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Are pot stocks cheap right now? (July, 2024)

Cannabis stocks

A step forward, a step back.

That’s how it feels to investors in cannabis stocks right now.

In late April, the U.S. Drug Enforcement Administration revealed it would reclassify marijuana as a less dangerous drug. It is currently a Schedule 1 drug, on the same level as more harmful drugs such as heroin. The reclassification would equate it to Tylenol with codeine, something that is in many households today.

“Today, the Attorney General circulated a proposal to reclassify marijuana from Schedule I to Schedule III,” Justice Department director of public affairs Xochitl Hinojosa said in a statement. “Once published by the Federal Register, it will initiate a formal rulemaking process as prescribed by Congress in the Controlled Substances Act.”

After the news broke, pots stocks rallied but have since given back those gains. So the question for investors is whether or not they are value or value traps? Roth MKM analyst Scott Fortune says it is likely the latter.

“Despite the run-up since the HHS rescheduling announcement in August 2023 within the cannabis industry, valuations remain well below the highs made during 2021 or during the SAFE Banking period in late 2022,” the analyst wrote. Currently, larger MSOs trade at ~6.7x 2024E EV/EBITDA (down from ~7.7x at the end of 1Q24) with tier-two operators slightly below at 6.5x, holding steady at these levels. After the 1Q24 reporting period, most estimates remained roughly in line for 2024, which we believe is a positive as consensus numbers imply tempered growth and limited margin expansion (minimal adult use state growth and ongoing pricing pressure) for the year. As it stands, with a status quo federal regulatory environment, the MSO group has a 6.7x ’24 EV/EBITDA consensus multiple, significantly lower than most consumer industry groups despite its expected ’24 EBITDA margin of 26%, only behind alcohol, pharmaceutical, and tobacco. We believe federal legislative progress should expand EBITDA multiples to 12-15x and EV/Sales multiples to 5-7x with rescheduling and as capital markets open up.

Fortune says some doubt about the Schedule 3 date might be putting off some investors, but says it would have material effects.

“Not only would Schedule 3 help alleviate concerns about high debt levels, but the elimination of 280E would also benefit smaller-scale operators in the ability to write off higher operating expenses,” he argued. “While the timing of the tax impact is still not clear, the future cash flow impact will likely be meaningful, leading to balance sheet repair. Without rescheduling and 280E tax relief, we expect further balance sheet pressure to lead to industry consolidation and benefit the stronger operators. We believe investors will prioritize the less-levered MSOs until we have more clarity around certainty and timing of regulatory improvement.”

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About The Author /

Cantech Letter founder and editor Nick Waddell has lived in five Canadian provinces and is proud of his country's often overlooked contributions to the world of science and technology. Waddell takes a regular shift on the Canadian media circuit, making appearances on CTV, CBC and BNN, and contributing to publications such as Canadian Business and Business Insider.
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