submitted more than 600 signatures. They need around 400 to qualify. A few weeks ago, Dallas cannabis advocates turned in almost 50,000 signatures to put decriminalization on that city’s ballot. Voters in several Texas cities have approved decriminalization initiatives. They include Austin, San Marcos, Killeen, Elgin and Denton. Gov. Greg Abbott (R) opposes municipal cannabis reform efforts, arguing that towns and cities lack the authority to override state law. A recent survey found that three-fifths of Texans support legalization.
- Arkansas cannabis activists have turned in enough signatures to get a measure on the November ballot to expand the state’s medical cannabis program. The measure would expand the kinds of health care professionals who could recommend cannabis to include nurses, physician’s assistants, pharmacists and osteopathic doctors. It would also allow them to recommend cannabis for any condition. Users would be allowed to grow their own supply. Another provision would fully legalize cannabis if it becomes legal at the federal level. Arkansans for Patient Access submitted 111,400 signatures. They needed 90,704. Arkansas has allowed medical use since 2019.
- Nebraska cannabis activists have turned in enough signatures to put medical cannabis legalization initiatives on the November ballot.
One initiative would require lawmakers to establish protections for doctors who recommend cannabis and patients who buy it. The other initiative would create a Nebraska Medical Cannabis Commission that would set up regulations for medical cannabis companies. Gov. Jim Pillen (R) opposes the reform. Nebraskans for Medical Marijuana submitted more than 114,000 signatures for each of the proposals. They needed 87,000.
- Maryland has booked $1.1 billion in cannabis sales since it legalized recreational-use sales a year ago. Recreational-use sales came in at $700 million and medical-use sales hit $400 million.
- Kentucky is now one step closer to offering medical cannabis. It is now taking applications for cannabis business licenses. Kentucky will award 48 dispensary licenses. Doctors can now apply to state medical boards for permission to recommend cannabis to patients. The state legalized medical cannabis in 2023. Patients should be able to apply for cannabis cards at the start of 2025.
- Germans can now apply to set up “cannabis clubs.” Germany legalized cannabis for personal use in April. The clubs will be allowed to sell 50 grams of cannabis a month to a max of 500 members. Germany also took cannabis off its narcotics list, which makes it easier for doctors to recommend it for medical use. This will help cannabis companies setting up operations there like our Curaleaf (CURLF).
- A “Florida Freedom Fund” set up by Gov. Ron DeSantis’s (R) to pay for a campaign against a November ballot initiative to legalize recreational use has so far raised only $10,000. A group lobbying in favor of the change called Smart & Safe Florida has raised over $60 million.
- Yet another poll suggests the vote on a Florida ballot initiative to legalize recreational-use cannabis is going to be close. A recent survey conducted by Florida Politics found 64% of likely voters support the initiative, called Amendment 3. The margin of error was 2.9%. The initiative needs 60% of the vote to pass. Other recent polls found support hovering just below the 60% mark. A group with a $60 million war chest to campaign for the change has not yet launched its efforts. Smart & Safe Florida says it will step up its campaigning in September. The most recent Florida Politics poll confirmed that young people decisively support legalization. All voters age 18-29 said they support the legalization initiative.
- The National Collegiate Athletic Association (NCAA) has voted to remove cannabis from its banned substances list for Division I players. The NCAA said cannabis is not a performance-enhancing drug, and it should be treated like alcohol. The NFL and the Ultimate Fighting Championship (UFC) have also relaxed rules on cannabis use.
- Brazil’s Supreme Court has voted to decriminalize cannabis possession for personal use. Selling cannabis remains illegal.
Company News
AYR Wellness (AYRWF)
AYR Wellness has opened another store in Illinois, in a Chicago suburb. That’s its third location in the state and its 92nd nationwide.
Trulieve Cannabis (TCNNF)
Trulieve continues to bet big on Florida. In early July it opened three new stores there in Homosassa,
Madison and Panama City. Over two-thirds of the company’s 200-plus stores are in Florida. Trulieve is the biggest funder of the Smart & Safe Florida fund, which will pay for ads backing a November ballot initiative that would legalize recreational use. The fund has raised over $60 million, and the lion’s share came from Trulieve. I expect Trulieve stock to make a huge move up if Floridians approve the ballot measure. Several recent polls suggest the vote will be close. But Smart & Safe Florida hasn’t really stepped up its campaign yet. The initiative needs 60% of votes to pass.
Verano (VRNOF)
Verano is expanding its Cabbage Club loyalty program to three new states, Connecticut, Maryland and Michigan. Under the marketing program, customers pay $149 or $249 for an annual membership in exchange for credits and coupons that exceed the cost of membership, early access to new products, line-skipping, special events, concierge service, plus a cookie at checkout. The program was first launched in Illinois and New Jersey. Verano says it will roll out the program in other states over the next eighteen months. Verano has 142 stores in 13 states.
Cannabis Plus Insider Portfolio News
This section offers updates on our Cannabis Plus Insider Portfolio names. These are companies that have exposure to the cannabis sector without actually touching the plant. They also must have favorable insider buying, according to my system for analyzing insider activity.
AFC Gamma (AFCG)
Our cannabis sector real estate lender AFC Gamma today spun off its non-cannabis lending activities into a real estate investment trust (REIT) called Sunrise Real Estate Trust (SUNS). This REIT may do well. But because it has no cannabis exposure, I suggest selling SUNS and rolling the cash into AFC Gamma and our other cannabis lender, Chicago Atlantic Real Estate Finance (REFI) in equal proportions. Both AFCG and REFI are income plays that pay yields well north of 10%.
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