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What a great week in a terrible year for cannabis stocks! The NCV Global Cannabis Stock Index rallied an incredible 21.7%, and it is now up 19.1% in Q3. Year-to-date, though, it remains down 8.0%, and it is down more than 90% still from the peak in February 2021.
So, what’s an investor to do? On the one hand, the stocks are very cheap. On the other hand, though, they have run up a lot.
This Was Good News
Recall that almost a year ago, President Biden suggested publicly that he would look into the scheduling of cannabis. His Department of Health and Human Services did so apparently, instructing the DEA to move it from Schedule 1 to Schedule 3. So, this was not a total surprise, and several have been anticipating it.
Rescheduling to Schedule 3 would eliminate 280E taxation, one of the two things we have called out as a potential catalyst for the sector. That tax is very onerous, requiring companies to pay much higher taxes than a normal income tax. In fact, companies with negative incomes after all expenses often are required to pay an income tax.
But, It May Not Take Place As Expected
We are not familiar with the DEA enough to assess the timing or the action it takes. It could reject the HHS request, which we do not expect, but it might say that it agrees that Schedule 1 is wrong but move it only to Schedule 2. This would not help at all! 280E stays in law unless it is moved to Schedule 3 or higher. The rescheduling could take a long time, and it might not be exactly what investors are now expecting.
There Could Be This Too
One of the consequences of the DEA moving cannabis from Schedule 1 to a less riskier Schedule is that the FDA may step up its regulatory role. We believe that this is a great risk to the current operators. The FDA has been unable to regulate CBD from hemp after nearly 5 years since it was legalized!
We are excited about cannabis likely being rescheduled, but we continue to have concerns. We have been discussing all year how cheap cannabis stocks are, and, even after the rally, this remains the case. Our suggestion to readers is to not chase the stocks here but to be prepared as we learn more about the scheduling. We also think that investors should look at the ancillary cannabis stocks, as they have lagged the big gains of the MSOs. Their customers experiencing better financials would be a good thing for them, and, if it doesn’t pan out, they have better balance sheets and do not have to pay 280E.
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