Shares of Canadian cannabis companies Tilray Brands (TLRY 0.86%), Canopy Growth Company (CGC 1.92%), Cronos Group (CRON +0.80%), and SNDL (SNDL 2.88%) exploded higher on Tuesday, rallying 41.7%, 67.5%, 15.7%, and 24.4%, respectively, as of 3:18 PM EDT. It wasn't hard to figure out why cannabis stocks had across-the-board rallies today: The U.S. Drug Enforcement Agency (DEA) agreed with the historic recommendation by the U.S. Department of Health and Human Services (HHS) to reschedule marijuana as a Schedule III drug, down from its Schedule I classification that the drug has had since 1971.
Rescheduling will come with huge financial benefits for U.S. cannabis companies. But will these Canadian companies trading on U.S. stock exchanges benefit, too?
NASDAQ: TLRY
Key Data Points
A historic day
Marijuana probably never should have been classified as a Schedule I drug to begin with. That's a designation shared with extremely dangerous drugs that have no known medical benefits and significant abuse potential, like heroin. A Schedule III drug is a lower-risk classification, on par with medically prescribed Tylenol with codeine (less than 90ml), ketamine, or anabolic steroids.
The rescheduling of the drug doesn't legalize marijuana at the federal level, and the DEA's recommendation by itself doesn't reclassify pot. The White House Office of Management and Budget (OMB) has to approve the recommendation, and the rule must go to public comment before being finalized. However, the historic recommendation following a year-plus study by the HHS tilts the odds heavily in favor that marijuana will be rescheduled.
Why would rescheduling cannabis be so beneficial to cannabis companies? It's largely a tax issue. Cannabis companies have already been operating in states that have legalized marijuana -- even though it was illegal at the federal level -- without legal consequences.
There has, however, been significant financial expense. Cannabis companies have been forced to operate heavily with cash and use alternatives to mainstream banks, increasing the physical danger to employees and adding costs. Moreover, U.S. cannabis companies have been prevented from listing on major U.S. stock exchanges, and instead have been trading over the counter. Institutional investors looking for cannabis exposure had to buy shares of Canadian companies like these four, which are listed on major U.S. stock exchanges.
But perhaps the most onerous headwind that will be reversed by rescheduling is that (state) legal cannabis companies will no longer be subject to Section 280e of the IRS tax code. This section says that no company trafficking in the sale of a Schedule I drug can deduct any operating expenses for tax purposes. So U.S. cannabis companies have essentially been taxed on their gross profits, and these tax burdens have made it virtually impossible to make material profits or cash flow.
However, if pot is rescheduled, U.S. cannabis companies will now be taxed like any other company, which is a huge benefit to their bottom lines.
Image source: Getty Images.
How these Canadian companies will benefit
While these Canadian companies haven't entered the U.S. directly, some have been preparing for this moment for a while. Canopy holds warrants that give it the right to purchase several U.S. cannabis companies.
Earlier this month, Canopy created a new U.S.-domiciled holding company, Canopy USA, LLC, to hold these warrants. Canopy will exercise them when one of the major U.S. stock exchanges allows U.S. plant-touching cannabis companies to be listed.
Back in January, Tilray CEO Simon Irwin told the Wall Street Journal that Tilray would seek and be able to enter the U.S. "pretty quickly" upon rescheduling, either organically entering the U.S. or by acquiring another cannabis company. And while Cronos only sells cannabis in Canada, Germany, and Israel today, it's also 45% owned by cigarette giant Altria. While Cronos actually exited the U.S. CBD business last year and Altria has considered selling Cronos, one has to think Altria may have plans to attempt a U.S. entry for this subsidiary in light of rescheduling.
Finally, SNDL Holdings has taken a somewhat novel approach to entering the U.S. After becoming a meme stock in 2021 and raising over $1 billion in cash, SNDL began to buy the debt of several U.S. cannabis operators through a joint venture called SunStream. Since it didn't own the equity of U.S. companies, SNDL therefore stayed within the rules to remain on the Nasdaq. And SNDL also had unrestricted cash of $195 million as of last quarter, giving it some dry powder to invest in the U.S.
Still, the most immediate benefit from rescheduling will go to U.S. multi-state operators (MSOs) that currently trade over the counter. As far as these Canadian companies' U.S. expansions, it's in the very early days, and it's still highly uncertain how successful they will be, given the established U.S. competition already in place. Investors may want to proceed cautiously with these four, especially after these huge rallies.
