Doug Kass: Trump Is Right, Say No To Drugs (and Cannabis Investing)

I have always told me kids, 'don't take drugs'... No drinking, no smoking. Just stay away from drugs."

- President Trump (at yesterday's rescheduling press conference)

I have aggressively traded cannabis equities throughout the past five years, buying cannabis stocks on weakness and selling on the slightest hint of regulatory reform and relief.

In most cases, this sort of positioning (and trading) has been quite profitable. At the same time I have consistently had misgivings about investing in the cannabis space, for several fundamental and structural reasons.

To begin with, the total addressable market (TAM) for cannabis is likely much smaller than the industry optimists have forecast. Already, recently permitted states have seen a disappointing adoption curve. Revenues, cash flow and profits have been well below analysts' and managements' projections. Some multiple state operators are are even exiting some states and jurisdictions.

Furthermore, the current structure of state silos (and dispensary restrictions in some states) have resulted in dis-economies of scale and an inability to create hoped-for oligopolies in industry consumer brands (and, with it, pricing power).

Product pricing also remains under pressure (as do revenues, cash flows and profits) and, if anything, rescheduling could exacerbate this condition.

Then we have past uncertain tax liabilities (from 280E), which are massive. Though likely to be eventually resolved, these liabilities represent still large company liabilities. Industry balance sheets are in poor shape - with secondary/tertiary state operators facing an almost impossible " debt refinancing cliff" (and an inevitable dilution of shareholders equity).

Based on the President's comments, banking and custodian issues, which are important to attract institutional investors, are unlikely to be resolved in the (reasonable) near term. Without institutional sponsorship, I am of the view that a depleted retail base of investors will not be able to sustain rallies in the sector.

This all brings us to yesterday's announcement that Pres. Trump endorses the process of rescheduling of cannabis (from a Schedule 1 to a Schedule 3 substance). (Here is Pres. Trump's rescheduling recommendation and reclassification comments from Thursday.)

Cannabis equities collapsed all Thursday afternoon, surprising and disappointing most (but not me). Let me try to explain why I think the stocks fared so poorly yesterday and why I don't expect much of a rally from currently depressed levels:

1. The stocks anticipated this news and had rallied into the announcement. (I had shorted that ramp, as posted. I have since covered).

2. In listening to Pres. Trump, he did not exactly provide a ringing endorsement for cannabis. He did not sanction its use as a recreational drug. Rather, he is in support of medical research and actually distanced himself from recreational use of cannabis.

3. Trump emphasized the benefit of hemp; he apparently is in favor liberalizing the use of hemp. This is a competitive threat to cannabis.

4. The decision was heavily influenced by his dear friend Howard Kessler (a leader in cannabis research) and by Kim Rivers Trulieve  (TCNNF)  and some other multiple state operators.

5. As I noted earlier this week, the President's rescheduling request is a request to proceed with the process of rescheduling. This could take one or two months. This means that the punitive impact of 280e tax liabilities might still be felt in the 2025 tax year.

6. The uncertain tax status of past 280e tax liabilities remain an issue for the cannabis companies that have not yet paid those taxes.

7. Banking, custodian and uplisting issues remain unresolved. Nothing in the President's comments suggest that there is an immediacy to resolve these important issues.

8. Without institutional support, the depleted ranks of cannabis traders and investors don't have the bones to sustain a rally in the sector.

Bottom Line

President Trump's endorsement of rescheduling was not forceful and failed to resolve a number of important issues. There will continue to be trading opportunities in cannabis stocks.

Nonetheless, rescheduling has not resolved important structural and fundamental problems facing the industry and investors.

Trade cannabis stocks, don't invest in cannabis stocks.

And say no to drugs.

This commentary was orginally posted in Doug's Daily Diary on TheStreet Pro.

At the time of publication, Kass had no positions in any securities mentioned.