Cannabis stocks continue to get weighed down by the SAFE banking debacle.
As you recall, late last year legislators failed to approve cannabis sector banking reform called the SAFE Banking Act that would have made it easier for banks to serve cannabis companies.
Cannabis stocks sold off way too much on this news, and they look like a strong buy here. The time to buy stocks with decent prospects is when consensus hates them, and that is the case with cannabis names right now.
It’s hard to find anyone who is bullish on the group. But this is good news for bargain hunters because it’s not all bad news for the cannabis sector. Several bullish trends are playing out regardless of what lawmakers do in Washington, D.C. this year on cannabis, which may be very little.
What’s bullish for the group? Here are five factors that favor quality cannabis names.
1. Public opinion supports progress on legalization. Though opinions about cannabis depend on age and political leanings, public sentiment generally favors recreational cannabis use legalization. Polls consistently show this.
Key popular opinion leaders are on board, too. Think what you will about Elon Musk, but he is definitely an influential opinion leader. While underscoring that he does not promote drug use, Musk recently tweeted: “Banning alcohol caused the biggest rise in organized crime in American history. That was dumb. Same logic applies to other drugs. Alcohol is just a legacy drug.” Lawmakers on both sides of the aisle pay attention to Musk because of his influence.
2. Banking reform might be less important than investors think. I understand that approval would have signaled a sentiment change in Washington, D.C. that would have attracted investors. But the reality is, many banks and financial institutions already serve the sector. Large Wall Street investment banks make money covering the group and handling trading in cannabis names for clients, and they create financial instruments like swaps. As for actual banking, this happens all the time. Here are some examples.
* In late December, our Trulieve (TCNNF) got a $71.5 million loan from three banks including Valley National Bank.
* Our Curaleaf (CURLF) on January 4 filed a shelf registration for an offering of stock, debt and warrants worth up to $1 billion over the next two years.
* The entire business model of a specialty finance company called Silver Spike Investment (SSIC) is to provide financing to cannabis companies in the form of loans, equity stakes and other instruments. How is this not banking for the cannabis group? This looks like an interesting name to own for exposure to the cannabis sector. It reports profits, and it trades at a 66% discount to its reported net asset value of assets of $13.73.
There’s a troubling demographic angle to this. While wealthy bankers can profit by providing loans and other financial services, retail clerks at the ground level making $15 an hour face the risk of armed robbery, given the amounts of cash lying around since this is an all-cash business. Might politicians pick up on this dichotomy to try to promote broad banking reform for the group?
3. While politicians in Washington, D.C. dither, states keep charging ahead with legalization of both recreational and medical use of cannabis. This steady progress supports projections by market research groups like BDSA that U.S. legal cannabis sales will grow 55% to $42 billion in 2026 compared to around $27 billion last year.
The biggest development here is that two large states have joined the legalization trend. New York launched its first dispensary in late December, and it has so far approved 36 of them. New Jersey is ramping up its legal sales infrastructure after first launching recreational use sales in April 2022. It now has around 20 dispensaries. Third-quarter sales were $177 million. These two states expand legal cannabis sales to about 22 million adults.
Connecticut launched legal recreational sales on January 10 this year. Rhode Island launched legal sales in the beginning of December last year.
Maryland voters approved legal recreational use last November, and sales will probably start in July this year. The state has a population of about 6.1 million. A survey by Cannabis Public Policy Consulting found people in the state have an above-average interest in purchasing. Companies among our holdings with exposure include Curaleaf and Trulieve.
Missouri will launch legal recreational sales this year, and a state department of revenue spokesperson confirms companies will be able to deduct business expenses on state taxes.
Revenue trends in more established states suggest sales growth will be big in these states. Illinois sales came in at $1.5 billion in 2022. That’s a 12% gain over 2021, and it’s a 131% advance over 2020. Massachusetts recreational sales totaled $1.42 billion last year.
Meanwhile, several other states should make progress over the next year or two.
