Cabot Cannabis Investor Issue: September 27, 2023

The Senate banking committee is likely to approve key cannabis sector banking reform today.

Approval would be a significant catalyst for the group. So, it may spark a tradable rally.

What to Do Now

Short-term traders may want to sell the strength in this volatile group. Another option would be to de-lever cannabis exposure by selling a portion of AdvisorShares MSOS 2x Daily ETF (MSOX) holdings and swapping the funds into the unlevered version, AdvisorShares Pure U.S. Cannabis ETF (MSOS). That maintains exposure to the group in front of expected catalysts ahead but dampens some portfolio volatility.

Long-term investors, like me, should just hold tight through the volatility because several more catalysts lie ahead, though I may de-lever a bit in the manner described above to lock in some gains, if there is enough strength to warrant this.

Potential Catalysts Ahead

The big one is further progress on rescheduling cannabis under the Controlled Substance Act to Schedule III from Schedule I. The Drug Enforcement Agency (DEA) may publish a proposed rule here by year end, says one regulatory lawyer in Washington, D.C.

Other potential catalysts include a full Senate vote on SAFER, possibly soon; voter approval of a recreational use legalization referendum in Ohio this fall; and Florida Supreme Court approval of a similar referendum in Florida.

SAFER Banking Progress

Near term, the Senate banking committee should vote today on the Secure and Fair Enforcement Regulation (SAFER), which would permit a lot more banks to serve cannabis companies. This would help them by allowing dispensaries to use credit cards and giving companies wider access to cheaper financing.

Cannabis lobbyist Don Murphy of the Marijuana Policy Project expects the full Senate could vote on the bill within weeks. This would be another big catalyst.

TD Cowen cannabis sector analyst Jaret Seiberg is not so sure. He cautions that “key fights over social justice provisions are being punted to the Senate floor.” He thinks this lowers the odds of full Senate approval. By “social justice provisions,” he means the desire among several Senate Democrats to include language that expunges criminal convictions for cannabis possession or ensures those most hurt by the war on drugs benefit from legalization. “If Democrats overreach, the bill will not advance,” says Seiberg. He thinks this is possible.

Another challenge for SAFER is that prospects in the Republican-controlled House of Representatives are not as bright. Murphy does not rule out passage here, as well. He predicts SAFER will be law by the end of 2024, but that it could happen much sooner. Again, Seiberg is less optimistic. “House GOP leaders either oppose the SAFE Act or are agnostic,” he says. “In addition, leadership of the House is a mess right now with conservatives and moderates fighting. It is hard to see much of an appetite for tackling something as politically tricky as the SAFER Act.”

Here’s another factor that may contribute to near-term downside volatility. When stocks advance a lot, companies use the strength to raise capital. The inevitable stock offerings have already started to hit the cannabis sector because of the strength this month. Both Canopy Growth (CGC) and Cannabist Company (CCHWF), formerly called Columbia Healthcare, moved to raise capital into the strength. This has created some sector weakness since investors are wondering who’s next. Stocks typically decline on stock offering news.

Here’s a roundup of other key cannabis-related news at the federal level.

* The Congressional Research Service (CRS) says in a new report this month that the Drug Enforcement Administration (DEA) will likely go along with a Department of Health and Human Services (HHS) recommendation to reschedule cannabis under the Controlled Substances Act (CSA). HHS has recommended cannabis be moved to Schedule III from Schedule I. The move would help cannabis companies by allowing them to deduct expenses against income in federal tax returns. Legal experts think the DEA may issue a proposed rule on rescheduling by the end of the year. “If past is prologue it could be likely that DEA will reschedule marijuana according to HHS’s recommendation,” says the CRS. That would be a meaningful catalyst for cannabis stocks.

* A House committee has approved a bipartisan bill that would prevent federal agencies from denying employment or security clearances based on prior cannabis use. The House Oversight and Accountability Committee passed the bill in a 30-14 vote. Ten Republicans backed the measure. The bill is sponsored by Reps. Jamie Raskin (D-MD), Nancy Mace (R-SC) and Earl Blumenauer (D-OR). It is called the Cannabis Users’ Restoration of Eligibility (CURE) Act.

