Throughout U.S. history, federalists and states’ rights advocates have battled it out.
Federalists believe in strong centralized power. The other side wants issues to get resolved locally. Federalists are usually on the left, and states’ rights advocates are normally conservatives.
But not always. It depends on the issue.
Cannabis, for example, turns this alignment on its head. Marijuana changes conservatives into federalists. Richard Nixon was the force behind the extreme Schedule I status of cannabis (in the same class as heroin and above cocaine and meth). Likewise, conservatives today oppose relaxation of federal regulation. Liberals are the states’ rights advocates. Blue states are consistently more likely to liberalize cannabis laws.
Why is political history relevant to cannabis investing?
Because it is important to know that history shows federalist-states’ rights battles on issues almost always eventually resolve – from the banking regulation in the 1800s through the civil rights era.
Likewise, the federal vs. state tensions around cannabis will eventually resolve. Importantly for us, the states’ rights advocates will prevail. How do we know? We don’t. But it seems likely because polls consistently show two-thirds or more of the population favors legalization. It is the will of voters.
A very long-term risk in cannabis investing is that once marijuana becomes fully legal (many years from now), the giant consumer goods companies like Starbucks (SBUX) and Procter and Gamble (PG) are likely to step in and take command.
Between now and then, though, the best cannabis names will rise by significant multiples as progress towards legalization continues. And they may eventually get bought out by the consumer giants.
Though it will be years before cannabis is fully legal, the many developments along the way will support our names. I’m talking about developments on issues like de-scheduling under the Controlled Substances Act, banking reform, tax reform, more state approvals, and market growth, etc.
Cannabis investing today is about waiting for this dynamic to play out, as it inevitably will.
Below is the latest read on the most significant developments in the federalist-states’ rights cannabis battle. It shows continued progress at the state level, vs. stasis at the federal level.
Before we get to the updates, please remember I am not offering political commentary intended to favor one side over the other. I am apolitical. (This helps with investing.) I also never encourage the use of cannabis. That is an individual choice. I’m just observing the sector as an investor.
What to Do Now
No portfolio changes. But I suggest continued accumulation as a classic contrarian bet. The group is washed out and despised. Not even the most excitable cannabis cheerleaders can find any reasons to be bullish, given the drubbing we all took last December when politicians let us down on banking reform. “I don’t plan to talk about legislative stuff anymore,” says one sector commentator. “It is not worth it to get our hopes up.” That’s pretty negative, which I love to see, as a contrarian. Cannabis investing YouTube channels report viewership is at lows, also a good contrarian sentiment read.
Averaging in
When groups are washed out and you are taking contrarian positions ahead of the time when sentiment inevitably improves, the best thing to do is follow a rules-based approach. For me, this means adding incrementally to our portfolio names and exchange-traded funds (ETFs) mechanically whenever they are down by 2% or more. If you are more conservative, set the percentage higher, up at 3%-4% for example.
The key is to continue to add incrementally, to accumulate your contrarian position over time. The exception is that regular buying over-the-counter names is less appealing because of the archaic trading commissions.
But don’t just listen to me. Here is how Curaleaf (CURLF) executive chairman Boris Jordan sizes up the dynamic for cannabis investors right now. Yes, I understand he has a bias. But he also has extensive investing experience.
“I like to buy when there is blood in the street. Use the volatility to your favor,” says Jordan, who co-founded the investment group Renaissance Capital Group, and SPK Group, a private equity shop.
“I have seen this happen many times,” says Jordan, referring to the high profitability that can result from contrarian investing. “I saw this happen during dot-com, and in the emerging markets in 1998. Everyone thought that emerging markets were gone, nobody is ever going to invest in them. There were defaults all over the place. In the next four years people made billions because that was the time to buy.”
Jordan cautions that he is not calling the exact bottom in cannabis, as no one can. “I am not telling you this is the time to buy. I am not a market timer. But what I do is when things like this happen and I start seeing such dislocation where assets are so mispriced, I step in slowly every day, and I buy, I buy, I buy in small quantities. I start to average, average, average. I have always gotten paid for doing that. Unfortunately, retail investors do the opposite. They buy the momentum rallies and they sell the dips. That is a real shame.”
Don’t make that mistake. Here is another one to avoid. Jordan cautions that you should stay diversified across sectors to reduce risk. “Don’t bet the shop on a high-risk industry.”
My take is that in the worst-case scenario, we won’t get bullish news on the group until the 2024 elections heat up (September-October). That’s when it will serve the Democrats in Washington, D.C. to drop hints of enticing developments to win votes, as they did last October.
