April was another month where equity markets sold off, and cannabis got hit harder than most. The S&P 500 is off to its worst start since 1939, and the NASDAQ notched its worst opening quarter since launching in 1971. For cannabis stocks, it was the worst month since COVID-lows of March 2020.
Cannabis stocks suffered more in part due to their higher beta and small-cap nature, but also ongoing frustration with the lack of political progress, slower Q1 earnings, and continued lack of access for institutions. Investors have lost patience, many have thrown in the towel, and the space is broadly maligned. Sentiment is the worst I’ve experienced. I would say this is a bullish indicator, but to be fair, I also would have said that last month.
MSOS is the largest cannabis ETF and serves as a solid proxy for US cannabis stocks. It continues to get crushed, and YOLO (a global cannabis ETF) is not far behind. On a relative basis, Green Giants had its strongest month of outperformance and is now besting MSOS by over 7% year-to-date. I’m well aware this is of little comfort, but I am pleased our stock selection is generating alpha.
For the year, and since inception, we continue to to lead the cannabis pack, while lagging the broader small-cap market.
Below is a graphical illustration of how the various benchmarks performed. You can see the high correlation, with cannabis experiencing the sharper drop.
I was hopeful that April would be a better month for cannabis stocks. We walked in with New Jersey voting on opening adult use on April 11th, the 4/20 holiday sometimes provides a bounce, and Senator Schumer was supposed to drop his CAOA bill. Some of this never happened, and the market did not care about the positives that did take place.
New Jersey Approves Some Operators To Begin Adult Use Sales
On April 11th, I watched the The New Jersey Cannabis Regulatory Commission Zoom meeting and did a dance when they read off the list of approved operators. We hold six stocks in the Green Giants portfolio and five out of the six were on the list (one of our holdings does not have a presence in New Jersey). We went 5/5 on eligible names and missed the only operator that was not granted a license, AYR. AYR was removed from the Green Giants portfolio in late January because I felt that there are stronger management teams, and to move into more dominant tier-one MSOs. Missing the drop in AYR, and having all potential New Jersey operators approved, was the primary reason for our outperformance this month.
New Jersey fast-tracked approvals and stores opened on April 21st, one day after the 4/20 holiday. On opening day, the state’s 12 adult-use dispensaries sold cannabis to 12,438 customers for a total gross sale of nearly $1.9 million. Since opening day, demand has stayed strong. Just a handful of stores are servicing the entire state of New Jersey, plus nearby residents of New York and Pennsylvania. Despite a new state opening with over nine-million residents, cannabis stocks were down over 10% by mid-month.
Schumer Delays CAOA
The real pain began on April 14th when Schumer announced he will introduce his cannabis decriminalization bill in August, not April as previously anticipated. Schumer’s Cannabis Adminstration and Opportunity Act (CAOA) is the Senator’s cannabis reform bill. While many feel it is more realistic to pass incremental reform, Schumer’s proposal shoots for full-blown legalization, with a hefty federal excise tax. It also remove cannabis from the list of controlled substances and incorporates criminal just reform. The expectation was that CAOA would be introduced this spring, likely around the 4/20 holiday.
We learned mid-month that the timeline had been pushed back and the new plan was “sometime before the August recess.” While this was another blow to sentiment, I don’t know anyone that expected Schumer’s bill to have enough bi-partisan support to pass. Perhaps he can use the next three months to gain more momentum, but my guess is that his attempt is too ambitious and will end up being a non-event after years of hype.
A Brutal Closing Week
The final week was the worst, with two days in the -5% range and liquidation rumors surfacing. This was during a period where all stocks were sliding, but the cannabis losses were much steeper and without any meaningful news. There was talk that the Competes Act (which currently includes SAFE Banking) conference will take longer than some expected, but it felt more like people were getting exhausted and tossing in the towel. Some speculated a particular hedge fund, or hedge funds, were liquidating their cannabis book. Todd Harrison wrote about this in his new article 1-800-GET-ME-OUT.
