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Cannabis Investor
Profit from the Best Cannabis Stocks

October 11, 2023

Cannabis stocks have retreated from recent highs in the rally sparked by news that the government may reschedule marijuana under the Controlled Substances Act.

Retraces are perfectly normal after big moves. Many traders typically expect a 33% give-back.

The key question is whether the pullback is buyable. I say yes, for two reasons – one fundamental (catalysts, below) and one technical. Let’s start with the technical factor.

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Cannabis stocks have retreated from recent highs in the rally sparked by news that the government may reschedule marijuana under the Controlled Substances Act.

Retraces are perfectly normal after big moves. Many traders typically expect a 33% give-back.

The key question is whether the pullback is buyable. I say yes, for two reasons – one fundamental (catalysts, below) and one technical. Let’s start with the technical factor.

Fibonacci Numbers

What’s remarkable here, and a little bit eerie, is that the cannabis stock retrace was predicted almost precisely by Fibonacci ratios, which are natural mathematical values used by technical analysts.

Here is a little bit of background. Fibonacci ratios are based on a simple numerical sequence identified by mathematician Leonardo Pisano in the 13th century. (His nickname was Fibonacci.) The sequence is the sum of the two preceding values starting with zero: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so forth.

Using this sequence, the mathematician developed the concept of Fibonacci ratios. There are three key Fibonacci ratios. What’s fascinating here is that these ratios describe many relationships among shapes and sizes that occur in nature. So, technical analysts concluded they might apply in markets, too. Often, they are right, and in the case of the recent cannabis pullback, this has been the case so far.

Let’s take a look.

The key Fibonacci ratio, 61.8%, is calculated by dividing any number in the series by the one that follows it. For example, 21 divided by 34 equals 0.617.

Another key ratio, 38.2%, is created by dividing a number in the series by the number two places to the right in the sequence. For instance, 55 divided by 144 equals approximately 0.3819.

A third key ratio for traders, or 23.6%, is found by dividing any number in the series by the number that is three places to the right. For example, 8 divided by 34 equals 0.23529.

So, here’s the eerie part.

* After the rescheduling canna-bounce, the AdvisorShares Plus US Cannabis (MSOS) declined 23% to $7 from $9.10, which marked the upper end of the trading range in the rescheduling news rally.

* The AdvisorShares MSOS 2X Daily (MSOX) fell 38% to $4.33 from the $7 upper end of the trading range in the rescheduling bounce.

Since putting in their Fibonacci ratio retraces, both exchange traded funds (ETFs) seem to have based, and they have begun to tentatively gather strength and rebound. (To determine the top of the trading range, I am excluding the very short-term aberrational spikes.)

Does the nearly precise Fibonacci ratio retrace predict with certainty that cannabis stocks cannot fall a lot more from here? No. But the Fibonacci ratio retrace is worth considering as a basing level, from a technical point of view.

Catalysts Ahead

Otherwise, I’ll point to four expected catalysts over the next several months which will likely attract interest in the group. They should drive cannabis stocks higher from here. I also offer one bonus wild card catalyst.

Potential catalyst #1: Progress in Washington on rescheduling is likely by year end.

The Congressional Research Service (CRS) said in a recent report 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.

HHS has recommended cannabis move to Schedule III from Schedule I. The move would help cannabis companies by letting them 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. History shows the DEA typically goes along with HHS recommendations. The DEA has issued recommendations as short as 60 days after an HHS recommendation. That would put DEA action this time around at the end of October.

A favorable DEA recommendation would not be the end of the matter. The Department of Justice would make a final ruling. Legal experts predict that could happen by the middle of 2024 (another catalyst).

Potential catalyst #2: The full Senate may vote on SAFER banking.

The Senate banking committee has approved the Secure and Fair Enforcement Regulation (SAFER) act, which would permit a lot more banks to serve cannabis companies. This would help by allowing dispensaries to use credit cards, and by giving cannabis companies wider access to cheaper financing. Cannabis law experts in Washington, D.C. expect the full Senate could vote on the bill soon. It is likely to pass.

This would be another big catalyst, but not as big as progress on rescheduling. The reason is that prospects for SAFER banking in the House of Representatives do not look entirely promising given the leadership turmoil there. Rep. Kevin McCarthy (R-CA) was recently ousted as House speaker.

Several of the top contenders for speaker of the House do not have favorable voting records on cannabis (more on this, below). Another challenge for SAFER is that the House is controlled by Republicans, who are generally less likely to favor legal reform that favors cannabis companies.

Potential catalyst #3: Florida’s Supreme Court will hear legal arguments on the viability of a proposed recreational use referendum.

Oral arguments are scheduled for November 8. A convincing tone to the arguments put forth by cannabis proponents would be a bullish catalyst.

The referendum outcome is key to the sector, since Florida would be a large market. The state has a population of 22 million, and an estimated 138 million tourist visitors per year.

