Here’s Why Cannabis Stocks Have Pulled Back

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We are on the edge of closing out the second consecutive major quarterly advance in the New Cannabis Ventures Global Cannabis Stock Index, which is up 39.4% since year-end with a few days remaining in the first quarter. Including the 61.7% advance in Q4, the index is up more than 125% since the end of September.

Within the robust rally over the past six months, we have seen a sharp correction, with the index having retreated 35% from the close on February 10th to the close on March 8th. Currently we are testing the early March low, down 33% below the multi-year peak.

We shared a very bullish outlook last May, suggesting then the start of a sustainable rally based on potential federal reforms ahead, more states legalizing and improvement in markets that had already done so. Since then, we have pointed many other factors that suggest the fundamentals are improving as the legal cannabis operators are converting consumers from the illicit market. We have seen institutional investors take significant stakes in American cannabis companies, and we are seeing access to capital improve and an active market for M&A that we believe will help MSOs deliver strong returns as they consolidate the highly fragmented industry.

With all of these positive factors, why has the market, then, declined by 1/3 over the past six weeks or so? The easy answer is that it got ahead of itself! In January, the surprise switch in control of the Senate set off a buying stampede. By the peak on February 10th, the market had rallied more than 108%. This pace, which annualized to over 6700%, clearly was an unsustainable rate of growth. Even with the year-to-date gain thus far of 39.4%, continued gains at this rate would leave the index up over 277% for 2021. We are bullish, but we will take the under on that one!

We have long cautioned that progress at the federal level will likely be slow, and it appears that the market is finally figuring this out. The recent reintroduction of the SAFE Banking Act was certainly a sign that we shouldn’t expect a quick change from NASDAQ or the NYSE regarding their prohibition of American cannabis companies from listing. While the talk of legalization at the federal level really ramped up, especially from the large Canadian LPs who were telling their investors this was the case, we anticipate progress will be slow on this front. We remind readers that the best-case scenario for the American cannabis industry is continued progress at the state and local level with perhaps a more robust SAFE Banking Act that would allow companies to move to higher exchanges. The status quo is working very well despite the challenges.

Another issue that has weighed on sentiment in our view is how some of the state legalizations are playing out. Virginia’s adoption of adult-use was unexpected, but delaying implementation until 2024 diminished its impact. New Jersey’s first sales will be a little later than anticipated heading into the year. New Mexico couldn’t get their legislation to legalize for adult-use to the finish line, though it could do so in a special session. More recently, the current adult-use legalization proposal in New York, which we believe could be revised favorably, doesn’t appear to be especially friendly to the existing operators in the state, with limits on their ability to open retail stores. We are encouraged with the bigger picture: States are moving quickly to adopt adult-use, which will drive substantial industry growth for years to come.

Finally, while earnings season was good, with companies generally meeting or exceeding expectations and showing strong growth and improving profitability, the forward guidance generally wasn’t any better than what the analysts were already anticipating for the most part. After getting burned in 2019 by not meeting aggressive guidance provided when they went public in 2018, it’s not surprising to see the MSOs take a more conservative approach.

While the recent pullback has been steep, we continue to believe that the bull market that began last March is intact. We shared 9 growth drivers as the year began, and every single one of them appears to remain valid. As we look out over the balance of the year, we anticipate continued  exceptional top-line expansion and bottom-line performance, ongoing progress at the state level in terms of improving existing medical programs and adopting adult-use and a very strong M&A environment. In particular, look for MSOs to be aggressive in California, which is a massive market that is getting better after a rough start, and Colorado, a mature but still growing market that remains highly fragmented. The valuations in these markets are much lower than in the East.

These corrections are never fun, but we expect to look back later this year at this period as a buying opportunity. After two years of massive declines, cannabis stocks rallied just 5% in 2020 after clawing their way deep out of the hole. We are off to a fantastic start in 2021, and everything we look at suggests prices could be higher than the interim peak in February at some point later this year.

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Alan & Joel

Exclusive article by Alan Brochstein, CFA
Alan Brochstein, CFA
Based in Houston, Alan leverages his experience as founder of online community 420 Investor, the first and still largest due diligence platform focused on the publicly-traded stocks in the cannabis industry. With his extensive network in the cannabis community, Alan continues to find new ways to connect the industry and facilitate its sustainable growth. At New Cannabis Ventures, he is responsible for content development and strategic alliances. Before shifting his focus to the cannabis industry in early 2013, Alan, who began his career on Wall Street in 1986, worked as an independent research analyst following over two decades in research and portfolio management. A prolific writer, with over 650 articles published since 2007 at Seeking Alpha, where he has 70,000 followers, Alan is a frequent speaker at industry conferences and a frequent source to the media, including the NY Times, the Wall Street Journal, Fox Business, and Bloomberg TV. Contact Alan: Twitter | Facebook | LinkedIn | Email

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