Cannabis Shares Rally on Recommendation for Less Stringent Prohibition

On Aug. 30, shares of the U.S. cannabis multistate operators rallied around 20%, with Canadian licensed producers up less, following news that the U.S. Department of Health and Human Services recommended to the Drug Enforcement Administration that it reclassify cannabis to a Schedule III drug from Schedule I. Cannabis, along with heroin and ecstasy, is currently listed as Schedule I, which means it is considered to have a high potential for abuse and no medical value. Schedule III drugs are considered less dangerous, with a lower potential for abuse and having some medical value. Lower scheduling would not necessarily be a panacea for the cannabis industry, but it could be enough to bring some important benefits to U.S. multistate operators, including paying normal tax rates, improved banking access, and potential listing on a major U.S. stock exchange.

The DEA must conduct its own review before solely determining any final rescheduling. Our fair value estimates and no-moat ratings for our coverage are unchanged, as we have already incorporated the loosening of federal prohibition into our forecasts. That said, MSOs like Curaleaf and Green Thumb GTII are the most likely to directly benefit from a rescheduling. Both trade in 5-star territory.

Canadian licensed producers are less likely to benefit, given their lack of U.S. cannabis operations. Canopy Growth is the most likely to benefit because of its options for the U.S. assets it seeks to consolidate under Canopy USA. Although Canopy is trading below our fair value estimate, our Extreme Uncertainty Rating leaves it in 3-star territory; shareholders face a significant risk of dilution as a result of likely equity issuances to deal with maturing debt. Other Canadian LPs Tilray, Cronos, and Aurora Cannabis would need to acquire or invest in U.S. exposure, though they also offer attractive risk-adjusted upside.

(Aug. 31, 2023): A previous version misnamed the Drug Enforcement Administration.