Though several Republicans spoke out against the bill, the bipartisan vote is another example of how the momentum behind state legalization and more favorable cultural attitudes towards cannabis continues to chip away at anti-cannabis policies at the federal level. In July, the Senate approved legislation that would prevent intelligence agencies from denying security clearances on the basis of prior cannabis use.

* Senate Majority Leader Chuck Schumer (D-NY) is circulating an online petition calling for the federal legalization of cannabis. “It’s time to legalize marijuana nationwide,” Schumer said in a mass email which asked supporters to put their name and contact information on the petition. So far this year, neither Schumer nor any other senator has introduced legislation to legalize cannabis. House Democrats have filed such a bill, but its prospects are dubious in the Republican controlled chamber.

* A recent press release from Sens. Cynthia Lummis (R-WY) and Steve Daines (R-MT) says the two will introduce legislation that blocks federal agencies from legalizing cannabis without Congressional approval. Both Senators are sponsors of the Secure and Fair Enforcement Regulation (SAFER) Act that would allow banks to serve cannabis companies.

* Earlier this month, fourteen House and Senate Republicans sent a letter to the Drug Enforcement Administration (DEA), asking the agency to reject a rescheduling recommendation from the U.S. Department of Health and Human Services (HHS) and keep cannabis in Schedule I of the Controlled Substances Act. Cannabis advocates view it as a positive that only fourteen out of over 250 conservative lawmakers in Congress signed the letter, and that none of the lawmakers who are doctors signed on. Neither Daines nor Lummis signed the letter.

Favorable Cultural Momentum Continues

A key reason to hold medium-term positions in cannabis names is that what I call “cultural momentum” towards more favorable views on cannabis continues to build at the local level and around the world. Here are some recent highlights.

* We see this trend in rising cannabis sales. Rhode Island cannabis sales hit another record in August, when consumer purchased $9.67 million worth of product. That was the fourth month in a row of record sales. Recreational use was launched in December 2022, and medical use was already legal. Flower was the most popular product, followed by pre-rolls, edibles, vape carts, and concentrates. Other states posting record sales in August include Montana, New Mexico, Connecticut, Maine, Massachusetts, and Maryland. Canadian cannabis sales also hit a record level in July retail, at $446.1 million in Canadian dollars.

* An advisory committee in the National Collegiate Athletic Association (NCAA) has recommended that marijuana gets removed from the list of banned substances list for college athletes.

* Alaska is loosening restrictions on cannabis advertising. The new rules will allow cannabis ads on buses, bus stop shelters, college campuses, and on signs around stores and billboards. The changes will also make it easier for suppliers to give away free samples and coupons, as part of their marketing. The changes go into effect October 8. Alaska legalized recreational use in 2014.

* Like Switzerland and Luxembourg, Holland is rolling out a pilot program that allows a small number of state-sanctioned cannabis growers to supply retail outlets like coffee shops. While the sale of cannabis has long been tolerated, even though this is technically illegal, Holland has been stricter about enforcing laws against production and distribution. The pilot program is meant to provide insights on how to phase in legal suppliers on a wider basis.

Cannabis Portfolio Company News

Our companies continue to take steps to position themselves in markets that may soon see rapid growth because of legalization efforts.

Cresco Labs (CRLBF)

Chicago-based Cresco Labs (CRLBF) continues to boost its position in Florida, ahead of possible recreational use legalization in 2025 following a potential referendum vote on legalization in 2024.

Cresco recently rolled out flower and rosin offerings sold under its premium brands FloraCal and Cresco in the Sunshine state. “A growing number of patients are looking for more premium quality flower options and live rosin products—which is exactly what our FloraCal and Cresco brands offer,” said CEO and co-founder Charlie Bachtell. The products sold under these brands have been available in several states including Illinois, California and Pennsylvania.

The Florida Supreme Court has until April to approve or reject the language in a proposed referendum on legalization. If it does not act by then, the referendum is deemed valid. Legalization of recreational use would make Florida one of the biggest markets in the country, given its large population and tourist industry.

Cronos Group (CRON)

Cronos Group (CRON) is rolling out its Peace Naturals brand in Germany, following an agreement signed in July to sell products in a partnership with Cansativa Group, a big distributor in the country.

