MSO STOCK GET A TWO WEEK RALLY — THEN MORE PAIN

Cannabis stocks gave investors a small taste (pardon the pun) of how fast they can move up in July—20% in two weeks. The reason this time? Senate Majority Leader Chuck Schumer finally got his—more comprehensive cannabis bill???—to the floor of the Senate.

Every time there is a hint or rumor—or in this case, a real proposal for legislation—these stocks have a rip-roaring time—but then fall back and continue their depressing long term downtrend.

American Multi-State Operators (MSOs) cannabis stocks have been sold relentlessly since peaking in March 2021. Investors loved them when they were expensive now they hate them now that they are cheap.

Schumer’s bill does take into account many of the things that Republicans have been asking for (support for users who get addicted)—but after a two week rally, the Street still sees little chance of the Senate passing a bill like this—so the rally quickly ended. 

And I do expect lower prices on these stocks through the year until some legislation in the US is given a realistic chance of passing. 

MSO’s Are Very Unusual Beasts

It isn’t all that often that you see an entire sector drop by almost 80%. It is rather unusual.

The truth about these MSOs is that everything about them is a little unusual. 

What those unusual characteristics have created is one of the most inefficient and volatile sectors I’ve ever encountered in the stock market.

Here is the funky situation:

1 – The MSOs sell a product that is federally illegal in the United States. Despite that they can operate in states where cannabis is legal.

2 – Because cannabis is federally illegal these American companies can’t list on any American exchange, and instead they have to list in Canada.

3 – With federal illegality, American institutional investors can’t own companies that sell a federally illegal product.  The few that have been willing to are smaller hedge funds who don’t have the same compliance requirement standards.

4 – The result of this is that almost all MSO shares are held by the most aggressive of retail investors (aka the “dumb money”) who have had to buy them over the counter. Plus, the daily trading volume on these stocks is shockingly small for companies of their size thereby creating incredible volatility.

Less than five percent of MSO shares are held by institutions right now.

Institutions can’t own them, panicked momentum retail investors dictate their trading price, there isn’t anyone to step in and soak up the relentless selling.

There is overwhelming support for legalization amongst the US population. In the latest Gallup poll last fall 68% of adult Americans believed that cannabis should be legalized, including 54% of Republicans.

More importantly there is also support from both sides of the political aisle in Washington to various degrees.

Schumer’s comprehensive cannabis decriminalization bill (the CAOA) is not expected to pass as is, but should allow Senate leadership to pivot to a more modest but still key piece of legislation like SAFE Banking — which would be a huge catalyst for the MSOs.

The House of Representatives have already passed SAFE Banking with overwhelming bipartisan support SEVEN different times so getting it through the Senate is the big step.

It hasn’t even been voted on in the Senate once. Schumer himself blocked it last year because he wanted something more comprehensive.

SAFE Banking would protect banks and financial institutions who choose to service cannabis related businesses. Cannabis is still listed as a Schedule 1 drug which means banks could face penalties for serving legitimate cannabis businesses.

This has created the insane situation where billion-dollar cannabis operators can’t accept credit cards and are running cash businesses.  

That makes them obvious targets for violent armed robberies.

It also means that compliance departments won’t let fund managers touch these stocks with a ten-foot pole and custodians won’t even allow their clients to buy them.

Can’t own them. Won’t own them. Who is left to own them?

SAFE Banking would also allow for MSOs to up-list to proper US exchanges, get proper access to capital and of course see American institutional investors start to own shares.

Schumer finally introducing his bill in the Senate is a huge step to get the process rolling.

When President Biden won the election in 2020 large MSO share prices were 4 to 6 baggers on the hope of some sort of positive cannabis political action.

If you see politicians buy shares of these stocks please let me know!

The Cheapest, Fastest Growing Stocks In The Market

If GARP (Growth At a Reasonable Price) is a successful investment strategy what would growth at an incredibly low price accomplish?

My favorite cannabis chart has always been the one below. No industry comes close to the growth of the MSOs, yet very few industries are valued against EBITDA as cheaply.

I’ve rarely seen a chart with such an outlier.

For comparative purposes we can consider that MSOs trade at half the multiple of consumer packaging and alcohol companies but are expected to grow six times as fast over the next three years.

Shouldn’t they therefore be trading at six times the multiple instead of half?

Why are they so cheap? Because nobody with real investment dollars or more than a ten second attention span owns them! And because there is uncertainty on the big catalyst. The market hates uncertainty.

SAFE Banking passing will provide an immediate and large adjustment to the 7 times EBITDA valuation multiple that the MSOs trade at now. Given their growth rates what should that multiple be? 15 times EBITDA? 20 times EBITDA?

Who knows exactly….but it has to be a lot higher than where it is now.

The chart that fascinates me the most about these MSOs and shows how these stocks are not trading on fundamentals is below.

It overlays the huge decline of Cathie Wood’s ARKK, an ETF that was made up entirely of the most overhyped, overvalued stocks that Robin Hood day traders were chasing with the cannabis ETF, MSOS-NYSE

When you look at this chart it is as if these two ETFs were made up of exactly the same securities. They are most definitely not!

Wood’s ARKK Innovation ETF (ARKK-NYSE) owns the most speculative of the COVID bubble stocks. Zoom Video Communications (ZM-Nasdaq), Teladoc (TDOC-NYSE), Robinhood (HOOD-Nasdaq) ——the stocks that were trading at absurd multiples of sales and have deservedly crashed.

Meanwhile the MSOS ETF has held multi-state cannabis operators that trade at single digit multiples of EBITDA, are growing incredibly fast and have an obvious and massive catalyst in front of them with SAFE and eventually decriminalization.

The dumb money that owned the ARKK stocks also owned the MSOs.

Why Many Politicians Want SAFE: Reduce Violent Crime

Regulatory action always trails public acceptance. But it does get there eventually…

This year there is an urgent reason why top Democrats and leading officials have been willing to become more vocal about SAFE Banking—violent crime.

Craft Cannabis Coalition has been tracking armed robberies of cash only cannabis shops in the state of Washington. Through April of this year there had been at least one armed robbery per day and they don’t believe they are able to fully track all that are happening. Worse there has also been multiple deaths this year.

There is no reason for this to be happening.

That is why we are now seeing heavy hitters like Treasury Secretary Yellen, Speaker of the House Nancy Pelosi, Senator Patty Murray (3rd ranking Democrat in the Senate) speaking up in favor of SAFE.

This cannabis violent crime problem is only going to get worse. With heavily populated states like New York and New Jersey now having approved adult use sales and operators there also forced to be cash only businesses watch out!

If the state of Washington can have an armed robbery problem just imagine what higher crime areas in New York and New Jersey can create.

If I had to guess I would say that it is likely even money that SAFE Banking gets done in 2022. But that is just a guess.

Valuations keep coming down, and every stock rally gets sold. Until a bill can be crafted that the Republicans can support, the downtrend here will continue. These stocks aren’t even basing yet–continued new lows every couple weeks.

I’m not long any stocks in this sector–but I do watch it closely. Any hint of a bi-partisan bill will mean these stocks jump higher in a hurry.

Sources:

1. https://whalewisdom.com/stock/arkk
2. https://washingtonstatewire.com/oped-armed-robberies-of-cannabis-retailers-require-immediate-response/
3. https://news.gallup.com/poll/356939/support-legal-marijuana-holds-record-high.asp

Keith Schaefer