Working Assumptions
The rout in cannabis stocks is making it abundantly clear that legalization is not happening in 2021, and 2022 is not looking great for comprehensive reform. Add to this a significant slowdown is in industry sales in 3Q21, and the current setup for cannabis stocks is challenging. We expect the upcoming earnings season to be tempered by uncertainty over these issues, and some companies will likely lower guidance. Companies with significant exposure to CA are trading at a discount to the group for a reason. This will likely become more apparent in the coming weeks, with the Hedgeye California Tracker showing a significant slowdown in industry sales. Adding to the concerns was the 12% decline in industry bell-weather GTBIF, just 11 days before earnings.
The Cannabis MSOS is down 25.75% YTD, the worst-performing asset class across nearly every sector we track on the Hedgeye ETF DashBoard (see slide below). There is an apparent disconnect between growth valuation and other assets classes, but all of that takes a back seat to politics. Cannabis is and will always be a highly regulated industry, and what happens in Washington is critical to sentiment and valuation until the end of prohibition.
As reported by Politico's Natalie Fertig, "for the first time in months, there is a clue of a timeline on when Sens. Ron Wyden (D-Ore.), Cory Booker (D-N.J.) and Majority Leader Chuck Schumer (D-N.Y.) will take the next step on their Cannabis Administration and Opportunity Act (CAOA). "The second we get done with reconciliation, that'll be front and center," Wyden told Natalie on Capitol Hill last week. That sounds great, but the CAOA is a "watershed moment" for cannabis legalization, and much works need to be done. The bill will take years to do properly with complex drug policy, racial justice, and corporate accountability issues. So for Wyden to say publically, "he's looked through some of the comments that were submitted on the CAO Act" is akin to doing nothing for cannabis stocks.
As @HedgeyeDC pointed out in our recent legalization call, the Senate has not hit many of its deadlines this year, and the current goal of hashing out a reconciliation bill by the end of October is looking increasingly unlikely. Throw in the holidays in November and December, and a federal budget still to deliberate, making any CAOA revisions a spring event. Now the midterm elections enter the mix, which means politics will enter the equation, and Majority Leader Chuck Schumer is looking to get re-elected to his fourth term.
The last hold out for the hope of any possible incremental legalization steps in 2021 is attaching SAFE to the NDAA, which could be voted on in November. Unfortunately, the NDAA process takes us back to the "politics of Cannabis" and Majority leader Schumer. Our in-house view is that the Majority Leader will likely pull SAFE from the final Senate version for political reasons. On this point, we hope we are wrong, as tens of thousands of state-licensed cannabis businesses are unable to partner with the banking industry due to federal prohibition. This means they cannot accept credit cards, deposit revenues, access loans, or basic financial service needs. This situation is untenable as no industry can operate safely, transparently, or effectively without access to banks or other financial institutions. If enacted, state-legal marijuana programs and businesses would operate more efficiently, and entrepreneurs would have more access to capital streams, which would remove one of the biggest hurdles that currently prevent small businesses from getting into the industry.
Should safe pass, yes, but cannabis policy is politics, and Senator Schumer is a political animal trying not to become the democrat version of Al D'Amato.
NY - SPRING 2023
From the Rochester City Newspaper
The head of the state's Cannabis Control Board said Wednesday during a stop in Rochester that she anticipates licenses for the first recreational marijuana dispensaries in the state not being issued until the spring of 2023 at the earliest. Tremaine Wright, the board chair, made the statement during a "cannabiz" symposium held at Comedy at the Carlson. She said the board was working on an 18-month timeline to build the requisite policies framing the new legal marijuana market. That timeline, she said, doesn't necessarily mean dispensaries will be open or fully stocked by then either, but rather that they will have the legal authority to operate. (We would note that this might also have contributed to the decline in GTBIF & CCHWF last week!)
"What we do control is getting (dispensaries) licensing and giving them all the tools so they can work within our systems," Wright said. "That's what we are saying will be achieved in 18 months. Not that they're open, not that they'll be full-blown operations because we don't know that."
Her remarks were met with audible groans from the crowd, made up mainly of fledgling cannabis entrepreneurs and longstanding growers and dealers in the illicit market. The Cannabis Control Board was formed by Gov. Kathy Hochul in September after the passage of the Marihuana Regulation and Taxation Act. That law specifies April 1, 2022, as the earliest that the sale of recreational cannabis can begin, at least a year sooner than Wright's prediction of when it will actually start. Much like in the rest of the state, Rochester's cannabis industry is already gearing up, with dozens of brands and delivery services standing at the ready.
Most budding businesses have made due by exploiting the so-called "gifting clause" in the law that allows adults to give each other small amounts of weed for free. Businesses, however, have begun offering small amounts as promotional "gifts" to customers who buy other, substantially marked-up items, such as T-shirts lighters, or stickers, whose prices more than cover the value of the marijuana. Wright blasted the practice last week as illegal and subject to unspecified "severe financial penalties." Local businesses appear fixed on building a cannabis establishment in Rochester. Steve VanDeWalle, a cannabis entrepreneur and grower based in Rochester, announced the creation of a local "cannabis council" meant to create a local network of cannabis industries. "In the craft cannabis business, instead of having one billionaire, let's have a thousand millionaires," VanDeWalle said.
HEXO - COME HOME TO ROOST
Last week, HEXO reported a Q4 adjusted EBITDA loss of $13.0M, well short of expectation, but the board did fire the CEO, so not wholly unexpected. In addition, the release acknowledged going concern risk with its senior secured convertible notes issued on May 27, 2021. The Company is working with the Senior Secured Convertible note holder to renegotiate terms and did not provide and assurances on the call. Management notes the following risk:
"The Company has sufficient funding for ongoing working capital requirements; however, current funds on hand, combined with operational cash flows, are not sufficient to also support funding potential cash requirements under the Senior Secured Convertible Note, investments required to continue to develop cultivation and distribution infrastructure, and the future growth plans of the Company. As a result, management is exploring several options to secure the necessary financing, which could include the issuance of new public or private equity or debt instruments, supplemented with operating cash inflows from operations."
The Company has a liquidity problem that will not be going away anytime soon! As a result, the Company will likely end up in the hands of its creditors.
<CHART3>
