Cannabis Stocks Struggling With Unhealthy Components

U.S. cannabis companies may be wondering if they will ever catch a break in Washington. The industry has been facing challenges in the nation's capital for years, and it seems like there is no end in sight.
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Democrats attempted to include cannabis banking reforms in this month’s $1.65 trillion omnibus spending bill, but were unsuccessful. If the SAFE Banking Act had passed, U.S. marijuana companies would have had access to normal financial services like checking accounts and commercial mortgages.
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The bill could have eventually made it easier for cannabis companies to move their stock market listings from Canada to more liquid exchanges in the U.S. As the drug is still illegal at the federal level, major banks and stock markets avoid dealing with U.S.-based cannabis companies, severely limiting their access to capital.
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There is little chance of legal reform for the cannabis industry over the next two years while Republicans control the House. Democrats' failure to make good on promises to help the industry means companies must continue to operate in a legal limbo. This uncertain environment makes it difficult for businesses to plan for the future and limits their ability to grow and create jobs.
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Cannabis companies may have a tough time raising cash over the next few years, as the industry is carrying more debt than ever. Cannabis companies took on a lot of short-term borrowings during the pandemic, when booming demand for marijuana made lenders more willing to serve higher-quality pot growers. In April 2021, Green Thumb Industries, which has operations in multiple states, secured the first big debt deal with a sub-10% coupon in a milestone for the sector.
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U.S. cannabis companies have borrowed around $4.2 billion since the start of 2021, according to Viridian Capital Advisors. This is expensive to refinance, as the average cost of debt for cannabis companies has increased from 9% in the second quarter of this year to 13% to 16% today, depending on the borrower, Viridian estimates. Borrowing is so costly that U.S. cannabis companies often delay paying their quarterly income taxes. The fee the Internal Revenue Service charges for late taxes is much lower than what pot growers would otherwise pay for loans.
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Raising equity at current share prices is unappealing to many investors. The MSOS AdvisorShares Pure U.S. Cannabis ETF, which tracks major U.S. marijuana stocks, many of them listed in Canada, is down 73% this year. According to Frank Colombo, director of data analytics at Viridian, "Issuance of equity for U.S. plant-touching businesses has come to a virtual halt." American cannabis companies issued equity worth less than $80 million this year, compared with around $2 billion for 2021.
Large cannabis companies like GTI and Curaleaf are likely to have enough cash on hand to repay their debt. However, smaller cannabis growers may have more difficulty, especially if growth estimates for 2023 and 2024 turn out to be optimistic.
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U.S. pot sales are slowing down, according to Headset estimates. Consumers are trading down to cheaper brands or going back to illegal sellers who charge less. The legal market is also oversupplied, so prices are falling. In contrast to the wider inflation trend, average U.S. wholesale cannabis prices were 28% lower than a year earlier as of November, according to Stifel. If this continues, it would make it harder to pay down borrowings.
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Cannabis stocks in the United States look very attractive from a value perspective. One of the top companies in the industry, Curaleaf, trades at just 1.8 times projected sales. This is down from close to 9 times sales just a few months ago, when there was more optimism about the possibility of cannabis reform. Even at these lower prices, though, investors would be wise to be cautious until the industry's legislative luck turns.