What happened

Shares of Canadian cannabis and liquor company SNDL (SNDL -0.72%), formerly known as Sundial Growers, fell 16.6% this week through Thursday trading.

It was a tough week for cannabis stocks, especially those in the U.S., which fell even more than SNDL did. The declines had to do with hot money selling out of the sector, following recent buying on hopes that the U.S. Congress would pass Secure and Fair Enforcement (SAFE) Banking Act provisions within the end-of-year National Defense Authorization Act (NDAA) that Congress is about to pass.

However, those hopes were dashed this week, leading to a reversal of recent buying and an abrupt sell-off in the sector. While SNDL currently operates in Canada, it also has some indirect exposure to U.S. cannabis. That's why it fell in sympathy, albeit not as much.

So what

Since there appeared to be agreement between both Democrats and Republicans in both the House and Senate on SAFE Banking provisions, which would indemnify national banks working with state-legal U.S. cannabis companies from liability, many thought that the measure would pass in the lame-duck session of Congress. The legislation would probably be more symbolic and only mildly beneficial to U.S. companies, and not a game-changer. However, cannabis stocks had run up in anticipation of SAFE's passage.

However, Senate Republican leaders, notably Senator Mitch McConnell and Chuck Grassley, raised objections this week to attaching the SAFE Banking provisions to the NDAA. The problem is that if the SAFE Banking provisions aren't passed in the NDAA, there is limited time to pass them at all before the new Congress comes in at the end of January.

Notably, Republicans have taken control of the House of Representatives. While the SAFE Banking provisions have repeatedly passed the House on a bipartisan basis, it's unclear if Republicans would bring the legislation up in the new Congress.

While SNDL isn't a U.S. cannabis company, it actually does have a fair amount of exposure to the U.S. market through its joint venture SunStream Bancorp, formed in partnership with SAF Group. The vehicle makes loans to U.S.-based multi-state operators and is able to earn very high rates of interest, in part because of a lack of competition from mainstream banks that would come from the passage of the SAFE Banking Act.

So, it may not even be the worst thing for SNDL if SAFE Banking doesn't pass, as it would mean less competition for loans among U.S. MSOs. On the other hand, the health of its investee companies likely depends on eventual legalization since it is very hard to make money as a cannabis company in the U.S. due to the extremely high tax burdens that come with federal illegality.

Now what

Despite the SAFE Banking Act's lack of success this week being a mixed bag for SNDL, the stock fell in sympathy with U.S. MSOs, as these stocks tend to be broadly correlated and often move based on movements regarding U.S. Federal legislation -- or a lack thereof.

While SNDL was formerly a tiny, near-bankrupt stock in 2020, it became a meme stock in 2021 and was, therefore, able to raise $1 billion through equity sales at absurdly high valuations. The move allowed SNDL to buy a profitable liquor business, as well as invest in debt securities of both Canadian and U.S. cannabis MSOs, which is a savvy way to try to consolidate the industry. If investees are successful, SNDL earns high interest income on its loans. If they go bankrupt, SNDL and SunStream's senior positions in the capital structure will allow them to take over the bankrupt company's assets.

Trading well below its book value, SNDL has actually become probably the lowest-risk option to play the North American cannabis industry. It's an ironic change from just a couple of years ago.