Cabot Cannabis Investor Issue: June 28, 2023

There is a potentially nice trading opportunity setting up in cannabis near-term.

When Washington, D.C. lawmakers return from their July 4th break on July 10, they are likely to get down to serious business on the SAFE Banking Act.

This proposed law would boost investor interest in the space because it would allow banks to work with cannabis companies. This would help cannabis companies in several ways.

Cannabis companies would no longer have to operate in cash only. They’d get cheaper access to financing. They’d have better access to vendors and business partners, and they could better attract management talent, notes Kim Rivers, CEO of our Trulieve (TCNNF).

The bill may also include provisions that allow cannabis companies to more easily graduate to bigger stock exchanges from the over-the-counter exchange. This last benefit is more of a wild card.

Big picture, approval of the bill would be a watershed moment because it would be one of the first acknowledgments at the federal level that cannabis is a legitimate business, says Boris Jordan, founder chairman at our Curaleaf (CURLF).

Here is more detail on what might play out next month, sparking a move up in the group. When lawmakers come back from break July 10, the Senate banking committee is likely to mark up a SAFE banking bill that has been introduced simultaneously in the Senate and the House. Then they are likely to vote it out of committee before the August break, say cannabis lobbyists in Washington, D.C. After that, the bill will go to a vote in the full Senate sometime later this year. SAFE has filibuster proof support in the Senate (at least 70 votes), believes Don Murphy, Director of Federal Policies at Marijuana Policy Project, an industry lobbying group.

The bill’s fate in the Republican-controlled House is less certain. But that won’t stop cannabis stocks from rallying in July on concrete signs of progress in the Senate on SAFE. The risk here is that Senators on the left try to load up the latest “clean” version of SAFE with “social justice” amendments that make it harder for Republicans to support the bill. This has sunk similar bills in the past. SAFE stands for the Secure and Fair Enforcement Act.

Here are some other potential July catalysts for cannabis.

* Maryland starts recreational use sales on July 1. This is well known, and possibly priced into the stocks. Nevertheless, headlines around the event may attract investor interest.

* Some analysts think we could get a Florida Supreme Court decision in July on the wording of a proposed referendum that would allow Floridians to vote on legalizing recreational use in the 2024 elections.

Florida is a potentially big market given its population of 22 million and the 138 million tourist visits per year. Approval is probably not priced into cannabis stocks since the Florida Supreme Court has a conservative bent. Conservative politicians are aware that a cannabis referendum would bring out voters on the left.

Florida, where medical use is permitted, is currently a $2 billion annual revenue market. That would go up to $6 billion with the legalization of recreational use, believes Rivers at Trulieve, the biggest operator in the state. Trulieve has funded the referendum effort. Projections of a court decision in July could be premature, since the court has until the end of April 2024 to decide.

What to Do Now

Any of the names in our cannabis portfolio would be successful plays on a move up in the group linked to Senate progress on SAFE banking after July 10. I especially single out our largest holdings, Cresco Labs (CRLBF) Curaleaf and Green Thumb (GTBIF). A more diversified way to play the potential move is via the exchange-traded fund (ETF) AdvisorShares Plus US Cannabis (MSOS) and the leveraged version AdvisorShares MSOS 2X Daily (MSOX). I personally favor MSOX for trading positions, since theoretically it moves twice as much as MSOS, in either direction. But if big moves in your positions make you excessively emotional, which hurts market performance, go with MSOS in the ETF category. I suggest lightening up on trading positions on any eventual positive Senate banking committee vote on SAFE, since the group is volatile and there may be a slowdown in catalysts in August. Today I am increasing leverage in the portfolio by selling 600 shares of MSOS and putting the proceeds into MSOX. I will use today’s closing prices for the change.

News Roundup

Here are the most relevant developments over the past two weeks.

Dismantling Nixon-Era Cannabis Restrictions

U.S. Department of Health and Human Services (HHS) Secretary Xavier Becerra said in a mid-June press briefing he hopes to provide President Joe Biden a federal cannabis re-scheduling opinion by the end of the year.

The Food and Drug Administration (FDA), under purview of HHS, is reviewing scientific literature to weigh in on whether marijuana should be de-scheduled under the Controlled Substances Act. Currently, it is in the Schedule I category, the most restrictive classification that includes drugs like heroin.

