On August 30, we received the biggest development regarding the United States’ drug policy in 50 years.
The U.S. Department of Health and Human Services (HHS) has recommended marijuana be reclassified from a Schedule I substance to a Schedule III.
This will move marijuana from being in the same category as heroin to the same category as Tylenol with codeine.
The reclassification is massive news for cannabis multistate operators (MSOs).
These are legal businesses that have approved the use of marijuana for medical or recreational purposes. And they already operate in 40 states.
The federal tax code for businesses involved with a Schedule I drug, including MSOs, is incredibly penal. Section 280E of the code was designed to bankrupt companies dealing in illegal drugs.
Under federal tax code, businesses that are involved with any Schedule I drug are not allowed to deduct most expenses for tax reasons.
So MSOs’ effective income tax rates can be as high as 80%!
This tax burden has been crushing the profitability of these companies and the cash flows they can generate… even though they are selling a product that is fully legal in the states where they operate and they’re selling a product that more than 70% of Americans believe should be fully legalized.
Upon marijuana being rescheduled to Schedule III, these companies will be taxed as normal businesses. Their tax rates are going to drop from upward of 80% to a more normal 20%.
The impact on free cash flows is going to be huge!
Larger MSOs will see free cash flows double, triple or more. And the smaller operators that aren’t currently producing free cash flow suddenly will see the cash roll in.
This a game changer and a massive catalyst for the cannabis industry and MSOs specifically.
With the rescheduling, there are a number of additional benefits for MSOs.
As businesses that deal with a Schedule I drug, MSOs have been paying incredibly high interest rates on their debt. Most of these companies have double-digit interest rate burdens.
Once marijuana is rescheduled, MSOs’ cost of financing should drop to more reasonable levels, which will allow the companies to save tens of millions of dollars in interest expense.
Additionally, it is expected that the rescheduling will allow these companies to finally list on the major U.S. stock exchanges.
Because of the Schedule I status of their product, MSOs are forced to list on a smaller Canadian stock exchange. That means very few people can buy shares of these companies, and their stock prices reflect that. Currently, very few American institutional investors have any exposure to this sector.
Uplisting to U.S. exchanges could bring billions of dollars in new money into the sector.
This rescheduling news is incredibly bullish for these MSOs, and there is a way for U.S. investors to own a basket of them.
The AdvisorShares Pure US Cannabis ETF (NYSE: MSOS) owns the strongest operators in the sector and is available to U.S. investors.
Last year, I wrote about the fact that President Biden had ordered the HHS to look at rescheduling cannabis. I advised that this exchange-traded fund (ETF) was going to soar once that evaluation was complete. While I was right and this ETF has soared on the news of the rescheduling recommendation, I was too early on this trade.
The AdvisorShares Pure US Cannabis ETF got crushed over the past year, as there was no interest in this sector after the U.S. government’s repeated failures to push other marijuana legislation forward.
So right now, these stocks are priced as if they are going out of business.
Despite this month’s rally, MSOs’ valuations are still far too low relative to the potential they have on rescheduling.
Plus, the sector has several other catalysts that should arrive in the coming months.
These include the passage of the Secure and Fair Enforcement Banking Act (which will finally give MSOs proper access to the banking system), a surge in listings on major U.S. stock exchanges, and inflows of institutional investment dollars.
The next 12 months for this sector should be very exciting.
The Value Meter rates the AdvisorShares Pure US Cannabis ETF as “Extremely Undervalued.”
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