US cannabis stocks tumbled in January, exacerbating issues confronting industry

U.S. cannabis stocks suffered a rout in January, tumbling more than the broader market as hopes for federal marijuana legalization in the near future continued to fade.

The recent slide is expected to exacerbate existing issues confronting marijuana businesses, such as limited banking and funding options as well as higher taxes.

An exchange-traded fund that tracks U.S. multistate operators – AdvisorShares Pure US Cannabis ETF – tumbled nearly 20% in January.

By comparison, the much broader S&P 500 declined by a little more than 5%.

The January slide came after steady declines in cannabis-related stocks in 2021, as major federal marijuana reform looked less and less likely in the short term.

“Most of the downturn, in my view, is a cumulative slow-motion capitulation to the idea that there won’t be any federal legalization (of marijuana) anytime soon,” said Frank Colombo, director of data analytics for New York-based Viridian Capital Advisors.

The cannabis ETF, which trades on the New York Stock Exchange Arca as MSOS, went from about $40 a share in early 2021 to a high of more than $55 a share.

On Monday, it closed at $21.05, down from its 2022 opening price of $25.93.

Marijuana stocks soared in the first few weeks of 2021 with the heady optimism that resulted from a new Democratic administration and a flip in the Senate from Republican control.

“The few blips up (last year) all corresponded to times that there was a little bit of optimism (about reform),” Colombo said.

One inflection point occurred after Senate Majority Leader Chuck Schumer said in late January 2021 that he was going to introduce a sweeping marijuana reform bill. Schumer hasn’t yet introduced that legislation.

“All of the other positive news like states going rec didn’t really do much,” Colombo said. “The market is fixated on this whole legalization stuff.”

Monday proved to be the latest example.

After House lawmakers revived the SAFE Banking Act on Friday as an attachment to a technology and innovation spending bill, investors immediately responded: MSOS increased on Monday by 5.36% to $21.05.

Business challenges

Matt Karnes, founder of New York-based cannabis financial advisory firm GreenWave Advisors, agreed that the lack of progress on federal marijuana reform has exacerbated the market downturn.

“The cannabis industry – plant-touching and to a lesser extent ancillary – is likely more vulnerable to market volatility associated with overall economic uncertainty due to the inherent limitation/headwinds of federal (marijuana) illegality,” he told MJBizDaily via email.

Karnes noted that the market volatility exacerbates existing challenges for marijuana businesses, including:

• Limited access to capital markets.
• Stock trading restrictions.
• The costs of prohibition, including higher taxes and higher debt costs.

For example, state-legal marijuana companies pay higher taxes than other businesses because of the Section 280E provision of the IRS tax code.

They also pay higher interest rates on debt than other businesses because of the riskier nature of the industry and the federal government’s prohibition governing marijuana.

In terms of trading issues, part of the price decline last year was attributed to Credit Suisse Group deciding to stop executing stock transactions of cannabis companies with U.S. operations.

Sales slowdown

Another concern that might play into stock pricing is the softening of sales in the fourth quarter of 2021.

Pablo Zuanic, an equity analyst for New York-based investment banking firm Cantor Fitzgerald, noted that the fourth-quarter sales data didn’t provide the “spark” needed for cannabis stocks.

Sales growth in most states slowed compared to the third quarter, with sales actually falling in some states such as Nevada.

“We realize that (the first half of 2021, especially the second quarter) was fueled by COVID stimulus (money) and child-tax credits, and now purchasing issues (inflation) are playing a part,” Zuanic wrote in an investor note.

One important inflationary measure rose at a level not seen since the early 1980s, and interest-rate hikes are expected in March.

Given the current economic context, Zuanic wrote, sales will be driven in the months ahead in the medical marijuana markets that are relaxing rules as well as in the states such as Connecticut, New Jersey and New Mexico that will be launching recreational cannabis markets.

Even with softer sales and inflationary pressures, Colombo noted, marijuana business fundamentals overall are strong, compared to late 2019, when stock prices dropped, merger and acquisition deals collapsed or were revised, and some MSOs struggled financially.

“It’s really a night and day difference,” he said. “Companies are so much more profitable and developed than they were even a year and a half ago.

“I still think of the industry as being in the toddler stage, but it’s not an infant anymore. It’s walking, talking, performing. Companies have positive EBITDA.”

EBITDA – or earnings before interest, taxes, depreciation and amortization – is a key metric to gauge the financial health of a company.

M&As still strong

Despite the market volatility, Zuanic expects M&A activity to “ramp up” this year.

M&A activity already has been relatively strong in the first weeks of 2022, with $476.2 million in transactions, according to a recent Viridian report.

That included Massachusetts-based Curaleaf closing in January on an acquisition of Arizona-based Bloom Dispensaries for $211 million.

Colombo said he expects debt raises to be relatively robust this year as well.

Florida-based Trulieve Cannabis just closed on its final, $75 million portion of an industry-record $425 million debt raise at an interest rate of 8% annually.

Equity raises, meanwhile, are being impacted by the stock volatility.

“Big companies don’t have the burning need to do financing,” and the depressed stock prices will generally keep them from doing equity raises, Colombo said.

Ultimately, the question is what will be the catalyst for driving stocks upward.

“It’s not going to be from the economy,” Colombo said. “It looks like inflation is definitely here, so the overall macro picture isn’t favorable.

“I don’t think it has to be full legalization (either) – but it has to be something like the SAFE Banking Act being reconsidered.”

Jeff Smith can be reached at jeff.smith@mjbizdaily.com.