One concern has been the shortage of scientific studies on safety and efficacy needed to support a favorable FDA decision. But Jordan at Curaleaf says there may be sufficient research supporting a de-scheduling if the FDA considers studies done abroad in countries like Israel. The Department of Justice will make the final decision, based on input from HHS and the Drug Enforcement Agency. “I think it is inevitable, but I don’t know the timing,” says Verano (VRNOF) founder and CEO George Archos.

De-scheduling (down to Schedule III) would be a huge catalyst for cannabis stocks, since it could neutralize a draconian IRS tax provision, called 280E, that prohibits cannabis companies from deducting most expenses on tax forms. Cannabis companies paid over $1.8 billion in extra taxes because of the regulation, according to Whitney Economics. Verano would net about $100 million in annual revenue with the change, about 11% of its current annual sales, says CEO Archos.

New Cannabis Lobbying Effort

A large group of marijuana companies, trade organizations, law firms, doctors, and activists has launched a new lobbying group called the Coalition for Cannabis Scheduling Reform (CCSR). As the name suggests, the group will try to persuade the FDA and other agencies to de-schedule marijuana under the Controlled Substances Act.

“We’re optimistic that the FDA and the administration will listen to the science and the legal arguments, which will inevitably point them to Schedule 3 or lower, or in an ideal case, de-scheduling,” said Bryan Barash, vice president at cannabis tech firm Dutchie and co-chair of CCSR. Members include our Cresco Labs, Curaleaf, Green Thumb, and Verano.

Price Compression Easing

After falling precipitously for over two years, Colorado marijuana prices reversed the trend and firmed up in June. The price for a pound of cannabis rose to $703 from $649. The reversal could incrementally improve company performance and investor sentiment towards the sector, which has been plagued by oversupply and plummeting prices. In January 2021, cannabis cost $1,731 per pound at the wholesale level in Colorado.

“We are seeing stabilization in some markets,” says Verano’s Archos, the CEO there. “The one benefit of restrictive capital is you don’t hear much about cultivation being built.”

Favorable State-Level Tax Reform

States continue to reform tax laws to allow cannabis companies to deduct expenses against income. In mid-June the governor of Illinois signed a bill that allows cannabis companies to take tax deductions prohibited under IRS code 280E.The governors of Connecticut and New Jersey also approved a similar provision, recently.

Another Hit to Excess Supply

A big California marijuana distributor called Herbl went into receivership in June after falling behind on loan payments. While this is a disaster for Herbl employees and creditors, the change could benefit remaining players in the space since it represents another step towards removing excess supply from the market. The event will also further discourage investors from investing in supply growth.

Cannabis and Basketball

The National Basketball Association has lifted bans that prevented players from consuming cannabis and investing in and promoting cannabis companies. The decision marks another cultural shift towards broader acceptance of cannabis that could support efforts to legalize it at the federal level, and in states that still prohibit it. “We decided that, given all the things that were happening in society, given all the pressures and stress that players were under, that we didn’t need to act as Big Brother right now,” said Commissioner Adam Silver. “I think society’s views around marijuana has changed to a certain extent.”

Cannabis Lounges

Visitors to Las Vegas will soon have lounges where they can legally smoke cannabis because Nevada recently issued its first cannabis consumption lounge licenses.

The Nevada Cannabis Control Board (CCB) issued two licenses for use in the Las Vegas Valley, and one for use in Washoe County in the northwestern corner of the state.

“Receiving this confirmation from the state allows us to move on to the final design and buildout of our consumption lounge,” says Larry Scheffler, co-CEO of Planet 13, a dispensary near the Las Vegas Strip that got one of the licenses. The cannabis lounge “will give customers the ability to try products prior to buying, watch live entertainment, and enjoy food and drink in a social setting.”

Israeli Medical Use to Expand

Israelis will soon find it easier to legally purchase cannabis for medical use. In mid-June, the Knesset Health Committee agreed to lift restrictions requiring residents to apply for a license to buy medical marijuana. Under the new rules, specially trained doctors will provide prescriptions without a licensing requirement. The new rules should go into effect in about six months. Israel is a small country, but the change adds momentum to ongoing cannabis reform internationally.

Company News

AYR Wellness (AYRWF)

Lenders are resorting to the tactic of “amend and extend” to help cannabis companies through the current bout of hard times caused by oversupply, price compression, and delays in federal reform that would help the industry.

