Cannabis Investor and Expert Alan Brochstein, CFA, Talks about the Evolution of the Sector; the Risks and Opportunities
"I believe that there was a landmark revelation in Spicer's comments that people may be overlooking" - Alan Brochstein, CFA
Point Roberts, WA and Delta, BC - March 6, 2017 (Investorideas.com Newswire) Investorideas.com, a global news source and investor resource covering actively traded sectors including cannabis and hemp stocks features an exclusive interview with Alan Brochstein, CFA. Alan is a well-known expert in the sector and founded 420 Investor, a subscription-based due diligence platform for investors interested in publicly-traded cannabis stocks.
Alan talks about the evolution of the sector and some of the short and long term risks and opportunities.
Alan can you share your background and what drew you to the cannabis sector?
A: Alan Brochstein, CFA
My entire thirty-year career has been in the investment industry, with most of it in equity analysis and portfolio management. In 2013, when I was running an independent equity research and consulting practice and working with a handful of institutional money managers, I stumbled upon the publicly-traded cannabis stocks and was surprised on a number of fronts. First, just the fact that there were publicly-traded stocks was quite a shock. Second, it didn't seem as if investment professionals were aware. Third, and most importantly, I was disappointed when I looked at these few stocks to see such terrible fundamentals, high valuations and poor corporate governance practices. Quite simply, these companies didn't really reflect the industry. As a teenager who was very involved with the Libertarian Party back in the 80s, cannabis legalization was a big issue for me, but I had really not been paying attention for over twenty years to the progress that was being made. Over the balance of 2013, I devoted a great deal of time to catching up and learning about the social justice, economic, civil liberties and health issues surrounding cannabis legalization.
How would you break down the past few years in terms of the evolution of the sector and in particular, the impact of the last election in terms of legalization in several new states?
A: Alan Brochstein, CFA
The sector has evolved slowly. I joke that I goofed when I named my service "420 Investor" and should have called it "420 Trader". I track about 450 companies in North America, a number that keeps growing. Most of these companies are either stock selling schemes or just not likely to succeed. The tremendous recent progress of the industry is a two-sided sword, as on the one hand, it represents a fundamental opportunity that attracts investors. At the same time, it also attracts opportunists looking to prey on that investor interest. Hence, the market has been one more appropriate for traders of penny stocks rather than investors.
The legalization of Colorado set off a tremendous bull market in the few stocks that were in existence then (back in early 2014), even if the companies weren't ever going to benefit from what was going on in Colorado. Both the Colorado and Washington implementations went reasonably well. While the industry continued to expand, adding Oregon and Alaska to the states that had fully legalized as well as dramatically expanding the number of state-legal medical cannabis programs, the stocks suffered for two years following that early 2014 move where the typical stock went up over 600% in fewer than three months. The recent elections, which doubled the number of "recreational" states, including the addition of California and Massachusetts especially but also Maine and Nevada, brought a lot of interest to the sector, which recently posted levels not seen since early 2015, as measured by the 420 Investor Cannabis Stock Index. Unfortunately, we are seeing some of the same opportunism among penny stock promoters and newsletters that we saw back in 2014, but at the same time, we are seeing some new entrants in the sector that better reflect the industry in terms of having sales, for example.
We have reached an inflection point, in my view. Recently, two companies announced that they will soon offer Exchange-Traded Funds (ETFs) for the cannabis sector, and there is also a mutual fund. While I find these investment vehicles to have fatal flaws, it shows that there is demand.
Yes, there remains way too much noise in the sector, but I recently launched my fourth model portfolio that reflects my view that investors now have options for long-term investing. My "420 Quality" model portfolio will include these names and is not going to be trading-oriented.
When you look at the Canadian market and the publicly traded stocks and the US stocks and market, what are some of the biggest differences in terms of risk and opportunity in each?
A: Alan Brochstein, CFA
The Canadian market has been a big focus of mine. Having a federally legal medical program that will in all likelihood permit sales to all adults beginning in 2018 is a substantial difference from the United States, which is federally illegal. This matters in terms of scaling the businesses as well as raising capital. Since Justin Trudeau was elected in late 2015, the publicly-traded licensed producers in Canada have raised over C$700M, and this excludes subsequent warrant exercises as well as capital raised by private companies. Publicly-traded U.S.
companies struggle to raise capital. Even NYSE-listed REIT Innovative Industrial Properties (IIPR), one of the few stocks that doesn't trade on the OTC, wasn't successful in its IPO, dramatically reducing the size of the offering. Another opportunity for the Canadian companies is their ability to extend their intellectual property and capital into other markets. Germany, for instance, allows imports and will be implementing its federally legal medical cannabis system for local production by 2019, a development that is favorable for a few Canadian companies that are already in that market. Similarly, other parts of the world, including Australia and South America, provide opportunity for the Canadian LPs. The risks in Canada, in my view, are primarily potential delays in legalization as well as the valuation of the stocks.
