Cannabis companies remain in hunker-down mode as challenges persist. Those include price compression, competition from hemp-based THC product sales, and uncertainty about potential federal reform.
Not all cannabis companies are going to survive. Ayr Wellness (AYRWF) looks like it is about to go under. I’ve only ever kept a very small position in that name, so the company’s demise did not cause too much damage.
Cresco Labs (CRLBF) will survive, but its first-quarter earnings report demonstrated how sector trends are stressing cannabis companies. Revenue declined because of price compression and because it had to cut ties with some customers due to their financial weakness.
What Could Go Right
Terrance Cole should be formally appointed to head the Drug Enforcement Administration (DEA) soon. Then we should finally get clarity on where President Donald Trump really stands on rescheduling. This reform would significantly benefit cannabis companies by increasing cash flow. Moving cannabis to Schedule III from Schedule I under the Controlled Substances Act would neutralize an IRS provision barring cannabis companies from deducting operating expenses.
In Senate confirmation hearings, Cole said he would make rescheduling a top priority. That’s the good news. However, tantalizingly, he declined to clarify where he stands on the issue. It may not matter, because Trump likely has the final say. Trump endorsed rescheduling during his election campaign. I don’t see any reason to think he changed his mind. Cannabis investors will benefit if he lives up to his “promises made, promises kept” mantra and directs Cole to get rescheduling done.
Elsewhere, the odds remain favorable that Pennsylvania could legalize recreational use this year. Pennsylvania is a large state, so this news would be bullish for the group. Many of our portfolio companies operate in Pennsylvania, and several have been expanding their presence in the past year.
What to Do Now
In this environment, it pays to stay with companies that are most successful at playing the hunker-down game, and companies that otherwise have sound financial strength. From our portfolio, I’ll single out Cronos (CRON), Cresco, Green Thumb (GTBIF), and Trulieve Cannabis (TCNNF). For diversified exposure, consider AdvisorShares Pure U.S. Cannabis (MSOS). Other portfolio names warrant smaller exposure, and Ayr Wellness is a hold.
Our Cannabis Plus Insider Portfolio of cannabis lenders continues to look attractive for their rich yields and capital appreciation potential in a rescheduling and banking reform scenario. They are: Advanced Flower Capital (AFCG), Chicago Atlantic Real Estate Finance (REFI) and Chicago Atlantic BDC (LIEN). They pay yields of 16.2%, 13.2% and 13.6% respectively.
In dividend investing, yields like these are often considered “too high” and a sign of trouble at a company. The theory is that if a stock falls so much that a dividend yield spikes, that’s a bad thing because the stock decline signifies business weakness.
At least as of the most recent updates, it does not appear these elevated dividends signify weakness. All three companies have recently affirmed their dividend payouts. A major bank that has been funding Advanced Flower Capital recently extended another $20 million in financing, an obvious endorsement of the viability of this cannabis lender.
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 institutional investors will not ignore cannabis stocks 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.
Federal News
* The hemp-derived cannabis products industry could be eviscerated by a provision in a House committee spending bill. The proposal would redefine hemp to prohibit cannabis products with any “quantifiable” amount of THC or “other cannabinoids that have similar effects” as THC.
The proposal would keep the legal status of “industrial hemp” and permit the cultivation and sale of hemp grown for fiber, whole grain, oil, cake, nut, hull, microgreens or “other edible hemp leaf products intended for human consumption.”
In short, the proposal would close the “hemp loophole” in the Farm Bill. The change would be good news for cannabis companies, since it would eliminate hemp-derived offerings that compete with their products. A similar proposal was in the House Appropriations Subcommittee on Agriculture, Rural Development, Food and Drug Administration bill last year, but it was never approved.
* A House committee wants a broad review of the Biden administration’s cannabis rescheduling proposal. The committee wants a review of proposed new acceptable medical use standards in the rescheduling proposal and the “mental health hazards of regular use of high-potency marijuana.”
The U.S. Department of Health and Human Services (HHS) under President Joe Biden recommended moving cannabis to Schedule III from Schedule I of the Controlled Substances Act (CSA). The House Appropriations Committee added the requests for a review of this proposal to the 2026 spending bill. The committee wants the HHS Inspector General to do the review.
* President Donald Trump wants to eliminate federal protections for state-level medical cannabis programs. In his budget proposal, Trump suggests the deletion of a rider that bars the Justice Department from interfering with state medical cannabis programs. Trump has called for a similar move in the past, but the proposed change has always been taken out of the budget plan before Congressional approval. The budget plan rider protecting state medical cannabis programs has been in effect since 2014.
State News
* Cannabis reform advocates in Florida have collected enough signatures to advance efforts to get a recreational use referendum on the 2026 ballot. The campaign garnered enough support to start the next step in the process, a financial and judicial review. Smart & Safe Florida says it has collected 377,832 valid signatures. That is about 150,000 more than required to advance the review process. Smart & Safe Florida got a similar referendum on the 2024 ballot, but it fell slightly short of getting enough voter support.