On June 26, for example, AYR Wellness announced an agreement with lenders to extend debt maturities. The agreement will defer principal and amortization payments for two years on $69 million in debt obligations. AYR will pay amendment fees, and interest on the debt will go up by 0.5%. The company has now successfully extended the payment terms on $96.9 million in obligations.

Though TerrAscend (TRSSF) is not a portfolio company, it is worth noting it recently inked a private placement of equity and unsecured convertible debentures that raises $20 million. Insiders participating in the debenture offering included CEO Ziad Ghanem, CFO Keith Stauffer, chief people and culture officer Jeroen De Beijer, and director Edward Schutter. The deal confirms interest in funding cannabis companies despite all the sector challenges. TerrAscend recently got Toronto Stock Exchange approval to list on its exchange. Proceeds will be used to fund the new listing effort, dispensary acquisitions in Maryland, and general working capital.

Cresco (CRLBF)

Chicago-based Cresco Labs opened two stores in Florida in St. Petersburg, and in Destin, a town in the Panhandle. The openings increase Cresco’s Florida retail footprint to 31 dispensaries. Cresco now has 66 locations nationwide. Florida cannabis sales could triple to $6 billion annually from $2 billion, if recreational use becomes legal. Legalization may be put to voters in a referendum in 2024. If approved, recreational sales would likely start in 2025.

Green Thumb Industries (GTBIF)

Green Thumb in June opened Rise Dispensaries in Las Vegas, Philadelphia, and Danville, Virginia. That takes its total dispensary count nationwide to 83.

Organigram (OGI)

Organigram will carry out a four-for-one reverse stock split effective July 5, to comply with Nasdaq listing requirements. The company also announced a new line of infused pre-rolls called SHRED X Heavies, its first infused pre-roll offering that will have a potency of over 40%.

Tilray (TLRY)

Tilray completed its acquisition of HEXO. The merger creates Canada’s largest cannabis company by revenue and boosts Tilray’s market share to about 13%. The combined company will have a 40% market share in flower and a 29% share in pre-rolls. Tilray expects to realize cost savings of more than $27 million.

Trulieve (TCNNF)

Trulieve opened dispensaries in Fort Myers, Florida and Phoenix, Arizona. The company also announced the appointment of Tim Mullany as CFO. Mullany has previously been CFO at Jack in the Box (JACK) and Rave Restaurant Group (RAVE).

Verano (VRNOF)

Verano announced the launch of a new brand of cannabis extracts called On The Rocks. The lineup will include rosin cartridges, concentrates and gummies. On The Rocks is a solventless extract, or an extract made without the use of chemical solvents. Verano is launching On The Rocks in Pennsylvania, Illinois, Florida, Arizona and New Jersey. “Introducing On The Rocks solventless extracts to our expanding brand portfolio recognizes and responds to cannabis connoisseurs’ appetite for refined experiences, flavors and formats,” says Verano CEO and founder George Archos.

Sector Performance

I’ve increased leverage in our portfolio by adding the AdvisorShares MSOS 2X Daily (MSOX). It is a top-five position and this has hurt the portfolio as the sector selloff continues. This has been a negative near term, but I believe the added leverage will pay off when sector sentiment rebounds. The New Cannabis Ventures Global Cannabis Stock Index is down 22.9% year to date, compared to a 27.2% decline in our portfolio. I personally continue to add leverage by purchasing the MSOX on any significant weakness of 2%-4% or more. Please use limit orders a bit below the bid because the bid ask spreads on our names and ETFs can be abusively wide. Portfolio prices as of the close June 27.

Portfolio

Company Profiles

Ayr Wellness (AYRWF) This is a vertically integrated multistate operator based in Miami. It has 83 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.

AYR recently 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 $96.5 million in cash and $618 million in net debt. This debt overhang is one reason why Ayr trades at a miniscule .12 times sales. The company says it will be cash flow positive for the year in 2023. The company is founder-run, which can be a plus in investing. BUY

Cresco Labs (CRLBF) Chicago-based Cresco will become the biggest cannabis company in the world, if its acquisition of Columbia Care (CCHWF) is completed. The deal will double Cresco Labs’ retail footprint and give it the number one market share in five markets. It will reach over 70% of eligible U.S. consumers. Cresco maintains the deal will close despite delays which have some analysts questioning that. The companies are debating asset divestures and the right amount of cash to raise relative to the combined debt.

