A huge trading opportunity could be coming if the Biden administration reforms marijuana laws

By Michael Brush

These cannabis stocks and ETFs stand to benefit if the proposed rescheduling of the substance takes place

The Drug Enforcement Agency (DEA) is being asked to soften its stance on cannabis.

Cannabis stocks advanced sharply to start the week, after the nation's leading health agency recommended sweeping changes to federal marijuana laws. Still, it's up in the air whether the proposed changes will ultimately help cannabis companies and investors any time soon - if at all.

Below, I'll share key investor pros and cons in the major reform proposal rolled out on Jan. 12 by the Department of Health and Human Services (HHS).

Stock traders should take note that there's a potentially huge and tradable catalyst on the way soon. But first, given the polarizing nature of cannabis culturally and politically, let's acknowledge the remarkable nature of the 252-page HHS proposal, especially for anyone familiar with the U.S.'s "war on drugs."

HHS asked the Drug Enforcement Agency (DEA) to soften its stance on cannabis by downgrading it to Schedule III from Schedule I under the Nixon-era Controlled Substances Act. The change would help cannabis companies by boosting cash flow enormously.

To make a credible recommendation, HHS had to find that cannabis has acceptable medical uses and a relatively low potential for abuse and dependence. HHS built its case by citing extensive research and the now-widespread doctor-recommended usage across the country. This new policy proposal would represent a sea change for the federal government.

"It really goes back and covers a lot of the misinformation that has been out there on the effects of cannabis over the last 20 years," said Boris Jordan, the founder and executive chair of Curaleaf (CURLF) (CA:CURA). "It is easy to forget all the stuff that was being said about cannabis during the war on drugs. Now there is almost a 180-degree flip on the benefits and side effects of cannabis."

Investing takeaways

Here are the five key investor takeaways from the proposed federal cannabis-law reform.

1. Rescheduling would rain cash on cannabis companies: The reform would boost sector cash flow by exempting companies from an Internal Revenue Service rule called 280E, which bars the deduction of operating expenses against Schedule I drug revenue. "It would release a lot of investible capital into the sector," Jordan said.

Curaleaf, for example, could expect a $200 million boost, according to Jordan. For context, the company reported $47 million in operating cash flow and $92.3 million in net losses in the third quarter of 2023. If rescheduling happens in late 2024, 280E nullification would apply to the whole year, Jordan noted. Any eventual 280E exemption might only apply to medical-use sale revenue, however, which would blunt the benefit.

2. There's a big short-term catalyst on the horizon: Near term, the next step would come in the form of a proposed rescheduling rule from the DEA. The timing is critical: It has to happen soon for the Biden administration to reap election-year boasting rights, obviously part of the plan here. To clear all the hurdles to get full rescheduling done before a potential administration change in January 2025, the DEA would have to publish its proposed rule by March or April at the latest.

3. A major risk is that HHS invented an entirely new standard to support rescheduling: Change happens slowly in law, so it's jarring to see that HHS set up a new test for assessing the currently accepted medical use of cannabis. It's a "newly minted standard," said Shane Pennington, a controlled-substance regulatory expert and partner at law firm Porter Wright Morris & Arthur.

The new test weighs the level of state-approved medical use. It also considers whether healthcare associations recognize a medical use, and "credible" evidence of a therapeutic effect. HHS found that 30,000 doctors recommend cannabis to 6 million patients, and that there's an accepted medical use to treat anorexia, pain, and nausea and vomiting related to chemotherapy.

Because this is a new standard, it opens the HHS rescheduling process to legal challenges by cannabis opponents who may question the validity of the new standard. If the DEA ultimately approves rescheduling, cannabis opponents will likely launch more challenges in court. An overhang of uncertainty may persist for investors.

4. Another risk is HHS's low bar on scientific evidence: This also opens reform efforts to potential attacks. To check the box on scientific support, HHS said it merely needed to see at least "some credible scientific support" for one medical use. Compared to the biopharma gold standard of double-blind random-sample trials, that's a low hurdle.

Some HHS logic also seems questionable. The department concluded that there's low potential for abuse, but then cited evidence that nearly a third of non-medical cannabis users consume virtually every day. That seems like a big number for a substance with supposedly low abuse potential.

But cannabis-law experts push back. "Both in thoroughness of the analysis and its tone, this is a very, very substantial document," said Arnold & Porter partner Howard Sklamberg, another controlled-substance regulatory expert. "The part of the analysis covering the science and medicine would be very hard to challenge. You would have to show the agency was acting in an arbitrary way." He doubts that will happen. "It would be hard for a judge to say 'I am going to overturn the HHS science.'" Sklamberg is worth listening to because he chaired the Food and Drug Administration's Marijuana Working Group, which set FDA cannabis policy.

5. The comment period could drag out: After the DEA drops its proposed rule, there would be a 60-day comment period. But the review process could take longer. "I expect there will be a lot of public participation," said Pennington. He called the HHS proposal a "target-rich" environment. "There is plenty to argue about, and people are really fired up to engage." If a robust debate ensues and a lot of experts call for hearings, the approval process could drag out.

Reform timing

Sklamberg expects full rescheduling to be complete by the summer. He reasoned that this should be the Biden administration's target if it wants to keep cannabis reform off the typically crowded year-end legislative agenda. Pennington is skeptical, noting that the rescheduling process historically has dragged out for as many as nine years.

But these are unusual times politically, so something closer to Sklamberg's timeline could make sense. It depends in part on how much the administration wants this. U.S. President Joe Biden is slipping in the polls even among young people, which provides motivation. Also consider the following: "This whole process was kicked off by an executive order, which is not normal," said Sklamberg. "The fact that the White House initiated this process through an executive order shows it is a high priority."

Stocks and exchange traded funds (ETFs)

For better-quality names, Poseidon Asset Management cannabis investor Morgan Paxhia favors Green Thumb Industries (GTBIF) and TerrAscend (TSNDF). Green Thumb has a strong balance sheet and it's in growth markets such as Ohio, Maryland, Pennsylvania, Florida and New Jersey. TerrAscend is improving its balance-sheet strength and expanding in Pennsylvania and New Jersey.

I'll suggest Curaleaf, in part because it's the company positioning most aggressively for European growth as countries there liberalize cannabis rules. For exchange-traded funds, I own the more liquid AdvisorShares Pure US Cannabis MSOS and the leveraged version, AdvisorShares MSOS 2X Daily MSOX.

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned MSOS and MSOX. Brush has suggested GTBIF, CRLBF, MSOS and MSOX in Cabot Cannabis Investor. He has suggested MSOS and MSOX in his stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks.

More: Green Thumb, Trulieve and other cannabis stocks up as much as 21% as details emerge on HHS recommendation to lower drug classification

Also read: Study pinpoints one source of 'munchies' tied to cannabis use

-Michael Brush

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

01-20-24 0756ET

Copyright (c) 2024 Dow Jones & Company, Inc.