July 31, 2024
Commentary
Introduction
The month of July witnessed generally weaker equity markets as fears of a global recession worked to bring major indexes lower. To add further worry and uncertainty to equity markets, the US Presidential race saw a number of unprecedented events that added complexity to consider. There was an assassination attempt on the life of former President Trump as he was campaigning in Pennsylvania, followed by the decision by President Biden not to run for re-election. These two issues are tied together in that Biden was trailing Trump in polling and the awareness and related media attention of the assassination made the gap between the two insurmountable for the sitting president. What transpired next could have profound implications for the cannabis sector as VP Kamala Harris became the presumptive Democrat nominee and began to gain in the polls. She has selected a running mate in Governor Tim Walz of MN who has shepherded in adult use to his state. Both Harris and Walz are seen to be cannabis advocates and if elected could provide significant leadership for further federal reform. We will go over all the political announcements and their implications in this commentary. Also important in the US federal reform update was the July 22nd ending of the public consultation period to submit comments on the re-scheduling of cannabis to the DOJ and DEA. With this backdrop in mind, despite the near-term uncertainty and volatility, there are significant near-term catalysts at play in the US cannabis sector. Considering the impact of these catalysts along with the strong operational performance of the Funds’ top cannabis holdings, we believe the Fund’s NAV has a significant upside for the balance of the year.
Ninepoint Cannabis & Alternative Health Fund - Compounded Returns¹ as of July 31, 2024 (Series F NPP5421) | Inception Date - August 4, 2017
1M |
YTD |
3M |
6M |
1YR |
3YR |
5YR |
Inception |
|
|---|---|---|---|---|---|---|---|---|
Fund |
1.4% |
7.1% |
-17.0% |
-6.7% |
17.3% |
-17.2% |
-6.6% |
4.9% |
US Cannabis Re-Scheduling: End of Public Consultation July 22, 2024
The sixty-day public comment period that was established by the Department of Justice (DOJ) to gauge responses to the reclassification of cannabis from a Schedule I to a Schedule III substance in the Controlled Substances Act ended July 22nd. Headset data shows that the DOJ received ~43,000 comments with ~91% of the respondents favouring rescheduling. Headset also noted that the number of submissions broke prior DEA records. According to the Drug Policy Alliance (DPA) a group whose work is focused on ending cannabis incarcerations in the US, coordinated submissions on behalf of supportive individuals and organizations and noted the following data.
- 69.3% or 29,750 submissions support de-scheduling, decriminalizing, or legalizing marijuana at the federal level.
- 42.4% or 18,207 comments, mention the need for federal marijuana reform to advance racial justice or social equity.
It wasn’t just individual users providing personal comments in support or against. There were more than 30,000 healthcare practitioners across 43 U.S. states that support 6 million registered patients who also recommended re-scheduling.
Submissions to the DEA Public Consultation for Re-Scheduling
Next Steps Post July 22
Now that the 60-day public comment period has ended, the DEA reviews the submissions to determine if any of the submissions have legal standing requiring an administrative hearing. Head of the DEA Anne Milgram can choose to select an administrative law judge to preside over the hearing(s) under her authority as DEA administrator. The question though is whether an administrative hearing will be held at all.
Cannabis operators and lawyers have noted it will be challenging for opponents to demonstrate that they have legal standing while attempting to prove that the legislation harms them. These requests for administrative hearings must provide a “written statement of position on the matters of fact and law involved in such hearing.” If the DEA Administrator grants an in-person hearing, the DEA will publish a notice of the hearing and those that are participating. One group that has submitted an entry is a group of State Attorneys General suggesting it is against Re-scheduling. This group would be considered to have legal standing but at this stage would be unclear as to the negative impact that it would have with Re-Scheduling.
After administrative law hearings are complete, the DEA makes its final decision. Assuming the DEA agrees with rescheduling, the DEA publishes the new rule in the federal registrar, while allowing a 30-day period to give aggrieved parties the right to litigate against rescheduling in federal court. Important to note that advocates may also file suits if they are aggrieved by the final rule. As we note in the commentary below, with respect to the Presidential Election, Trump vs Harris has more meaningful implications when it comes to future federal cannabis reforms.
Presidential Election: Implications for Cannabis Re-Scheduling
On July 13th, former President Trump was the target of an assassination attempt that had far-reaching implications for the election in November. Americans witnessed a significant rise in support for the former President, which when combined with a weak Presidential Debate by President Biden in late June, led to increased pressure to change the Democratic presidential ticket. Shortly thereafter, President Biden announced he would no longer seek re-election.VP Kamala Harris became the Democratic nominee. The question is what the policies or positions these candidates have and what will the implications be for cannabis re-scheduling.