The Columbia Care deal will create “the highest value footprint in cannabis, access to 180 million Americans, all 10 of the 10 highest projected 2025 revenue states, and exposure to the largest industry growth drivers of the next few years,” says Cresco Labs CEO and co-founder Charles Bachtell.

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 trailing price to sales ratio of .59. BUY

Cronos Group (CRON) There’s been some big insider buying at Cronos Group and I think it makes sense to follow the insider into this name. Cronos is mainly a foreign operator with exposure to Canada and Israel. It’s in turnaround mode, and often insiders buying their own turnaround is a good combination.

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. In the U.S., Cronos sells hemp-derived supplements and cosmetic products under the brands. Cronos has a 10% stake in Cronos Australia, a publicly traded company.

Cronos has $836 million in cash, or about $2.30 per share, against minimal debt of $3.5 million. Some of that cash could be deployed in acquisitions, possibly to expand in the U.S. adult-use market.

As for the insider buying, director Jason Adler purchased $3.9 million worth of stock in the $2.80 to $3.10 range in November and December. This is the first insider purchase in this name since August 2020. In the middle of May, he purchased another $665,000 worth of stock at $1.71 to $1.90. Cronos trades at .63 times book value. BUY

Curaleaf (CURLF) Massachusetts-based Curaleaf was the industry leader last year. It operates 152 dispensaries and 28 grow sites in 19 states and its European operations. Here are three factors that support growth. It has one of the strongest brand portfolios in the U.S. led by Select, the number one selling vape brand in its markets.

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

2. Curaleaf is an industry consolidator. The company’s executive chairman has a lot of experience rolling up fragmented and distressed industries. M&A is supported by a healthy balance sheet and good access to capital. Given how much the cannabis group has fallen in the past year, there are probably a lot of good bargains out there.

3. Curaleaf will benefit from progress on legalization in Germany and 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 1.58. BUY

ETF AdvisorShares Pure US Cannabis (MSOS) This exchange-atraded 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 a 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. Green Thumb was the third-largest cannabis company in the U.S. last year, with operations in 15 markets. 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. It has 83 retail stores and 18 manufacturing facilities in 15 U.S. markets.

Green Thumb is expanding its medical footprint in Florida through a lease agreement with the convenience store chain Circle K. This could be a big deal, since the Circle K chain has 600 locations in Florida. Ongoing market developments in Illinois and New Jersey could be strong catalysts for Green Thumb Industries.

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 1.76. BUY

Organigram (OGI) Organigram holds the #3 position among Canadian licensed producers. It also sells high-margin flower in Israel and Australia. It signed a deal in May to supply a German medical cannabis operator called Sanity Group. 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.

OGI expects to generate positive free cash flows by the end of calendar 2023. OGI also guided for higher revenue this year. It expects improved profit margins because of increased international sales, which produce higher profits, and increased sales of higher margin finished products like those in its Holy Mountain line-up.

British American Tobacco (BTI) is a big investor in Organigram, owning 19.4% of the company, an endorsement of its potential. The two companies collaborate to develop cannabis products. The price to sales ratio is .97. 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, but 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. Once Germany legalizes, other countries will follow suit, probably using Germany’s regulatory framework as a blueprint on how to proceed.

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 1.53. BUY

Trulieve (TCNNF) Trulieve has long been the biggest medicinal marijuana vendor in Florida, where it has 50% market share. It has 186 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 via acquisitions. It is diversifying its presence into Pennsylvania, Maryland, Georgia, Ohio and Massachusetts, among other states.

The company finished the first quarter with $195 million in cash against $1 billion in debt. The company projects operating cash flow of $100 million this year. “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 .62. BUY

Verano (VRNOF) Chicago-based Verano is one of the top five publicly traded multi-state operators in the U.S. by sales. The company has 126 stores and fourteen cultivation and processing plants in thirteen markets. 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 are about to legalize recreational use like Maryland, and states that may soon legalize recreational like Florida, Ohio and Pennsylvania. The company’s strategy has been to position with medical dispensaries in states most likely to soon go recreational.

Verano also has consistent operating cash flow at a time when financial strength is important due to pricing pressure in the sector.

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 roll out 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 has been dialing back capital spending and cutting overhead to bolster its balance sheet. But it has some of the strongest operating cash flow in the business. It ended the first quarter with cash of $95 million against debt of $502 million.

Verano is founder-run, which can be a plus in investing. Verano has a price to sales ratio of 1.07. BUY

The next Cabot Cannabis Investor Issue will be published on July 26, 2023.