These cannabis stocks have solid growth prospects - with help from the Biden administration

By Michael Brush

U.S. reclassifying marijuana would give companies a tax break and more cash to spend

Prospects for cannabis isn't as depressing as investors think

Cannabis stocks rise sharply in response to positive headlines about legal reform. Then they fall sharply on investor doubts. For a contrarian investor, that low point is the best time to buy. Since the beginning of May, cannabis stocks are down 28%, using the AdvisorShares Pure US Cannabis exchange traded fund MSOS as a proxy for the group.

Yet the prospects for cannabis isn't as depressing as investors think. Here are five catalysts that could play out and give these companies a boost.

1. Progress on "rescheduling": This is the big one. The Nixon-era Controlled Substances Act (CSA) classifies cannabis as a Schedule I drug, alongside the worst of the worst - like heroin. U.S. President Joe Biden wants to move cannabis to Schedule III, alongside more commonly accepted drugs with medical uses, such as Xanax, Valium and Ambien.

The U.S. Department of Health and Human Services (HHS) has asked the U.S. Drug Enforcement Agency (DEA) and its parent the Department of Justice (DOJ) to reschedule cannabis. The DOJ has published a proposed rule to make this happen. It is in a 60-day comment period which ends July 22. After that, the DOJ could then implement the change, which would take effect in 30 days.

This change would be a windfall for cannabis companies. The main benefit would come from the neutralization of Internal Revenue Service provision 280E, which blocks cannabis companies from deducting operating expenses. The bigger companies would benefit the most since they'd get the most cash back to reinvest in their businesses, pay down debt and buy back shares.

Here are some of the biggest potential winners. Curaleaf Holdings (CURLF) founder and executive chair Boris Jordan says 280E nullification would save the company $150 million in 2024 taxes. Green Thumb Industries (GTBIF) would save more than $100 million. Verano Holdings (VRNOF) would save over $80 million. Cresco Labs (CRLBF) CFO Dennis Olis says his company would save about $70 million.

But will rescheduling happen? And when? "I certainly think the final rule will be published before this administration ends. I think it is quite possible it will be published well before that," says Howard Sklamberg, a drug regulation expert and former Food and Drug Administration official who is now a partner at the law firm Arnold & Porter.

Cannabis company leaders agree. A final rule could be published by late September or early October, says Curaleaf's Jordan, who is well connected to Washington, D.C. via lobbyists. "We're optimistic that the change to Schedule III will be implemented in 2024," says Ayr Wellness (AYRWF) CEO David Goubert.

One snag might be the need for a DOJ administrative law judge hearing on the proposed change. These can drag on for years. But Sklamberg says a hearing likely would be done quickly, or not at all. "That would mean they could publish a final rule by the fall," he adds. Jordan at Curaeaf doubts hearings would delay the process since they could happen during the 60-day comment period.

Skeptics point out there will be a deluge of comments for the DOJ to wade through. But many of these comments won't be substantive.

2. State legalization progress: The big state to watch is Florida. Voters will decide on a recreational-use legalization referendum in November. Florida already allows medical-use sales. Since rec-use legalization can triple a state's sales, Florida could become a huge $6 billion market for cannabis.

Recent polls suggest voter support for rec-use comes in just below the 60% needed for approval. Kim Rivers, CEO at Truelieve Cannabis Corp. (CA:TRUL) (TCNNF) which is Florida's biggest cannabis company, counters that polls ahead of the 2016 medical-use referendum vote showed a similar shortfall. But that initiative was approved by 71% of voters.

"We believe passage with 60% approval is achievable, but we are not taking a single vote for granted," Rivers says. Voter attitudes may swing more positive after cannabis companies ramp up their ad campaigns in earnest in the middle of August.

Other states are taking steps in the same direction. Ohio will launch rec-use sales this summer, which could turn cannabis into a $2 billion market there. Pennsylvania also may approve rec-use sales. "Pennsylvania could absolutely go adult-use," Rivers says. "Momentum continues to build for bipartisan adult-use legislation," she adds.

Companies with the biggest exposure to these three states include Trulieve, Curaleaf, Cresco, Green Thumb, Ayr and Verano. "In Pennsylvania, we're well-positioned to maximize the potential adult-use opportunity with the number one brand," says Cresco CEO Charles Bachtell. "We expect the adult-use conversions in Ohio, Florida and Pennsylvania to provide meaningful year-over-year growth in both 2025 and 2026."

More than a third of the loan portfolio of cannabis lender AFC Gamma (AFCG) is in Ohio, Florida and Pennsylvania. "We are increasingly optimistic about the outlook for the cannabis industry," says AFC Gamma CEO Daniel Neville. "The industry has seen expansion fueled by increasing state legalization and growing consumer acceptance."

3. Progress on cannabis banking reform: Banks don't want to serve businesses selling an illegal product, so cannabis companies have to run stores in cash. This is cumbersome and it attracts criminals.

That could change if Washington, D.C. approves banking reform called the Secure and Fair Enforcement Regulation Banking Act (SAFER). This potential catalyst has been kicking around for years. But progress on rescheduling could improve the odds of approval.

The bill has already been approved by the U.S. Senate banking committee and full Senate approval is likely since the body is controlled by Democrats. Erkes at Cresco thinks there also is majority support in the House, so full Congressional approval is possible after the November elections.

4. Progress in Europe: Germany is leading the way. It recently decriminalized cannabis by removing it from its narcotics list. This action is boosting prescriptions. "We have seen a substantial increase in patient counts. These increases have surpassed expectations," says Jordan at Curaleaf. The UK also allows medical-use sales. Other European countries are likely to follow.

Curaleaf is building the biggest European presence. Besides Germany, it sells cannabis in the UK and Poland. Curaleaf recently purchased a Canadian cannabis producer called Northern Green Canada, which is certified to sell product in Europe.

5. Joining indices: Cannabis companies like Curaleaf are graduating to bigger, more respectable exchanges including the Toronto Stock Exchange (TSX). Major banks such as Bank of New York Mellon (BK), State Street STT (STT) and Euroclear Bank offer professional investors custody services for cannabis companies. Verano founder and CEO George Archos tells investors his company is eligible for inclusion in the MSCI and FTSE indices. Curaleaf's Jordan says his company is eligible for the MSCI Canada Small Cap Index, the S&P/TSX Small Cap Index, and the FTSE Canada All Cap indices. Inclusion in indices can boost demand for a stock.

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned MSOS. Brush has suggested CURLF, GTBIF, VRNOF, CRLBF, AYRWF, TCNN, VRNOF and AFCG in his stock newsletter Cabot Cannabis Investor. Follow him on X @mbrushstocks

More: Nasdaq finally 'warming up' to Canadian cannabis companies with U.S. exposure. Could American growers be next?

Also read: Daily marijuana use outpaces daily drinking in the U.S., new study says

-Michael Brush

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06-08-24 1041ET

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