* Last year, states took in $4.4 billion in recreational cannabis-related tax revenue, a $200 million increase from the year before, says the Marijuana Policy Project (MPP). That brings the total tax take to nearly $25 billion since legalization began over a decade ago.
“At a time when federal funding cuts are putting pressure on states’ budgets, adult-use cannabis taxes are bringing billions of dollars into states’ coffers,” said MPP interim director Lauren Daly. California took in the most, at $1 billion, followed by Illinois at $577.4 million, Michigan at $523.5 million and Washington at $516.5 million.
* Pennsylvania could generate $2.1 billion in annual cannabis-related tax revenue five years into legalization of recreational use, according to a recent Marijuana Policy Project (MPP) study. The analysis was based on tax revenue trends in Arizona, Maryland and Michigan. It assumed a 16% cannabis sales tax.
“As Pennsylvania navigates a period of fiscal uncertainty, the Commonwealth is losing out on hundreds of millions of dollars in annual tax revenue that is instead flowing into the coffers of its neighboring states,” said MPP state policy director Karen O’Keefe. “Lawmakers should seize the opportunity to bolster the budget and grow the economy, while expanding freedom and implementing public health regulations.”
The tax benefit study comes as the debate on recreational-use legalization continues to heat up in Pennsylvania. Gov. Josh Shapiro (D) favors legalization, but many lawmakers on the right oppose the reform. Polls show a majority of Pennsylvanians in both of the main political parties favor rec-use legalization.
In a recent press conference, the Pennsylvania governor said he remains “hopeful” that lawmakers can deliver a rec-use legalization bill to him by the end of June. He said he is urging Senate Republicans to “put their ideas on the table” following their recent rejection of a House-approved legalization measure. “Every state around us, with the exception of West Virginia, has gotten it done,” he said. “You go visit some of these dispensaries along our border…and sixty percent of the people walking into those dispensaries are from the Commonwealth of Pennsylvania.”
* Texas lawmakers recently passed a bill to significantly expand the state’s notoriously restrictive medical cannabis program. The bill would expand the list of qualifying conditions to include chronic pain, traumatic brain injury, inflammatory bowel diseases, and hospice care. It would permit a wider array of delivery systems, including vapes, patches, lotions, and inhalers. It would also significantly expand the number of medical cannabis sales licenses to fifteen from three.
* Texas hemp advocates have delivered a petition with more than 100,000 signatures asking Gov. Greg Abbott (R) to veto a bill that would outlaw hemp-derived cannabinoid products. Opponents of Senate Bill 3 say it would destroy an $8 billion industry that employs 53,000 people. The petition calls for better regulation rather than a ban. Texas lawmakers legalized hemp-based products in 2019, after the passage of the 2018 federal Farm Bill, which legalized hemp products nationwide. A recent poll showed that 80% of Texas voters want cannabis legalized in some form.
* North Carolina Gov. Josh Stein recently announced the formation of a task force to explore legalizing THC products. Stein favors cannabis legalization, but the reform would face opposition in the legislature. The state Senate has voted to legalize medical cannabis, but the House has never allowed the bill to come up for a vote. Polls show cannabis legalization has broad bipartisan support in the state.
* Nevada has passed a law overturning a rule that had prohibited people from becoming foster parents due to cannabis convictions. Nevada legalized recreational-use cannabis in 2016.
* Hotel revenue increases substantially after states legalize recreational-use cannabis. A recent study concluded that hotel revenue goes up 25% and the effect lasts for years. The research was published in the journal Production Operations and Management (POMS) and attributed the effect in part to cannabis tourism.
* The maker of Jack Daniel’s whiskey says cannabis use is hurting sales. Brown-Forman (BF.B) CEO Lawson Whiting recently cited cannabis use as one reason his company missed first-quarter earnings estimates. He also cited weight-loss drugs and lower alcohol consumption by Generation Z drinkers as continuing to weigh on its business.
International News
* Ukraine has granted its first permit allowing the importation of medical cannabis. Ukraine legalized medical cannabis in 2023.
Medical News
* Studies continue to show that cannabis use may be one way to reduce opioid addiction. A study in Pennsylvania recently found that 80% of patients using medical cannabis for pain said it was effective.
“This points to the possibility that cannabis could serve as a safer alternative or complement to standard pain management approaches, potentially helping to address the ongoing opioid crisis,” said Drexel University College of Medicine’s Ari Greis. Greis is also on the board of the Rothman Institute Foundation for Opioid Research & Education. The study, published in the journal Cureus, was based on a small sample of 129 people.
* Seniors in the U.S. are consuming more cannabis. Past-month cannabis use rose to 7% of seniors in 2023 from 4.8% in 2021, according to a recent study, but that may not be a good thing. The study cautioned that the trend may have some downsides.
