December capped a brutal 2021 for cannabis stock prices. After an initial run in January and February, the space sold off with remarkable consistency for the balance of the year. It’s amazing how failing to honor political promises can impact a sector.
Below is a graph illustrating the performance of the MSOS ETF, S&P 500 and Russell 2000 in 2021.
In December, the Green Giants strategy outperformed the MSOS ETF and American Cannabis Operators Index, but could not keep up with the small-cap Russell 2000 index.
Over time, MSOS and the American Cannabis Operators Index will help indicate whether we are doing a good job with stock selection. The Russell 2000 is included to show how the cannabis space is performing relative to other small-cap stocks. I spend zero time thinking about how to beat the Russell 2000 month-to-month, but instead see it as a long-term comparison for how the top-down cannabis trade is performing.
The first 2/3 of the month were driven by continued political frustration, peppered in with tax-loss selling. The last ten days of the month were surprisingly constructive, as the portfolio climbed 12% during this stretch with only one down day. This may have been a sign of tax-loss selling losing steam and investors beginning to return to a beaten-down sector. Or, it may just be noise in the bigger data set. Time will tell.
Let’s jump into some specifics.
Once Again, No SAFE Banking
On December 7th, the 2021 NDAA funding package was finalized and once again SAFE Banking was not included. The Secure and Fair Enforcement (SAFE) Banking Act is legislation that impacts the ability of federal banking regulators to intervene in the actions of banks dealing with a legal cannabis business. Currently, regulators can terminate the deposit or share insurance of a bank because they are doing business with a cannabis company. Banks cannot tolerate this risk, so they do not provide basic banking services to any cannabis-related businesses.
Passing SAFE would provide cannabis businesses basic banking, lower lending rates, stimulate sales due to easier credit card use, reduce robbery risk from less cash on hand and potentially pave the way for future favorable regulation. Some speculate that SAFE may pass in the first half of ’22, while others think it will get kicked until mid-term elections. I have no edge in political speculation and am instead building a portfolio that can perform as well as possible without SAFE.
Broadly, this means we will continue to focus on:
- Well-capitalized companies with affordable access to credit markets. This means tier 2 and up MSOs, with limited exceptions for smaller companies with heavy cash or credit-worthy assets.
- Investment-savvy operators. We are overweight companies run by former hedge fund and Wall Street professionals. I believe their skills in sourcing capital and allocating to the best opportunities are ideal for this type of environment.
- Increasing exposure to expanding markets. The East Coast has several key states flipping from medical to recreational use this year. These markets often see a massive increase in legal sales as the potential target market goes from only those with medical cards to anyone over 21.
Tax Loss Selling
Tax-loss selling was the other component weighing on cannabis stocks in December. Capital losses are tax deductible and you can even write-off $3,000 in realized capital losses against ordinary income.
Tax-loss harvesters will exit a name like Green Thumb Industries and *might* buy the MSOS ETF or another big cannabis name to maintain exposure while they sit out the required 30 day wash sale rule. When almost every cannabis stock was down last year, there were plenty of tax losses to harvest. The good news is that this typically reverses in January and the same stocks that were sold off benefit as they are bought back.
Curaleaf, the largest MSO by market cap, announced a $425 million private placement of 8% senior secured notes. This is the largest debt financing of any publicly-traded MSO to date, and an 8% interest rate is amongst the most competitive terms. In addition, the deal permits up to an additional $200 million in senior bank financing.
Aaron Gray of Alliance Global Securities stated he believes the deal will result in about $20 million in saving from lower interest payments. Curaleaf's last debt deal in January 2020 had a loftier 13% rate.
It is encouraging to see credit teams improving their rate by 500 bps, despite the fact the stock had fallen 27% over the training-twelve months. The divergence between credit and equity valuations continues to be a positive sign for cannabis stocks. If they were as broken as the stock market would have you believe, we would not be seeing consistently lower lending rates.
Another positive piece of news for the Green Giants portfolio was Ascend Wellness receiving final New York State approval for their investment agreement with MedMen NY Inc. The deal gives Ascend an 86.7% interested in MedMen’s New York cannabis operation for $63 million in compensation. They can acquire the remaining 13.7% equity for $10 million once New York launches their adult-use program, hopefully in late ’22.
New York is a massive opportunity for those that can acquire their limited licenses. The state has a population of 19.4 million with just 134,000 medical cannabis patients, under 1% . With adult use aka recreational cannabis, anyone over 21 can purchase without needing a medical card. This change is expected to grow the New York cannabis market from roughly $250 million in sales today, to over $2 billion in their fourth year.
Benjamin Graham said, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” We are in a period where cannabis companies’ successes are not being recognized. While frustrating, this presents ideal conditions for accumulating assets and building portfolios. If you are already “all in”, it may test your patience, but if you have additional capital to deploy, it is likely we will look back and think “I wish I had been able to buy more…”
As the chart below shows, MSOs represent an unparalleled value when comparing revenue growth and valuation:
As cannabis becomes more mainstream, political hurdles are lowered, and institutions are able to invest, the value will be unlocked. This won’t happen all at once, but instead will be a a series of moves with occasional large jumps. I don’t know the rate at which these changes take place, but I have never been more confident that it is inevitable.
Thank you for your continued support, and please don’t hesitate to get in touch if we can be help you with your cannabis investing needs.
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