But in my view, there will be plenty of bullish state-level news along the way. And possibly even some favorable news out of Washington, D.C., considering how Rep. Nancy Mace (R-SC) has adopted cannabis reform as an issue. She recognizes this stance is a way for conservatives to steal votes from the left, and she is trying to convince fellow conservatives that this is the case.
Leverage
I discourage buying long-dated options on cannabis names or ETFs as a way to get leveraged exposure to any eventual gains. The reason is that most options expire worthless. It is not formally in our portfolio, but the better way to get leveraged exposure is through the AdvisorShares MSOS 2x Daily ETF (MSOX).
2023: The Strong Getting Stronger
Here’s another interesting trend that will play out this year. Given the stress in the cannabis sector, many weak hands will fold or get bought out. This favors the financially strong players in the space like our Curaleaf and Cronos (CRON). At Curaleaf, executive chair Jordan predicts the company will end the year with “very positive” cash flow. Cronos nearly trades at cash levels. It has $881 million in net cash against a market cap of $979 million.
“We have accretive acquisitions in the works,” says Jordan. “Curaleaf will be very active on the consolidation front. There are many opportunities that will add to profitability over the next six to nine months.” He says Curaleaf will go shopping in “big markets where we have higher margins and we can get synergies. I am excited for companies that will be able to buy companies at very good prices and grow. It is cheaper to buy businesses than grow organically through capital spending, and that is very rare. It will be a very interesting market for the bigger players in the industry with a low cost of capital.”
A Wild Card in the Deck
Noah Hamman, the CEO of AdvisorShares Investments which runs the AdvisorShares Pure U.S. Cannabis ETF (MSOS), offers interesting speculation on a potential positive coming out of Washington, D.C. Of course, he has a personal interest in the matter, as someone who earns a living managing a cannabis ETF.
But he knows the space, so it is worth hearing him out. He recently speculated that the cannabis group would get a significant bid if Attorney General Merrick Garland issued a “Cole Memorandum” style edict clarifying the relaxed level of Department of Justice (DOJ) cannabis enforcement.
The Cole Memorandum was a DOJ memo from Barack Obama-era deputy attorney general James Cole stating the DOJ would not enforce federal marijuana laws in states that legalized cannabis. The Cole Memorandum was rescinded by Attorney General Jeff Sessions in 2018.
I do not know if Garland will issue a memo like this, and I am not predicting it. But when politicians are involved, surprises are always possible, and Garland has alluded to the possibility. Last June, when asked in Congress whether the DOJ intended to reissue the Cole Memorandum, Garland left the door open by responding in the following way: “The department is examining a range of issues that relate to marijuana and its production, sale, and use, and we intend to address these issues in the days ahead,” he said. So far, nothing. And it has been a while. But he also told Congress that federal law enforcement resources are not best used by prosecuting low-level marijuana offenses, even in states banning cannabis.
State-Level Updates
Here is a roundup of bullish developments in the continued march towards full legalization at the state level.
* Sales growth picking up: While many states continue to report sharp year-over-year contractions in sales, there are signs that this may be changing. Sales are growing sequentially. U.S. cannabis sales increased 5.3% in December compared to November according to cannabis data analytics firm BDSA.
* Price compression leveling off: Colorado wholesale cannabis prices stabilized in the fourth quarter compared to the third quarter. That follows steady price declines since the fourth quarter of 2020, which have cut prices by more than 50%. It’s too soon to know, but this could be a sign that price deflation is ending.
* Illicit sales crackdowns: The New York governor has proposed a cannabis budget of $67 million, $21 million of which would go towards enforcement against illicit vendors. Competition from the illicit market is one of the main challenges that publicly traded cannabis companies face. Though in the case of New York, this is less relevant to us as investors because it could be a fairly long time before public companies enter the New York market. However, this may change in our favor as investors. See the next bullet point.
* New York getting schooled on cannabis regulation: A federal judge (U.S. District Judge Gary Sharpe) recently shot down attempts to quash an order that bars New York from granting conditional dispensary licenses.
The decision is part of a lawsuit filed against the state by Variscite NY One, a Michigan company. It alleges New York’s Conditional Adult-Use Retail Dispensary license requirements discriminate against out-of-state cannabis operators. The Michigan company argues this violates a legal principle called the dormant commerce clause. It prohibits states from passing laws that discriminate against interstate commerce.
