The cannabis sector remains under pressure. But the stock price weakness makes the group a good buy for contrarians because there are plausible catalysts on the horizon.
Let’s be clear. It won’t be easy to buy. It never is, when sentiment is so dark.
Buying right never feels good, as the saying goes. When the right time to buy comes along, you won’t want to, is how technical analyst Walter Deemer puts it.
I personally continue to buy cannabis names on weakness, using limit orders. I think this is the way to go. The AdvisorShares MSOS 2X Daily (MSOX) looks especially attractive, for the leverage it offers. As a leveraged exchange-traded fund, it is volatile. You need to be psychologically prepared for that.
The Negative Sentiment Buy Signal
Buying now is doubly hard because sentiment overall is so dark, not just towards cannabis.
* One sentiment indicator I follow closely is in its historically low-level range. The Investors Intelligence bull-bear ratio was recently at 1.94. Anything below two means the market is a buy, by how I use this indicator.
I use sentiment indicators in the contrarian sense. According to the contrarian investing style, you want to buy when people are generally negative. That is the case now.
* It is also notable that a proprietary sentiment indicator created by Bank of America is near negative extremes. I am referring to their Sell Side Indicator (SSI). It calculates the average suggested allocation to stocks by sell-side strategists, as a percentage of an overall investment portfolio.
This average was at 52.7% in March. Quite remarkably, this is lower than in late 2008 (55%-58%) and even the March 2009 lows (53.1%). Both were great times to buy, as long as you had the courage and the patience – the two qualities you need to buy cannabis names now (and the overall market).
Historically, when the SSI is this low, you can expect 16% returns for the S&P 500 over the next twelve months. Subsequent returns were positive 94% of the time, compared to 81% overall. “Wall Street’s consensus equity allocation has been a reliable contrary indicator,” says Bank of America. “It has been a bullish signal when Wall Street strategists were extremely bearish, and vice versa.”
But wait, aren’t the talking heads with expensive haircuts on CNBC the smart money to follow?
Apparently, they are as susceptible as anyone to performance-killing groupthink. And they are definitely worth betting against when they all congregate on the same side of the boat, as they are doing right now, points out Bank of America research.
What Could Go Right?
What could go right for the cannabis sector? There are several potential catalysts on the horizon.
* As you will see below, states continue their inexorable march towards legalization of recreational use. Minnesota is well on the way, and Pennsylvania, Florida and New Hampshire may soon follow.
* Banking reform, and steps toward decriminalization, may reappear in Washington, D.C. at any moment.
* Germany will soon take steps towards legalization of recreational use, leading the way in Europe, where several countries will follow suit.
* Cannabis prices may be stabilizing, after a year of free fall. This would be welcome news and an inflection point of sorts for the industry if it pans out. The entire cannabis sector has been hammered by declining wholesale prices of around 30% year over year, the other main issue aside from the lack of reform progress in Washington, D.C.
The best cure for low prices is low prices, as economists like to say. This means low prices force suppliers out of business, and the lower supply creates price stabilization. That may be happening now for the cannabis group. If so, this would be a good time to get exposure. I believe that is the case. You will see below that at least two companies are observing price stabilization, and it is showing up in the sector data, too.
* Cannabis decriminalization will likely be a big issue in the 2024 presidential election. Campaigning starts in earnest in just nine months. Markets often begin to price in news six months in advance.
Below is the most relevant sector news since the last time I wrote to you on March 28, followed by a drill down on the key portfolio company updates.
Progress on Cannabis: State Roundup
While federal lawmakers continue to delay moves on legalizing cannabis and favorable banking reform, the tide keeps moving forward at the state (and cultural) level.
This is not at all surprising, given the vast majority of adults favor legalization. State politicians (and major league sports, as you will see) are only responding to popular sentiment.
It seems only a matter of time before federal lawmakers get on board. That would be a major catalyst for the group since it would clear the way for further sales growth, and institutional investor participation in the sector.
* The New Hampshire House of Representatives recently approved a bill to legalize marijuana for a second time this session, sending it to the Senate. Bill sponsor Jason Osborne (R) said he is “pleased to see New Hampshire take a step toward relieving gangsters and thugs from control of this market, keeping dangerous untested products away from consumers, and protecting children from harmful age-inappropriate products.” New Hampshire is the only state in New England that has failed to legalize cannabis.