The referendum would likely pass, but it would be close. About 60% of Floridians favor rec use legalization, according to a recent survey by the University of South Florida (USF) and Florida Atlantic University (FAU). The proposed referendum requires 60% approval to pass. (Other polls have shown 70% support.)

Florida’s Supreme Court has to rule on the legitimacy of the proposed referendum language by April. If not, it is automatically approved.

The court has a conservative bias, which suggests it is not predisposed to allowing a cannabis referendum that would bring out voters on the left. Attorney General Ashley Moody (R) has argued the ballot initiative is misleading. Among other things, she thinks voters would not be able to understand from the referendum language that cannabis would remain illegal at the federal level if Florida moved to legalize.

Trulieve Cannabis (TCNNF) CEO Kim Rivers believes the referendum language will pass muster. Her company has contributed more than $39 million to the Smart & Safe Florida campaign promoting the referendum. Trulieve is the biggest cannabis company in Florida, and it has a large market share. Florida economists estimate legal rec sales would bring in as much as $431million a year in tax revenue. Medical use is already legal in Florida.

Potential catalyst #4: Ohioans will vote on a referendum proposing the legalization of recreational use in November.

The vote will be close, but it is likely to pass. Poll results show adequate support.

Approval would be a catalyst for the cannabis group because Ohio is such a large state, and because it would bolster state level momentum towards recreational use legalization. The state would bring in as much as $400 million a year after five years of legalization, says an Ohio State University study. For context, the state budget is $86 billion.

Voter approval of the Ohio referendum would also put pressure on lawmakers in neighboring Pennsylvania to approve recreational use. Both states permit medical use.

Potential catalyst #5: A wild card catalyst.

This may come in the form of a reiteration of the “Cole Memorandum” in Washington, D.C. This refers to a memo issued by Attorney General James Cole in 2013 clarifying a hands-off approach to enforcing federal cannabis restrictions. The letter catalyzed state-level sector growth. It would be a cannabis group catalyst this time around, too. Curaleaf (CURLF) Chairman Boris Jordan expects Attorney General Merrick Garland at the Department of Justice will soon issue a letter clarifying rescheduling and policy on enforcing federal cannabis laws that would be similar to the Cole Memorandum.

What to Do Now

Consider buying any of our portfolio names, both as trades ahead of these potential catalysts and as multiyear positions for possible large sector sales growth over the next several years.

This is the full portfolio: Ayr Wellness (AYRWF), Cresco Labs (CRLBF), Curaleaf (CURLF), Cronos (CRON), AdvisorShares Plus 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).

For simple, broad diversification, focus on the ETFs MJ, MSOS and its leveraged version, MSOX.

Note that the larger cannabis companies like the ones in our portfolio look very cheap. The larger cannabis companies trade at an enterprise value of just eight times next year’s expected EBIDTA, compared to more than 14 for soft drink and alcohol companies, according to a recent analysis by Eight Capital.

Cannabis companies could potentially see much greater growth than these groups. In a recent note, Jefferies cannabis analyst Owen Bennett predicted annual U.S. cannabis sales could grow to $37 billion in 2025 and almost triple to $71 billion in 2033, from $26 billion last year. “A realistic upside scenario puts 2033 sales at more than $150 billion,” he says.

Cannabis news from around the world

Besides these potential catalysts, what I call the cultural momentum towards greater legalization and acceptance of cannabis continues to build at the state level, though there have been a few setbacks. The powerful cultural momentum is important because it suggests continued progress at the state level, but also because it pressures holdouts at the federal level to change their views and back cannabis reform.

Let’s take a look.

* California recently acted on a flurry of cannabis-related laws, most of them favorable to the industry.

First, the negative. Gov. Gavin Newsom vetoed a bill that would have allowed Amsterdam-style cannabis cafes, despite widespread bipartisan support. The bill would have permitted cannabis dispensaries to become cafes and offer food, coffee, and live shows. Cannabis lounges, where customers can consume on-site, are already legal. They can’t sell non-cannabis items like food. Proponents said the bill would have helped licensed vendors compete with the illicit market. Newsom said the move would conflict with smoke-free workplace policies.

In news that was more favorable to the sector, Newsom rejected a bill that would have burdened the cannabis sector with new packaging regulations. The Governor signed a bill to bar employers from asking about prior marijuana use during hiring, with exceptions for construction and jobs that require security clearances. California also enacted a bill that gives legal cannabis vendors the right to pursue legal action against unlicensed cannabis businesses if they can prove damages.

* States netted more than $5.7 billion in cannabis-related tax revenue from July 2021 to the end of 2022, says the U.S. Census Bureau.

California, the largest market, took in more than $1.4 billion. Washington and Colorado, the first two states to legalize recreational use, came next, at $818.5 million and $648.1 million. The study offers data that cannabis proponents can use when lobbying other states for recreational use legalization. The agency plans to update the tally every quarter.

* The Pennsylvania House approved a bill that allows licensed cannabis vendors to deduct expenses when calculating state taxes. The bill now goes to the Senate.

Maine, Illinois, Connecticut and New Jersey have approved similar bills.