Cansativa supplies about 2,000 pharmacies which serve around 300,000 medical cannabis users in Germany. “Re-entering the German market, which has about 83 million people, is a significant milestone for Cronos and we look forward to expanding our reach and brand awareness in Germany with the help of Cansativa,” said CEO Mike Gorenstein.

Germany is in the process of rescheduling cannabis by taking it off its narcotics list. Analysts say the move will create big market growth, since the change makes it a lot easier for Germans to get medical use approval, so analysts expect rapid market growth. The German parliament is also considering a bill to legalize recreational-use cannabis.

Trulieve (TCNNF)

Trulieve (TCNNF) is chipping away at its big debt load, which stands at $968 million against $150 million in cash. The company announced the purchase of 57,000 of its $1,000-face-value senior secured notes on September 21 for $47.6 million, a 16.5% discount to par, plus accrued interest. The 8% notes were due in October 2026.

The company opened another medical dispensary in Florida this month. Trulieve is the market leader in the state, where it has over 125 dispensaries. It also opened another medical dispensary in neighboring Georga, bringing the total there to five.

Canna Plus Portfolio News

This portfolio consists of cannabis-related companies that do not touch the plant, where insiders have been buying shares.

Chicago Atlantic Real Estate Finance (REFI)

The company declared a quarterly dividend of 47 cents per share on September 18, in line with the prior quarter’s dividend, for a dividend yield of 12.3%. The dividend is payable October 13, 2023, to shareholders of record as of September 29. The real estate investment company (REIT) is a commercial real estate finance business serving the cannabis sector.

AFC Gamma (AFCG)

The company declared a quarterly dividend of 48 cents per share on September 15, in line with the prior quarter’s dividend, for a dividend yield of 15.4%. The dividend is payable on October 13, 2023, to shareholders of record on September 30. The REIT is a commercial real estate lender that primarily serves the cannabis sector.

Sector Performance

I’ve increased leverage in our portfolio by adding the AdvisorShares MSOS 2X Daily (MSOX). It is a top five position. This hurt the portfolio as the sector sell-off continues, but now it helps us in the sector strength.

Our main cannabis portfolio is up 5.3% year to date, compared to a 2% decline in The New Cannabis Ventures Global Cannabis Stock Index, for 7.3 percentage points of outperformance.

The Cannabis Plus Insider Portfolio is down .53% compared to a gain of 4.6% a month ago, including dividends. It has been hurt by the general market decline.

Portfolio prices are as of the close, September 26.

Portfolio

Company Profiles

Ayr Wellness (AYRWF) This is a vertically integrated multistate operator based in Miami. It has over 85 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 .39 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 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 price to sales ratio of .81. BUY

Cronos Group (CRON) 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. The company has a partnership with Cansativa Group which allows Cronos to sell its i Peace Naturals brand in Germany, where the cannabis market should grow dramatically over the next several years because of liberalization of restrictions on sales. Cronos has a 10% stake in Cronos Australia, a publicly traded company.

Cronos has $841 million in cash, or about $2.21 per share, against minimal debt of $3.2 million. Some of that cash could be deployed in acquisitions, possibly to expand in the U.S. adult-use market.

There’s been some big insider buying at Cronos Group and I think it makes sense to follow the insider into this name. Director Jason Adler has purchased large amounts in the $1.71 to $3.10 range. Cronos trades at .73 times book value. BUY

Curaleaf (CURLF) Massachusetts-based Curaleaf was the industry leader last year. It operates 152 dispensaries and 22 grow sites in 19 states and its European operations. It has one of the strongest brand portfolios in the U.S. led by Select, the number one selling vape brand in its markets. Here are three factors that support growth.

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 2.18. BUY

AdvisorShares Pure U.S. Cannabis ETF (MSOS) This exchange-traded 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 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 84 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 2.51. 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 increase 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 1. 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 2.53. BUY

Trulieve (TCNNF) Trulieve has long been the biggest medicinal marijuana vendor in Florida, where it has 50% market share. It has over 185 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 reports $188 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 1. 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 over 130 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. The company reports cash of $102 million against debt of $508 million.

Verano is founder-run, which can be a plus in investing. Verano has a price to sales ratio of 1.71. BUY

The next Cabot Cannabis Investor Issue will be published on October 25, 2023.