[Todd Harrison is the CIO and co-founder of CB1 Capital and a columnist for Investopedia. The views expressed herein are those of the author and do not necessarily reflect the views of Investopedia.]
2020 will be remembered for many things but for the U.S. cannabis industry, it’ll be remembered as the beginning. While the grassroots seeded a few seasons ago, history, with the benefit of hindsight, will point to the economic motivation stemming from the pandemic and this year’s social justice movement as the beginning of the end of our modern-day prohibition.
The first half of the year helped shape the FANGification of U.S cannabis but the landscape remains uneven at best and rife with risks. Much of that has to do with the federal treatment of cannabis and the complex regulatory framework that U.S. operators are forced to endure. And while some barbarians have slipped through the gates , most institutional investors remain on the outside looking in.
After a steady rise off the March lows, U.S. cannabis stocks retreated in September for several reasons: most were technically overbought, and the specter of a bipartisan agreement on stimulus dimmed with the passing of U.S. Supreme Court Justice Ruth Bader Ginsburg. That helped dash hopes that the SAFE Banking Act provisions in the House version of the stimulus bill would pass the Senate, which cooled sentiment surrounding the space.
The upcoming elections will further shape the operating landscape. States have been scrambling for tax-revenue and their constituents need jobs; legal cannabis drives both at scale. New Jersey, Arizona, Mississippi, Montana and South Dakota will vote on cannabis referenda and we believe New Jersey will pass adult-use, which should trigger New York, Pennsylvania, Connecticut and Rhode Island to do the same.
While further state adoption will increase the total addressable market, the federal elections offer a pathway to structural reform. A blue Senate would remove the chokehold on long-overdue legislation that protects states’ rights and allows for SAFE banking, debt financing and a lower cost of capital. A blue sweep would add steroids that could help fast-track institutional participation and U.S. exchange listings.
Cowen Research recently shared a nifty visual on U.S. cannabis election probabilities that offers a fair assessment. From a flow of funds perspective, should we see a blue wave, U.S. hedge funds would be first movers (we saw this buying begin in early October) followed by family offices and off-shore investors, and then large U.S. institutions likely once legislation becomes law, presumably around this time next year.
Should the GOP maintain the status quo, it could further bifurcate the industry chasm between the haves and have-nots. The half-dozen or so U.S. cannabis companies generating positive cash flow and positioned to achieve operating efficiencies at scale would gain share while the rest of the industry awaits a tenable federal solution and clarity around the timing of SAFE banking and access to capital markets.
Business is Good
The U.S. cannabis landscape is going to look a lot different in a few weeks. Whether that’s the addition of several states or a seismic shift that democratizes the space remains to be seen. And while we agree this industry maybe the truest, bluest bet on the board, we don’t view the election as a referendum on survival as much as a variable that will help shape the forward trajectory.
Value investor Benjamin Graham once observed that, “in the short-run, the market is a voting machine but in the long-run, the market is a weighing machine.” Those words ring true with an election looming and fast money circling, but the truth is, big money investors aren’t fixated on the outcome as much as they’re focused on the fundamental growth that will continue to scale.
Recent channel checks with industry leaders and a review of tax receipts suggest business is trending ahead of estimates. While those stateside fundamentals are the primary difference between cannabis 1.0 (Canadian cultivation) and cannabis 2.0 (U.S-led CPG), most investors still don’t know the difference between Cronos and Curaleaf. That disconnect, and the nascency of the industry at large, presents tremendous opportunities for those willing to do the work.
A snapshot of select U.S. cannabis operators helps frame this discussion. Leaving aside the electoral optionality and allowing for existing regulatory and tax impediments, companies that are executing against their plan stand to benefit regardless of what happens at the federal level. As JW Asset Management President Jason Wild recently noted in Barron’s , “you’re not going to find growth like this anywhere else at these multiples.”
The road ahead promises to be bumpy, as frontier markets tend to be; and then there is the issue of the broader market, one that is hinged to the specter of never-ending stimuli; the potential for a contested election or civil unrest; and an absence of clarity around the duration of the virus or the timeline for a vaccine or therapeutic response that will allow for a return to normalcy.
We don’t profess to know the answers to those questions but we’re relatively confident that over time, intelligent investors will buy legitimate growth at reasonable multiples; and we’re further assured by the sense that so few investors are seemingly aware that cannabis is an asset class, much less one that is in the throes of a secular bull market.
In November 2012, I tweeted, “Prohibition ended with the Great Depression and modern prohibition (cannabis) will end with our generation’s Great Depression.” The equity rally of 2020 may have masked the economic upheaval driven by the novel coronavirus, but the state budget shortfalls and structural unemployment suggest that while history doesn’t always repeat, it will likely rhyme.
Disclosure: CB1 Capital has positions in stocks mentioned.