Former President Trump is not overly friendly to the cannabis industry. Recently though, statements he made led to a spike in cannabis trading as the former President stated his support for de-criminalization, stating that as most of the US is now legal it is now inconsistent to keep people in jail or continue to incarcerate people for non-violent cannabis offences. In the early part of his administration, he replaced his first Attorney General (Jeff Sessions) after just 1 year in office. There were several reasons for the replacements, but we note that he was very right-wing and outspoken against cannabis legalization efforts. During the recent Presidential debate in late June, Trump ignored the topic of cannabis and even used his drug focussed policy question time to talk about tariffs instead, so it appears that cannabis is a low priority. The only official position on Trump’s website about drugs is “War on the Cartels”, focused on “deadly drugs, opioids, and fentanyl” trafficked by international cartels and criminal networks. The Republican VP nominee is Ohio Senator JD Vance. He has opposed marijuana banking legislation and to date has declined to publicly discuss adult-use cannabis in his state of Ohio. He is though, an advocate of the 10th Amendment, which allocates rights to States on certain laws that can not be interfered with by the federal government. This focus on states' rights would by extension include state-legal cannabis companies that employ 500k Americans. No candidate in our opinion should be against job growth. With a Final Rule published before the November election, we do not see how a Trump win derails the executive rescheduling process currently underway assuming the DOJ completes the process before the inauguration.
The Democrats Led by Kamala Harris
Having Kamala Harris step in as the presumptive Democratic candidate has given cannabis awareness and the related equities a shot in the arm. Democrats will want to complete the Rescheduling process before Inauguration Day, and a Democrat-led White House post November 5th could lead to further federal legislative changes. VP Harris backs a complete end to federal cannabis prohibition. She’s called for federal legalization as recently as March 2024, in a closed-door meeting with marijuana pardon recipients. And during her time in the Senate, Harris sponsored a comprehensive legalization bill in addition to other incremental cannabis reform measures. Her most notable leadership with respect to cannabis reform legislation was her sponsorship of the Marijuana Opportunity, Reinvestment and Expungement (MORE) Act, which would federally legalize cannabis and promote social equity. For the industry, a Democrat controlled White House along with a Democrat Senate and House will ensure further cannabis reform. And given Harris’ selection for running mate, Governor Tim Walz of Minnesota, there is a pro-cannabis legalization ticket as both Harris and Walz have been outspoken advocates for adult use, social equity as well as expungement of non-violent cannabis offences. At the time of writing in early August, despite global equity market sell-off pressure, US cannabis stocks have responded positively to the Harris -Walz ticket.
Florida Ballot Initiative
A poll commissioned by the “Vote No on 3” campaign in Florida provides the most recent positive poll data where over 64% of likely voters support the Florida adult use ballot initiative taking place on election night in November. This is a very important state vote as Florida is one of the largest states by population and despite still being a medical-only state, it generates more than $2 billion in revenues annually. In addition, when you consider the annual tourism Florida attracts, it is estimated that it could compete with California as the largest adult-use market in the US. In terms of public support “Smart & Safe”, the pro-cannabis lobby group has raised over $60 million to support outreach, education and voter turnout, while the campaign led by Republican Governor Ron Desantis had raised less than $5 million in campaign contributions to mid-July. Recently, billionaire Ken Griffin who moved his residency from Illinois to Florida donated $12 million and committed a total of $20 million to the “Vote No” campaign, but still well short of the Florida Smart & Safe Campaign. From September onwards to November, ads will fill the airwaves and given the funding to date, it appears that the pro campaign has the resources to bring this victory home.
Q2 Financial Results
With a global backdrop of consumer weakness and inflationary pressures affecting many consumer discretionary stocks such as MacDonalds and Starbucks, the top cannabis holdings in the Fund, as per company reports, continue to outperform with stronger than forecast financial results for Q2 for the Fund leading positions Green Thumb Industries (GTI) and Trulieve Cannabis (TRUL). In addition, our select Fund holdings in pharma continue to generate solid gains with Eli Lilly & Co. continuing to beat analysts' estimates.
Green Thumb Industries (GTI)
Q2 revenues and margins exceeded estimates as revenues reached $280 million, up 11% YoY while gross margin was $150 million or 53.7% vs 49.6% in Q2 23. Retail sales increased 8.8% YoY from Q2 23, with same-store sales growth of 2.3% on 76 stores, while GTI added 11 new stores YoY. Wholesale distribution was up 17.3%, led by New Jersey and Maryland.
As gross margins reached 53.7%, GTI achieved Adj EBITDA of $94 million or 34% with $20 million in cash flow from operations. There has been a lot written on 280E tax payments of late and GTI continues to make its payments, its cash flow generation of $20 million after paying $50 million in 280E taxes during the quarter. Further confidence in management’s capital allocation strategy is seen in its share buyback that began in September of 2023. To date, GTI has completed a total of $73.3M in share buybacks since repurchasing a cumulative 6.6M shares at an average price of ~$11.16/sh. For the second half of the year, we see continued growth from key markets with store openings in Florida, along with continued wholesale growth in New Jersey, Illinois and Pennsylvania. In addition, the August 6th opening of the Ohio market offers great opportunities for growth that GTI is well positioned for with the state maximum of 5 stores ready to go. Overall, GTI operates 97 retail locations spanning 14 different US state markets.
