The U.S. cannabis industry remains one of the most interesting investing opportunities today. Although the companies still operate in a technically illegal business, most U.S. states have legalized cannabis, at least on a medical basis, and over two-thirds of U.S. citizens are pro-legalization.
Those numbers make it seem as if federal prohibition will be repealed at some point. Yet while many had thought action would occur earlier this year, cannabis legalization measures have stalled in Congress. With hot money pouring into U.S. cannabis stocks after Democrats took control of Congress in January, that money has since grown impatient and left the space throughout the spring and summer. No wonder the AdvisorShares Pure US Cannabis ETF (MSOS 4.25%), an ETF that owns most of the leading U.S. multistate operators (MSOs), is down 14.9% on the year and a stunning 42.6% from all-time highs set back in February.
But after a long slump, could these stocks be in for liftoff once again? Many cannabis stocks have surged this month, with MSOS up 14.6% just through the first two weeks of November.
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A Republican legalization bill surfaces
Cannabis legalization is one of the rare issues that has bipartisan support, but the two parties have different preferred ways of implementing those measures. Democrats in the Senate released a draft proposal to legalize cannabis in July, but cannabis stocks sank on the news because many thought the proposals were too aggressive to pass. Mainly, high excise taxes up to 25%, with a large portion of those funds going to a social justice fund for communities of color, were thought to be elements unlikely to draw needed Republican support.
But on Nov. 5, Marijuana Moment picked up on a scoop that Rep. Nancy Mace (R-S.C.) was circulating a draft of her own legislation. Cannabis stocks climbed by double digits on the news, as the prospect for Republicans to join the congressional effort led to optimism over legalization.
But the unveiling of the bill was a "sell the news" event
Yet after a huge run in which several leading pot stocks were up 20%, 30%, or even 40% on the news of the proposal, most sold off when Mace's bill was unveiled two weeks later.
It's a bit curious why that happened. After all, both the Democratic Senate proposal and Mace's House proposal have similar features. They both remove cannabis from the Controlled Substances Act and allow states to make their own rules, similar to how alcohol is regulated. Both would also allow cannabis companies to use the banking system, and for U.S. cannabis stocks to list on the major stock exchanges. Today, they are listed in Canada and can only be bought over-the-counter in the United States. Both bills would also allow for the expungement of past cannabis-related crimes, although there may be some differences between the two in terms of how far expungements would go.
The main difference between the two bills is that Mace's proposal has only a 3% excise tax on sales for 10 years, while the Democrats' bill has a 10% tax that would rise to 25% after a few years. In addition, Mace's bill doesn't have social justice language in it, or the funds for as much investment into communities of color.
Apparently, the large difference between the two proposals was enough to draw some skepticism among investors that legalization may be subject to more long negotiations. So cannabis stocks took a breather.
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Leading names continue to report strong growth
Meanwhile, major U.S. MSOs are now reporting their third-quarter earnings. While all are reporting strong growth, not all are beating analyst expectations. Both Trulieve (TCNNF 3.18%) and Green Thumb Industries (GTBIF 2.55%) beat revenue estimates, while Curaleaf (CURLF 5.06%) and Cresco Labs (CRLBF 2.86%) missed expectations. Yet all of these companies are all growing fast, with revenue growth rates of 64%, 49%, 74%, and 41%, respectively.
If the tax and financing burdens cannabis companies must endure are removed, it would be a boon to all involved, as each company is earning healthy EBITDA margins, even if net income is stifled by unduly high taxes. On the other hand, legalization would open up potentially more competition and pricing pressure, so investors will have to monitor the details of both federal and state regulations as they evolve.
Still, given the consolidation in the space and very reasonable valuations on an EBITDA basis after their summer swoon, U.S. cannabis stocks still look like bargains today, should the industry fulfill its promise of growing to $100 billion by 2030, up from just $17.5 billion last year.
That is, of course, if Congress ever gets its act together and passes a long-overdue bill to repeal cannabis prohibition.