In the end, it was a painful month where all stocks fell, cannabis was hit harder, and investor sentiment reached a new low.
Cannabis investing is appropriate for investors with a high risk tolerance and long time horizon. 20 years ago I was an Investment Counselor for Fisher Investments and one of the questions we had to ask clients was “are you comfortable sitting through occasional 50% drawdowns to achieve your long-term goals?” This was for a global equities strategy. We would time stamp the answer so that when they were ready to panic at the wrong time, we had a reference point. It is one thing to say you are able to sit through large drawdowns, but another to remain calm during the storm.
To be successful in cannabis investing, you need to be comfortable with big declines. From April 2019 to March 2020 the YOLO (MSOS had not launched yet) ETF fell 75%. Many panicked and sold. Over the next year, YOLO went up 400%, and has now has fallen over 70% again. Below is a graph of YOLO since inception.
I’m not calling the bottom, but I am pointing out that in our very-short history we have already experienced this level of decline and have seen how quickly the space can go up 4x. I would understand selling if/when the fundamental story changes. However, to date I see changes to the timeline, rather than credible cracks in the foundation.
An Optimistic Case
Whitney Tilson of Empire Financial Research did a thoughtful presentation at the Benzinga Cannabis Capital Conference in Miami last month. Below are three slides I particularly liked. The full slide deck is available here.
First, framing the opportunity. We’ve been in a lull waiting for new states to come online and existing states to allow more new stores. We should see growth resume in the second half of the year as new markets open and more consumers move from the traditional market to legal outlets.
I thought when I launched Green Giants in October 2021 that it would be a good entry point. I was wrong on the short-term timing, but we know this is a volatile space and we have to endure drawdowns, or be market timers, to succeed. We’ve been through big declines before.
During past declines, 2x sales has served as a floor. That does not mean it will be a bottom this time, but at some point valuations will matter.
Risks Also Remain
To be fair, there are challenges. Cannabis sales are experiencing a post-COVID slump that is very similar to what we have seen with Netflix. When we were locked down, many people were home watching Netflix (remember Tiger King?) and using cannabis. Stimulus checks added more fuel to the cannabis fire and we saw a sharp uptick in sales during 2020 and into early 2021. As restrictions have been lifted and stimulus removed, Netflix has been way less popular and cannabis sales have flattened out, or declined. I'm not saying Netflix and cannabis are long-term linked, but as we have all gotten out more, both have seen a slump in demand.
Inflation and supply-chain problems also loom. Cannabis companies already have higher-than-normal borrowing costs (because cannabis is federally illegal, plant-touching operators cannot get normal bank loans and pay a premium from private lenders). This is one of the many reasons I favor the largest operators that have the lowest costs of capital, and businesses that are cash-flow positive.
Broader market declines are another risk. In the long term, I expect cannabis to more recession proof than most businesses. For many, it is more of a consumer staple than discretionary, especially for medical patients. Historically "sin stocks", or things that take the edge off, outperform in economic declines. However, in the near-term the illiquid nature, subpar exchanges, and small-cap status has caused cannabis stocks to get hit harder than most during declines. If the stock market continues to sell of, cannabis will likely suffer as well.
These are complicated and uncertain times. I appreciate everyone that is reading this and investing along with us. I know it’s been hard; I’m fatigued too. But, I’m grateful to have been investing for 25 years and I've been through other trying times. I was present for the dot-com bust, the 2007 quant unwind, the 2008 housing crisis and every-other big decline. It’s always super uncomfortable and it’s tempting to make changes. Sometimes the hardest thing to do is nothing.
Green Giants holds six of the ten largest US cannabis companies and does not use options. I feel this is the safest way to preserve capital and remain present for when the momentum shifts. For new investors considering the space, or adding new capital, history suggests this may be an above-average entry point.
Remain patient, be kind, and thank you for your continued support.
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