In Florida, an initiative to put recreational use to voters has around 148,000 signatures, up from 50,000 at the end of November. It needs 891,000 to get on the ballot. Florida has 22 million residents and 130 million tourists a year, so it’s a “huge market opportunity,” says Trulieve CEO Kim Rivers. She thinks there’s a good chance it will get approved if it gets on the ballot. Trulieve is the big operator in the state, where medical use sales are legal.
Minnesota lawmakers are working on a bill to legalize recreational use. The Minnesota state house passed a recreational use bill last year, but the senate rejected it. Polls show a majority of residents support legal recreational use. Governor Tim Walz (D) has stated that progress on legalization is a priority in 2023.
Wisconsin lawmakers are taking another shot at legalization this year. Polls show that a majority of voters in both major parties support legalization.
South Carolina lawmakers are working on bills to legalize medical marijuana. Polls show that a vast majority of voters favor medical cannabis legalization and a slim majority supports recreational use legalization.
4. Consolidation will favor the larger, stronger companies in the space. The cannabis sector continues to face pressure from declining prices. Wholesale prices are falling around 30% year over year, pushing the price of a pound of flower below $1,000.
The good news here is that this will shake out weaker players, which will benefit the stronger companies like the ones we own. Many smaller companies will just go out of business, but others will get bought out by the stronger companies (like ours) in a mergers and acquisitions wave this year.
5. There’s a slim chance for progress in Washington, D.C. this year. While few analysts give this much credence, it is not entirely out of the question. Consider the following.
Slightly more than half of House Republicans voted for SAFE banking in the last Congress. Sen. John Fetterman (D-PA), a strong supporter of legalization, has joined the Senate. And Senate Banking Committee Chairman Sherrod Brown (D-OH) has indicated he wants to move SAFE banking forward, cannabis reform lobbyist Justin Strekal of Better Organizing to Win Legalization recently wrote in Marijuana Moment. “There is actually a pathway to accomplish something pertaining to marijuana law reform,” he concludes.
I wouldn’t count on it. But even headline news of some progress would revive interest in cannabis stocks.
Company Update
Tilray Brands (TLRY)
Our Tilray reported a 7% decline in fourth-quarter revenue to $144.1 million, led by weakness in cannabis sales (to $49.9 million from $58.8 million). Alcohol sales jumped 56% to $21.4 million from $13.7 million.
Cost cutting continued (including layoffs, which are becoming more common in the sector), so gross profits rose 22% over the prior year to $40.1 million. But the company posted a net loss of $61.7 million compared to a net loss of $65.8 million in the prior quarter and net income of $5.8 million in the year-ago quarter. It finished the quarter with a strong cash position of $433.5 million.
Tilray continues to be a hold, or a buy if you are new to the sector. Here’s why.
Tilray says prices are stabilizing in Canada (where it has the largest market share at 8.3%) in all categories except vapes.
At this point, though, owning Tilray is important for exposure to legalization of recreational use in Europe, where Germany is leading the way. CEO Irwin Simon expects legalization in Germany in 2024. That’ll get the ball rolling in other countries. In addition to Germany, Portugal, Luxembourg and the Czech Republic have expressed “a clear political ambition to legalize adult-use cannabis,” says Tilray. Germany has a population of 83.3 million, and Europe’s population is 447 million.
We don’t need full legalization for progress in Europe to push Tilray stock higher. Headlines along the way will attract interest in this name. German Health Minister Karl Lauterbach has said a first draft of proposed regulations for recreational use will be released in the first quarter of 2023.
Tilray has significant infrastructure in Europe. It has grow facilities in Germany (Aphria RX) and Portugal. Its CC Pharma division distributes medical cannabis into 13,000 drug stores. Tilray says the medical market in Europe is going to be a $13.8 billion market by 2028.
Tilray also has extensive experience in production and sales in Canada, which it can apply in Europe. “This experience, paired with our competitively advantaged supply-chain footprint, gives us great confidence in our ability to lead the European medical market and German adult-use market in the future,” says Simon.