Trulieve Cannabis (TRUL)
TRUL also generated a strong revenue beat of $300 million vs $293 million average estimates, with revenues up 2% QoQ and 8% YoY. The company had a 3.5% increase in traffic vs a 1% decline in price compression, while consumer behaviour continues to bifurcate demand with a strong preference for premium while some consumers increasingly moving to value. Noteworthy in achieving profitable growth in both premium and value product categories is the gross margin of 60%, with a gross profit of $182 million. It should also be noted that Q2 has 420 holidays where there is substantial discounting and special promotions, so to achieve a 60% margin, up 1% QoQ and well above analyst estimates of 55%, speaks to the efficiency of cultivation operations across all state markets. With sound operations, TRUL generated adjusted EBITDA of $107 million or 35% of revenue, up 1% sequentially, and again well above analyst estimates of $91 million. Free Cash Flow was $45 million in Q2 with the company at Q2 end having $356 million in cash on the Balance Sheet, inclusive of an additional $2.0 million in tax refunds received during the second quarter, from amended tax returns, related to our tax challenge of 280E. Going forward, TRUL has exposure to growth markets including 3 new dispensaries in Ohio along with 2 additional dispensaries to be opened in Q1-25. In addition, the Florida Ballot Initiative is a huge upside catalyst for the company with its state leading 35-40% of the Florida medical market.
Eli Lilly & Co (LLY) had a very strong Q2 beating analyst expectations by a significant margin in addition to succeeding where key competitors were being challenged. Total sales advanced 36% YoY to $11.3 billion, beating sales expectations by more than $1.3 billion. Eli Lilly CEO David Ricks on the company earnings call, detailed how sales were driven by higher demand for its GLP-1 drugs, Mounjaro and Zepbound as production increases improved supply in the U.S. Sales of Mounjaro increased more than 215% YoY to $3.09 billion, surpassing expectations of $2.43 billion while weight-loss drug Zepbound generated $1.24 billion. Its important to note that Zepbound has only been in the market for 6 months after approval from the FDA for treatment of weight-loss whereas Monjauro was approved for type II diabetes in 2022. That differs from Q2 results at Novo Nordisk (NOVO), that reported weaker than expected results related to its weight loss drug Wegovy and diabetes medication Ozempic, due to pricing pressure in the US. NOVO explained in its quarterly release that it had to make increased price concessions to U.S. pharmacy benefits managers that establish price discounts on behalf of insurers. LLY continues to see growth as it begins international expansion for its leading GLP-1 drugs outside the US. Approvals already exist in 40 countries, but the company has waited until supply could deal with increased demand. Now that the company is in process of completing six new production plants and ramping production, the company sees significant global growth on top of its US market success. Looking at the Q2 bottom line for LLY, EPS was $3.92 adjusted vs. $2.60 estimate, with net income $2.97 billion, for the second quarter. That compares with a profit of $1.76 billion, or $1.95 a share, a year earlier. With the strong Q2 and forecast growth for the balance of the year, LLY boosted its full-year revenue by $3 billion to + $46 billion in sales, driven by the strong performance of Mounjaro and Zepbound.
Will The Chevron Deference Decision Impact Cannabis
As this decision came out late last week, some investors thought that it was in part responsible for weakness on the last day of the quarter. We have received communications from US legal experts that have reviewed the Chevron case. A thorough review of the process for Re-Scheduling brings us to the view that the Chevron decision will not have a negative impact. Legal challenges are a prospect but that did not change with this decision. The overturning of Chevron has actually helped Re-Scheduling because HHS has the power to review cannabis Re-Scheduling provided by Congress in the Controlled Substances Act. In 2023 HHS used a test adopting scientific and medical standards that are according to its delegated authority in the CSA making it less likely that a court could overturn the process. As a result, the media is making a lot out of this Supreme Court decision, but we are of the opinion that given the work of HHS, this change should not be an obstacle to Re-Scheduling.
Option Strategy
Since the inception of the option writing program in September 2018, the Fund has generated significant income from options premium of approximately $5.0 million. We will continue to utilize our options program to look for attractive opportunities given the above-average volatility in the sector as we strongly believe that option writing can continue to add incremental value going forward.
During the month we used our options strategy to assist in rebalancing the portfolio in favor of names we prefer while generating options income. We continue to write short dated covered calls on names we feel are range bound near term and from which we could receive above average premiums which included UnitedHealth Group (UNH) and HCA Holdings Inc. (HCA). We also continue to write short dated cash secured puts out of the money at strike prices that offered opportunities to increase our exposure, at more attractive prices, to names already in the Fund including Mckesson Corp. (MCK) and Universal Health Services Inc. (UHS).
The Ninepoint Cannabis & Alternative Health Fund, launched in March of 2017 is Canada’s first actively managed mutual fund with a focus on the cannabis sector and remains open to new investors, available for purchase daily.
Charles Taerk & Douglas Waterson
The Portfolio Team
Faircourt Asset Management
Sub-Advisor to the Ninepoint Alternative Health Fund
Statistical Analysis
Fund |
|
|---|---|
Cumulative Returns |
39.8% |
Standard Deviation |
27.5% |
Sharpe Ratio |
0.06 |