If this challenge continues to make progress, it could open up the New York market to publicly traded companies sooner than analysts think. Cannabis advocates have been extremely frustrated with New York’s approach to legalizing recreational use sales. “A kindergarten class could open the cannabis sector better in New York,” one cannabis sector expert recently quipped. Jordan, at Curaleaf, predicts New York and other states running deficits will rationalize their cannabis regulation because their Covid relief funds have run out and they need the tax revenue.
* Robust Missouri sales: On the first day of legal recreational-use sales, state-licensed shops sold an enormous amount of cannabis products. They sold more than $5 million worth. That is almost twice as much as Illinois on its first day. Illinois has twice as many residents. Missouri posted this sales tally even though the University of Missouri was not yet online. Missouri approved recreational-use sales in December, following voter approval of this policy change in November. The state has approved 335 recreational-use businesses. It approved 207 dispensaries, 72 manufacturers and 56 cultivation facilities.
* Florida referendum advances: Supporters of a proposed constitutional amendment to legalize recreational use in Florida recently got one step closer to putting the issue before voters in 2024. They collected enough petition signatures to get a Florida Supreme Court review of the measure. The Supreme Court will review the wording of the proposal to certify that it is not confusing.
The “Smart & Safe Florida” political committee submitted 294,000 signatures. It will then need to round up 891,589 signatures to actually get the issue on the 2024 ballot, assuming the Supreme Court goes along. That is not a given. One concern is the Florida court has a partisan tilt towards the right. Republican leaders in the state may not want a cannabis issue on the ballot in 2024 since this would bring out voters on the left.
Trulieve (TCNNF), one of our portfolio names, has put $20 million into the referendum effort. The petition committee has burned through $19 million. If approved, legalized recreational use would provide a big boost to Trulieve’s business, given its dominance in Florida. It is Florida’s largest medical-marijuana provider.
* Maryland progress: Lawmakers in early February advanced a bill offering details on how the state will regulate and tax the sector. Voters approved a legalization referendum last November. Legal recreational use sales are slated to begin July 1. Maryland legalized medical cannabis in 2012.
* Mississippi medical sales: The state recently launched medical cannabis sales. The state has issued licenses to around 140 dispensaries. Medical use was approved in January 2022.
* When you can’t leave home without it: American Express and Citizens Financial Group are both lobbying in favor of cannabis-friendly bank sector reform called the Secure and Fair Enforcement Banking Act (SAFE Banking), reports Cannabis Wire. The reform, which would allow banks to provide services to cannabis companies, is also supported by the American Bankers Association.
* Progress in Minnesota: Gov. Tim Walz (D) released a budget proposal that includes funding to support adult-use legalization and expungements. So far, nine committees in the Minnesota house and senate have approved a recreational use legalization bill.
* De-scheduling: Rep. Greg Steube (R-FL) has reintroduced legislation that would de-schedule cannabis to Schedule III from Schedule I, under the Controlled Substances Act. This is the third time Steube has introduced the legislation.
* Interstate commerce: California’s Department of Cannabis Control asked the state attorney general for an opinion on risks out of Washington, D.C. if the state greenlights interstate cannabis commerce.
Company Updates
Curaleaf (CURLF)
Curaleaf announced that it is getting out of grow and production operations in California, Colorado and Oregon. This makes sense because these are highly competitive markets with elevated price competition in part due to a lack of enforcement against the illicit market. “I want to focus on higher-margin markets,” says Jordan, the executive chairman. The move may incrementally reduce the decline in wholesale cannabis prices by taking supply off the market.
The company is also consolidating cultivation and processing in Massachusetts to a single facility in Webster and closing its Amesbury facility. This will create a non-cash restructuring charge, but the company is reducing payroll by 10% in this streamlining. That should create $60 million in cost savings in 2023. The company expects $125 million in free cash flow this year. Curaleaf also got permission in Connecticut to open a recreational use store in Stamford. Curaleaf already had medical dispensaries in Hartford, Milford and Groton.
Organigram (OGI)
Organigram announced that Nasdaq notified the company it violates listing rules because its stock has traded below $1 for more than 30 days. Organigram has 180 days to comply, and at that point, it may receive a 180-day extension of its timeline to get into compliance. (A reverse split would be one option.) Organigram continues to be listed on the Toronto exchange, and the Nasdaq notification does not affect that listing.
Trulieve Cannabis (TCNNF)
Trulieve announced that it opened a new medical dispensary in Winter Haven, Florida. It also introduced new brands to Massachusetts and West Virginia.
