Doug Kass: Why I Ditched My Cannabis Holdings Amid DOJ Rescheduling Rally

* Reading the fine print of the rescheduling announcement should give cannabis investors some pause over the near term (the 280E tax payment clock is still ticking!)

* Industry promotional discounting continues — same-store sales are still weak, store bases are overbuilt and new unit openings continue apace producing a chronic oversupply condition (with no real absorption mechanism)

* Though the intermediate-term outlook has markedly improved (as we believe adult use will ultimately be rescheduled), multiple headwinds and uncertainties remain to short-term price performance

* Still "trading sardines"

We feel comfortable in our decision for liquidating (with the exception of Glass House Brands (GLASF)) our entire cannabis holdings on the strength of the rescheduling announcement.

Throughout the last five years (after some initial miscues!) we have successfully purchased cannabis equities ( (MSOS) and the individual cannabis stocks) on weakness and we have sold out on strength associated with rumors or announcements of regulatory reform and changes.

We have position traded the group nearly 10 times (profitably).

While the rescheduling announcement brings much better clarity into the intermediate-to longer-term outlook for the sector — by eventually eliminating 280E, which struck at the existential existence of the industry (and now hopefully will ultimately stop the clock of those payments) — we still cannot dismiss near-term headwinds.

Accordingly, we will continue to view cannabis stocks as trading sardines.

Few are reading the fine print of the DOJ rescheduling announcement:

Marijuana or marijuana-derived products that are not distributed through a state medical marijuana program will continue to be classified in Schedule I.

Though I fully understand the two-part legislative process/hearings being proposed (first rescheduling of medical marijuana then June hearings to consider recreational adult-use rescheduling (with an end date to the hearings) — this will satisfy and insulate the proposals from legal opposition), I remain concerned about this wording of the announcement (above) — as it relates to the short-term trading in the space.

Remember when we sold out on the large percentage increase (four months ago when the Executive Order was first delivered by President Trump) — and some questioned our selling wisdom — that POTUS was giving support to medical cannabis and emphasized he was not in support of adult use. Well, this morning's announcement that defers rescheduling of recreational use supports our November claim.

Here is a good summary of the two-track rescheduling carve-out which we think will not satisfy the cannabis bulls (especially after the sharp ramp higher yesterday and today):

🚨 US CANNABIS — DOJ HAS MOVED

Acting AG Todd Blanche.

Justice Department official release just crossed.

The structure is a two-track hybrid — and the detail matters:

TRACK 1 — IMMEDIATE Schedule III, narrow scope:

→ FDA-approved marijuana products (Epidiolex & future…
— Denis Rudev (@DenisRudev)

I believe there is a lot of "hot money" in the group now (that has purchased strength) that might have not read the fine print of the rescheduling release from the DOJ and who don't recognize the constant deferrals of the industry's regulatory relief. Clearly based on that regulatory history and the treatment (that some believe to be controversial) of cannabis legislative advances/changes, the June hearings could always be delayed and the timetable for recreational marijuana rescheduling could be deferred.

In recent years cannabis investors have learned the hard way that one should be cautious about the timing of regulatory reform.

Bottom Line

Other near-term and intermediate-term industry challenges remain and I expect the stocks to sell off from the recent advances.

To summarize:

* Importantly, our biggest short-term concern is that retail — just like past periods of rallies in the space — will not likely be able to sustain the weed rally.

* There are likely still lengthy steps ahead before custodian and uplisting issues can be resolved — so retail "fire power" is not going to be complemented with institutional participation/buying power.

* Rescheduling (which improves companies' finances) could hasten even further product price compression (hitting sales, cash flows and profits).

* Multi-state operators now face rapidly rising security, labor, energy, compliance an other expenses.

* The state silo structure creates diseconomies of scale (unlike many other industries that enjoy scale offsets and national brand economies).

* Rescheduling will not legalize cannabis on the federal level, it won't remove SAR reporting requirements under the Bank Secrecy Act and it won't trigger SAFER Banking.

* Unless there is full legalization, interstate commerce between states (which would lead to economies of scale) will not be resolved.

* While the eventual rescheduling of adult use eliminates 280E UTP accruals, the uncertain status of past UTP balances (which have weakened balance sheets at the same time product pricing came down) will likely remain a drag on valuations and stock prices.

This commentary was originally posted by Doug Kass in his Daily Diary on TheStreet Pro.

At the time of publication, Kass was GLASF (S).