Most deductions remain prohibited at the federal level, under section 280E of the Internal Revenue Service (IRS) code. That would change, if federal agencies reschedule cannabis to Schedule III from Schedule I under the Controlled Substances Act. That reform may happen in the next year.

* Cannabis users continue to vote with their wallets. Illinois posted another strong month of recreational use cannabis sales in September. Consumers bought $139.5 million worth of products, the third-highest monthly sales since legal markets opened. Monthly medical marijuana sales, tallied separately, have not yet been reported for September.

The strong sales results confirm positive trends throughout the country. Connecticut posted another record-breaking $25.2 million worth of sales in September. New Mexico’s September sales just missed the monthly record set in August. Rhode Island, Montana, Connecticut, Maine, Maryland all posted record sales in August.

* Leadership turmoil in the House of Representatives may not bring joy to cannabis investors. Two leading candidates to replace Rep. Kevin McCarthy (R-CA) as House speaker do not look promising for the group. Judiciary Committee Chairman Jim Jordan (R-OH) and Majority Leader Steve Scalise (R-LA) have opposed virtually all cannabis-friendly bills that came before them in the past 15 years. That includes cannabis banking bills like the Secure and Fair Enforcement Regulation (SAFER) bill recently approved by the Senate banking committee.

* A bipartisan group of 22 state attorneys general has asked Congress to pass the Secure and Fair Enforcement Regulation (SAFER) bill. Their letter to Congress says they have “a strong interest” in promoting economic growth while protecting cannabis industry workers. The group notes that when people notice that a business is cash only, “employees and customers are at greater risk of violent crime in pursuit of that cash.” They cited a spike in robberies at cannabis businesses. The group also said approving SAFER would help states collect more taxes. The SAFER bill would allow dispensaries to use credit cards, and no longer operate as all-cash businesses. The bill would also give cannabis companies greater access to cheaper financing, from banks.

* The American Nurses Association now recognizes cannabis as a nursing specialty practice. The group says cannabis nurses play a key role in advising patients on how to use cannabis as a medicine. The group wants cannabis to move down a notch to Schedule II under the Controlled Substances Act, to enable more research and give cannabis nurses and patients protection from prosecution. The nursing group has five million members.

Portfolio Company News

* Cresco Labs (CRLBF) opened a Sunnyside dispensary in Altoona, Pennsylvania. The company also launched its Good News brand in the state. The moves are part of a strategy of building a presence ahead of potential legalization of recreational use over the next two years.

* Curaleaf (CURLF) has applied to list its shares on the Toronto Stock Exchange (TSX). The change would give Curaleaf greater access to institutional investors including in the U.S. It would also potentially get the shares on large bank trading platforms, increase trading volume, reduce volatility, and make the stock eligible to join indices.

As part of the plan, the company recently did a 2.7 million-share offering to satisfy exchange listing requirements. The offering, purchased by Canaccord Genuity in Canada, raised $12 million. The bank will offer the shares to institutional investors in Canada and the U.S.

TerrAscend (TSND) has seen trading volume grow more than three-fold since it listed on TSX July 4. The stock was subsequently cleared for trading on Morgan Stanley’s platform. It was the first time a cannabis company that does business in the U.S. listed on a major exchange.

Cannabis stocks generally trade now on smaller exchanges like the Canadian Securities Exchange and over the counter (OTC) market in the U.S. This prohibits many institutional investors and pension funds from investing in the space.

* Tilray (TLRY) October 4 reported sales grew 15% to $177 million for the quarter ended August 1. Cannabis sales grew 20% to $70 million. Alcohol sales increased 17% to $24 million, and distribution revenue increased 14% to $69 million.

But much of the growth came from the acquisition of the Canadian cannabis company HEXO in June. Acquisition-related sales growth can be less desirable than organic growth, because of the possibility that management overpaid. After the quarter closed, Tilray bought the cannabis drink company Truss Beverage and eight beer and beverage brands from Anheuser-Busch.

Losses narrowed to $56 million from $66 million in the prior year quarter. Tilray reported a loss of 10 cents per share vs. an estimated 13-cent loss. Adjusted EBITDA came it at $11.4 million vs. $13.5 million in the prior year. But the prior EBITDA number was inflated by the inclusion of one-off advisory fees. The company reported operating cash losses of $16 million vs. losses of $46 million the year before, a substantial improvement. Tilray ended the quarter with $466 million in cash against $563 million in debt. Tilray grew its leading Canadian market share position to 13.4%

* Verano (VRNOF) opened its 71st dispensary in Florida. The MÜV Apopka is near Orlando. The opening is part of a popular sector strategy of building a presence in states likely to approve recreational use sales over the next two years, like Florida, Ohio and Pennsylvania. The company has 133 dispensaries nationwide.

Michael Brush is an award-winning Manhattan-based financial writer who writes a stock market column for MarketWatch. He is editor of Brush Up on Stocks, an investment newsletter. Brush previously covered the stock market, business and economics for the New York Times, the Economist Group, MSN Money, and Money magazine.