By Alan Brochstein, CFA
2016 was a great year for cannabis stocks, as the market ended a 23-month downturn in February and sprinted into end of the year with a big run fueled by interest in the elections, which featured 9 different cannabis legalization votes (5 states for full legalization and 4 for medical initiatives), as well as excitement over the continuing move towards full legalization in Canada, where the biggest gains in the sector were achieved. From a high-level perspective, it is very clear where the industry is headed in the long-term as society is quickly embracing the idea that taxation and regulation of cannabis is sound policy.
After a collapse of 97% from the peak in March 2014 to the trough in February 2016 as measured by the 420 Investor Cannabis Stock Index, prices exploded. Through mid-December, the index was us up 63.4% year-to-date to 64.14. For some perspective, here is how the market has performed in 2016, maintaining a large gain despite a big pullback that began in early November in advance of the elections:
Cannabis stocks were likely to correct somewhat after the big run into the elections, as the fundamentals of most of these companies don't come even close to justifying the valuations, but, despite a landslide for cannabis initiatives, with only legalization in Arizona failing, the elections introduced a major overhang for the sector. While the Trump Presidency in and of itself wasn't necessarily a negative, the Republican retention of control of the Senate was a setback, as important legislation that would be beneficial for the industry has been held up by the Senate. More importantly, though, Trump has selected Jeff Sessions as the Attorney General. Sessions is passionately against even medical cannabis, and several other Trump Cabinet appointments share similar views. While it's not yet clear how the Trump administration will proceed, the entire industry is at risk due to the reliance upon a memorandum issued by the Obama administration in 2013, the Cole Memorandum, which defined rules for states with legal cannabis programs to follow in order to avoid federal enforcement of the Controlled Substances Act within those states.
Sessions isn't yet confirmed and might not be, and Trump hasn't issued any statements since the election regarding his intentions, so the range of expectations is all over the place. Some are not concerned at all, as Trump has previously spoken positively about medical cannabis and has said he supports the rights of states. Others are worried that the entire industry could be shut down. The likelihood is that there is little risk of pushback from the federal government with respect to states with medical programs, but there is a reasonable chance that new rules could be introduced with respect to recreational cannabis. An extreme view would be that it could be shut down, but a more likely outcome is regulation that could limit it to some degree. The genie is out of the bottle, though, and trying to roll back legalization in four states (soon to be eight) is extremely unpractical. An alternative extreme view is that the Republicans will look to Canada and see the light! How the federal government will deal with the issue is likely to be the biggest driver of cannabis stocks in 2017.
Update from SNN Editor, here a few articles from recently appointed Attorney General, Jeff Sessions:
For those who wish to invest in the cannabis sector, the best areas to focus upon include the Canadian licensed producers, GW Pharmaceuticals (NASDAQ: GWPH) and the revenue-producing OTC names. The Canadian story is much better appreciated today than six months ago, and the stocks have soared. The country has a robust federally legal medical cannabis program with over 120K registered patients that is growing 10% per month and is on the path to full legalization. Other international markets are opening up too, including Germany, which is likely to adopt a broad medical cannabis program in 2017. As far as GW Pharma, it remains on track to file a New Drug Application with the FDA for its potential blockbuster drug Epidiolex by mid-2017, with potential approval by the end of the year or early 2018. Epidiolex, which contains CBD extracted from cannabis, has been shown to be safe and effective in late-stage clinical trials in the treatment of rare childhood epilepsies and has broader potential. Finally, I recently identified nine names that trade on the OTC that have annual revenue in excess of $5mm, with some at or near $10mm. Most of these are ancillary companies that don't grow, process or sell cannabis, and a few of these have moved to cash flow breakeven, reducing their reliance upon external financing.
Cannabis stocks remain highly speculative. Despite the concerns about how the federal government will proceed, the legal cannabis industry is performing well, but the stocks, for the most part, don't really reflect the underlying industry. A milestone for the sector was the first NYSE IPO, a cannabis-focused REIT, Innovative Industrial Properties (NYSE: IIPR). While the deal, which was priced at the end of November, was a bust initially, with the size reduced by more than 50% and the price dropping once it began trading, this stock broadens the base of potential investors, opening the market to institutions. A lot of money was made by people speculating on cannabis stocks in 2016, and 2017 may be a year when longer-term investors will finally have some better options to participate in the growth of the cannabis industry through publicly-traded stocks.
Editor's Note: Alan Brochstein, CFA, began his career as a bond trader in NYC in 1986 with Kidder, Peabody and worked with CS First Boston and Criterion investments until transitioning to equities as a analyst/portfolio manager in 2000. In 2007, he began AB Analytical Services, where he provided research and consulting to several investment advisors while also becoming one of the most popular contributors at Seeking Alpha. In 2013, Alan launched 420 Investor, an online community focused on publicly-traded companies in the cannabis sector, and, more recently, he began New Cannabis Ventures, a news & information platform that highlights the most promising companies and influential investors in the cannabis industry.
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