* Connecticut cannabis sales continue to ramp up sharply following legalization of recreational use in January. March sales hit $22 million compared to $13 million in January. Our Verano (VRNOF), Curaleaf (CURLF), Trulieve (TCNNF), Green Thumb (GTBIF) and Ayr Wellness (AYRWF) all have material exposure to Connecticut.
* Minnesota moved closer to legalizing cannabis when yet another Senate committee recently approved a provision to do so. The bill has only two more committees to pass before it can go to the full chamber. A House companion bill has already gotten full committee approval.
* Delaware’s Senate sent bills to legalize adult-use cannabis and regulate sales to Gov. John Carney (D).
* A Montana Senate committee recently killed a bill that would have eliminated recreational use dispensaries, limited cannabis potency and sharply raised taxes on medical cannabis. The bill would have dismantled the state’s marijuana industry.
* Kentucky’s governor recently signed into law a bill legalizing medical cannabis. Kentucky became the 38th state to allow medical marijuana.
* Washington state lawmakers advanced legislation that would prohibit employers from administering pre-employment drug tests for marijuana.
* Utah’s governor signed into law a bill funding the Center for Medicinal Cannabis Research at the University of Utah.
* The National Basketball Association (NBA) has lifted its ban on cannabis use by players. It will no longer drug test for cannabis. The NBA will also allow players to promote and invest in cannabis companies.
* Major League Baseball (MLB) recently signed a CBD company to serve as the league’s first cannabis sponsor. It plans to advertise during the World Series. MLB removed cannabis from the league’s list of banned substances in 2019.
* The global medical cannabis market will grow by 80% to $57.4 billion from $31.8 billion last year, predicts the research group IMARC Group in a report released in early April.
Tilray Brands (TLRY)
Tilray, the leading Canadian cannabis company by market share, reported $145.6 million in fiscal third-quarter sales on April 10, up 2% over the prior-year quarter.
Tilray stock traded down on the news because it missed estimates. Canada remains a tough market because of oversupply, intense competition, and a thriving illicit market.
But it was not all bad news. The company booked $12 million in cost savings as part of a $30 million cost-cutting plan announced late last year. The company said adjusted gross margin increased to 47% from 33%, supporting adjusted gross profit of $44.3 million. Tilray reported adjusted EBITDA of $14 million.
Operating business cash flow losses for the quarter narrowed to $18.6 million from $46.4 million in the prior year. The company reiterated it expects to post positive operating cash flow this year. It ended the quarter with $408 million in cash, a key signal of financial strength as cannabis companies across the board battle declining wholesale prices and fight it out for survival in the current cannabis sector Hunger Games dynamic.
There was some good news on the pricing front, though. Tilray reported that price compression slowed. Price compression cost the company $3 million in the quarter, down from $12 million in the quarter before. “We do believe we’re starting to see the floor on price compression in the marketplace,” said CEO Irwin Simon. The company was reporting its third fiscal quarter, ending February 28.
Tilray stock was also weak because it reported the purchase of Canadian cannabis company HEXO. Investors often sell the buyer on acquisition news, because of fears they overpaid, or the integration will not go well.
Tilray was already the largest Canadian cannabis company by market share. The HEXO buyout will boost Canadian market share by 4.8 percentage points, to 12.9%. Tilray expects cost savings of $25 million in the HEXO transaction. It will do the purchase through a shares swap of 0.4352 Tilray shares for each outstanding HEXO share. The acquisition builds on the successful strategic alliance between the two companies. The deal is expected to close in June 2023.
Tilray announced that it expanded its position in the medical cannabis market in Europe, broadening distribution in the Czech Republic through an export and distribution partnership with Cansativa Group.
This builds on its strengths in Europe as Germany seems poised to legalize recreational use sales. Tilray has the leading medical cannabis market share across Europe. It has cultivation facilities in Portugal and Germany, and a medical distribution network via its CC Pharma. Tilray says it has relationships with 13,000 pharmacies in Europe. “So, we have infrastructure, we have the distribution with CC Pharma,” said CEO Simon.
By way of background, Tilray has a U.S. beverage division that owns a craft beer brand called SweetWater. This is the #1 craft brewer in Georgia, the #2 craft brewer in the Southeast, and the 10th largest craft brewer in the U.S. Tilray recently bought Montauk Brewing, the #1 craft brewer in New York. It owns a bourbon brand, Breckenridge Distillery, and two iconic Southern California beer brands, Alpine Beer and Green Flash.