Based on surveys and voting, the American public wants to see marijuana legalized, yet headlines in the last week have investors very nervous following White House Press Secretary Sean Spicer saying during a White House briefing on Feb. 23 that he predicts “greater enforcement” of federal marijuana laws. Where do you see the two contradictory realities meeting over the short term and long term?
A: Alan Brochstein, CFA
I believe that there was a landmark revelation in Spicer's comments that people may be overlooking, as the government is publicly supporting medical cannabis. At the same time, it talks about "recreational" cannabis as being potentially problematic. I believe that these comments about greater enforcement refer to two distinct areas. First, the federal government may play a more active role in determining the ground-rules. The Cole Memo laid out 8 rules that, if followed, would prevent federal interference in states with legal cannabis, and these may be made a bit tougher perhaps. One of those rules, avoiding diversion, is likely the source of concern for the Trump Administration, as there has been litigation from non-legal states against Colorado for not taking effective steps to prevent diversion to their states. This is a serious concern, as commercial organizations are clearly violating federal law by transporting cannabis products outside of Colorado. So, it's actually in the best interests of the cannabis industry for the federal government to step up enforcement in this area. So, more regulations and a more active federal role may be what lies ahead. At the same time, both former President Obama and Attorney General Jeff Sessions have suggested that the current laws need to be changed by Congress, which has acted like an ostrich with its head in the sand over the past few years. I don't expect full legalization at the federal level for quite some time, but there are several steps Congress can take that would help clarify what is permitted under state-legal cannabis and what isn't. Big areas of concern have been banking and medical research.
Can federally regulated banks work with state-legal businesses? Can state institutions who take federal money conduct medical cannabis research? The laws aren't clear, and the uncertainty has stymied the industry.
Also on that note, there was a big sell-off on some of the stocks, some dropping up to 15% on the Spicer comment. Do you see that as a buying opportunity for the right stocks?
A: Alan Brochstein, CFA
Without doubt, there is substantial uncertainty and potential risk to cannabis companies post-November. Cannabis remains federally illegal, and the hands-off enforcement policy since 2013 (Cole Memo) may be ending. With that said, the higher quality companies in the sector have pulled back rather dramatically since early November. While the Trump Administration is taking a potentially different approach to "recreational" cannabis than medical cannabis, which it has endorsed, I don't expect major changes ahead. The states that have implemented will not go back, in my view, though we could see not only some changes to how the federal government deals with state-legal cannabis from a regulatory perspective as well as some delays in implementing in the new states to legalize, which includes California, Maine, Massachusetts and Nevada. With that said, I believe that Congress may finally move over the next few years to address some issues like banking and research.
Separate from the growers and retailers, where do you see opportunity in the service providers in the sector and where do you see the biggest untapped potential?
A: Alan Brochstein, CFA
I am always looking for companies that provide technology to help achieve two goals: Lowering the cost of production and improving compliance. While I expect that there will always be a craft cannabis angle that some companies will play, and of course building brands will pay off for many, the production of flower will continue to commoditize over time. We have seen tremendous price pressure in Colorado and Washington just a few years after implementation of legal production for adult use. So, companies that can help growers lower their costs merit attention. Cutting labor and energy costs are big opportunities.
Similarly, many companies will struggle to remain compliant with regulations, which is essential in a legal, regulated market. Another area where I see opportunity is broadly in standardization and consistency of outcomes. The big criticism of cannabis, which is a very complex plant, is that the user experience varies too greatly. I think that those companies that are able to create solutions to this problem will win big. I also think those companies that can create health and wellness solutions as opposed to just marketing big doses of THC, will be tapping into a new market.
In closing, every big growth sector like this goes through a cycle of cleansing and purging to let the best rise to the top. Where do you see the stocks in the sector within this cycle and what should investors be looking out for in the short term?
A: Alan Brochstein, CFA
I have been disappointed with the pace of the development of the publicly-traded stocks until recently. While the vast majority of the companies don't merit attention in my view, we are starting to see companies that better reflect the industry. The Canadian story is playing out very well, and the GW Pharma (NASDAQ: GWPH) progress towards having the first FDA-approved cannabis-derived drug has been substantial. I suggest investors focus on revenue, and I have identified 10 companies that posted sales of $5M or more in 2016, and I expect this group to grow in size this year. Investors should focus on not only sales potential and financial metrics but also management quality, balance sheet strength and access to capital.
About Alan Brochstein, CFA and 420 Investor: Founded by Alan Brochstein, 420 Investor is a subscription-based due diligence platform for investors interested in publicly-traded cannabis stocks. His affiliated New Cannabis Ventures is a content aggregation site focused on investors and entrepreneurs in the cannabis industry. Alan Brochstein, founder, has worked in the securities industry since 1986, primarily with the responsibility for managing investments in institutional environments until he founded AB Analytical Services in 2007 in order to provide independent research and consulting to registered investment advisors.
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