“The use of cannabis products, especially with psychoactive properties, may complicate chronic disease management among older adults,” the authors wrote. “Given physiological changes and chronic diseases, older adults are susceptible to adverse effects of cannabis, which may require acute medical care. While more older adults are currently using cannabis, evidence to support its medical use in this population remains mixed.” The study, by the University of California San Diego School of Medicine’s Benjamin Han, was published in a JAMA research letter.
Portfolio Company Updates
AYR Wellness (AYRWF)
Challenging conditions in the cannabis sector have claimed their first victim in our portfolio. AYR Wellness, which has always been a small portfolio position, is in the process of defaulting on its debt. An expected restructuring will most likely wipe out the remaining value in the stock.
Cresco Labs (CRLBF)
Cresco Labs reported $166 million in first-quarter revenue on May 30, a 10% decline from the prior year.
The company blamed the decline on its need to shut down some customer accounts because of credit risk. Price compression hurt in Illinois. So did a reform of the seed-to-sale tracking system in Illinois. That has some customers delaying purchases to reduce inventory, which helps simplify the tracking system conversion process.
Given the challenging sector trends like price compression and increased competition (a 30% increase in Illinois stores in the past year, for example), Cresco Labs remains in hunker-down and survival mode, like many cannabis companies.
Cresco cut overhead costs by $1 million sequentially to $53 million in the first quarter. This helped produce $30 million in operating cash flow. The company ended the quarter with $162 million in cash, the highest in three years.
“We’re focused on ensuring our balance sheet remains in the strongest possible position to support long-term value creation,” said CEO Charles Bachtell in the earnings call. “By staying disciplined and thoughtful in how we deploy capital, we’re positioning Cresco Labs to drive margin expansion, gain market share and invest in sustainable growth when the right opportunities arise.”
Bachtell predicted the company will finish its debt refinancing over the next few months. “Our improved financial profile is attracting solid refinancing terms, and we are focused on securing a structure that enhances flexibility and reduces our cost of capital over time.”
Beyond hunkering down to protect its balance sheet and stay in survival mode, Cresco highlighted three strategic initiatives.
1) It is tactically expanding its footprint. “Our cash flow enables us to develop new states as long-term accretive opportunities,” said Bachtell. “We’re putting this to work in our highest margin in growth states. In Pennsylvania, where we’re number one in branded market share, we opened our eighteenth dispensary and we are in the process of bringing more cultivation rooms online to meet increased demand.” Cresco is poised to open three stores in Ohio, and it is building Kentucky’s largest cultivation facility.
2) Cresco is rolling out new products to support the strength of its wholesale business. In the first quarter, it introduced forty new flavors across various product categories. Looking ahead, it plans to roll out premium vapes under the Cresco brand. Cresco is the top wholesaler in Illinois and Pennsylvania, and it has a top-five position in its limited licensed wholesale markets.
3) Cresco is studying customer behavior and advancing its customer loyalty program to defend its Sunnyside store strength. It now sells a lot of products online (for store pickup), which makes it easier to develop intelligence on customers. Sunnyside stores typically generate 25% more revenue per store than the state average.
Outlook
Cresco expects second-quarter revenue to decline slightly due to the ongoing hit to revenue because of the seed-to-sale tracking system reform in Illinois. However, it says that in the second half of the year, new dispensaries in Pennsylvania and Ohio, increased capacity in Illinois and Pennsylvania, and product innovation should help offset price compression and increased competition.
The bottom line: Cresco seems to be doing a good job of hunkering down and building its financial strength so it survives long enough to benefit from any positive federal changes like rescheduling and banking reform that allows banks to serve cannabis companies. In the meantime, it is tactically expanding in states that seem like they are about to allow recreational use, like Pennsylvania, or recently did so, like Ohio.
Cannabis Plus Insider Portfolio Updates
Advanced Flower Capital (AFCG)
Our cannabis lender, Advanced Flower Capital, expanded its revolving credit facility by $20 million to $50 million. The additional credit came from the company’s lead financier, an unnamed FDIC-insured bank with over $75 billion of assets. AFC will use the funds to originate commercial loans. The credit facility can be expanded to $100 million. I’ll take the new credit as a vote of confidence in AFC, at a time when troubling cross currents haunt the sector.
“This expanded commitment from a long-standing banking partner underscores the strength of our platform and strategy,” said CFO Brandon Hetzel. “This facility remains a core component of our financing approach, and we look forward to further strengthening this partnership as we scale our lending capabilities.”
AFCG shares are down 33% year to date, in part because of worries about the lender since credit issues arose with one borrower. The new funding suggests concerns about AFCG may be unwarranted. The real estate investment trust now pays a yield of 16.3%. I’m a buyer at current levels for the yield and potential capital appreciation.
Sunrise Realty Trust (SUNS)
Our commercial real estate lender, Sunrise Realty Trust, recently announced that its partner EverBank has added $50 million to its senior secured revolving credit facility, bringing total committed capital to $140 million. The capital will be used to fund new and existing commercial real estate loans. Sunrise Realty Trust is not a cannabis lender, but it spun out from one of our cannabis lenders, and I have kept it in the Cannabis Plus Insider Portfolio.
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