The beverage business is relatively small and it is not exactly a growth engine. Sales grew slightly in the quarter to $20.6 million from $19.6 million the year before, mainly through acquisition. But the division has strategic importance. If cannabis becomes legal at the federal level in the U.S., which is likely at some point, Tilray will leverage its beverage distribution and marketing networks to sell cannabis-infused drinks. It also sells hemp-based foods in the U.S. (50% market share) and Canada.
Cresco Labs (CRLBF)
Since our Cresco Labs is still officially on track to purchase Columbia Care (CCHWF), despite the delays and the skepticism among some analysts, it makes sense to take a closer look at what we might be owning.
Columbia Care reported earnings and offered updates and an outlook on March 29. Here are the highlights.
Like Cresco, Columbia Care CEO Nicholas Vita confirmed that the merger is still very much on. “The strategic merits underpinning the combination with Cresco remain compelling and we continue moving forward on this path,” said Vita.
Next, the company continues to carry out a restructuring both because regulators demand it, but also to trim overhead and preserve cash to survive the current harsh environment in cannabis. (Declining wholesale prices. Regulatory reform doldrums in Washington, D.C.) Among other things, it is closing unprofitable operations in California and Colorado.
Columbia plans to book $35 million in cost savings this year, which it says will turn the company cash flow positive in 2023. Columbia generated $5.2 million in operating cash flow in Q4, and it ended the year with $48 million in cash. It has no significant debt maturities until May 2024. Columbia saw sales grow 11% last year to $511 million, though fourth-quarter revenue declined 5% sequentially, because of weak wholesale prices. Q4 retail revenue was flat, sequentially.
By way of background, Columbia is in sixteen markets across the U.S., including high-growth markets on the east coast like New Jersey, Virginia, and Maryland where legal recreational use sales are set to begin in July. The company is also in Pennsylvania, one of the states that experts say should legalize recreational use over the next year or two. It has 83 retail locations and eleven in development, and more than two million square feet of cultivation and production capacity. It has one of the largest retail networks in the sector.
Verano Holdings (VRNOF)
Verano reported fourth-quarter revenue of $226 million on March 30, an increase of 7% year over year. But it reported a sequential decline of 1%. The fourth-quarter sales growth (year over year) was driven primarily by strength in New Jersey, and Florida store openings. For the full year, sales came in at $879 million up 19% year over year.
The company reported gross profit of $103 million or 46% of revenue, down from $109 million or 52% of revenue for fourth-quarter 2021. Gross profit fell because of increased discounting and cost increases associated with expansion.
Adjusted EBITDA was $79 million or 35% of revenue, down from $82 million or 39% of revenue for fourth-quarter 2021. Verano posted operating cash flow of $29 million down from $63 million for fourth-quarter 2021 and $20 million in free cash flow, up from $14 million for fourth-quarter 2021.
The company reported $85 million in cash at the end of the year. CEO George Archos predicted his company will generate $50 million to $75 million in free cash flow for the year. At a time when the sector is having a Hunger Games survival moment, a strong cash position and free cash flow are important.
Verano continues to have exposure to what are the best markets because the markets are in growth mode. About 72% of sales came from its retail business, and the largest contributions came from Florida, Illinois, and New Jersey. Around 28% of sales came from the wholesale side, and the largest contributions were from Illinois, New Jersey and Connecticut.
Connecticut and New Jersey only recently opened legal recreational use sales, and Florida may be poised for growth because voters may get to decide on recreational use legalization in the 2024 elections.
Like other cannabis companies, Verano highlighted signs of price stabilization in the first quarter. “I think Q4 was kind of the dip and we’re starting to see things stabilized here in Q1 and moving forward,” said Archos. “We have seen some price stabilization.”
By way of background, Verano has 126 dispensaries and fourteen cultivation and processing facilities in thirteen states. It is the fourth-largest publicly traded cannabis company in the U.S. by market cap.
Curaleaf announced in late March it is buying Utah retail operator Deseret Wellness in a cash and stock transaction valued at approximately $20 million. Curaleaf will get three retail dispensaries with combined annual revenue of $14 million, building its presence in the state to four medical-use dispensaries. Overall sector weakness will create a wave of M&A activity, and this is an example of the trend.
AYR Wellness (AYRWF)
AYR recently announced that it has opened two new retail stores in Florida in Winter Haven and Palatka. The openings expand its Florida footprint to 59 retail stores. Florida has legalized medical use, and a signature drive looks set to put recreational use on the 2024 ballot, assuming the state’s supreme court approves the initiative. AYR also recently closed on its purchase of Tahoe Hydroponics Company, a Nevada cannabis cultivator. The deal was first announced back in July 2021.