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Cannabis investors have been plowing into a very beaten-up part of the market, the American cannabis operators, after the HHS revealed that it has requested that the DEA reschedule cannabis from Schedule 1 to Schedule 3. As we discussed last week, this is great news if it plays out, as it would end the very negative taxation of the industry, 280E. We warned last week that it might take a while and that the DEA might decide to go to Schedule 2, which would leave 280E intact. The market extended its rally this past week, and many companies have moved rather dramatically, which we think elevates the risk if things do not play out as expected.
Since August 29th, the day before the news hit, the largest MSOs have soared:
So, on average, these five stocks have rallied 24.5% on this news. Looking at the year-to-date returns, a few are up a lot now, but one, Trulieve is still down:
A few weeks ago, we suggested that investors look at price-to-tangible-book as a metric. While the change in sentiment makes this less timely, we believe that it can help investors assess the downside risk if things don’t play out as expected. Among the largest 5 MSOs, GTI has the best balance sheet but trades at 4.8X tangible book value. The worst balance sheet by far is Curaleaf. Here are the current market caps, net debt, current ratios and tangible book values for the largest MSOs:
Please note that the tangible book value is based upon the tangible book value at 6/30, but it is also updated for the potential exercise of any in-the-money dilutive securities. The net debt is also adjusted for these potential inflows of cash, as is the market cap.
As we discussed last week, we believe that the other parts of the market that have not rallied so dramatically could offer investors good potential returns with less risk than the American cannabis operators. Specifically, I have boosted my exposure in the 420 Investor Beat the Global Cannabis Stock Index model portfolio to Canadian LPs and to ancillary companies. Perhaps things will work out as expected, but cannabis investors should realize that this is not always the case for this sector. Even if cannabis is rescheduled, ending 280E, and even if SAFE Banking passes, some of the MSOs will likely need to raise capital. While the outlook may become better for the MSOs, the danger is great if 280E doesn’t end.
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Alan & Joel