POTX - CNBS: Cannabis Companies Continue To Face An Uphill Battle

2023-05-31 05:35:46 ET

Summary

• Cannabis companies face challenges in obtaining funding, advertising, and scaling, as well as potential declines in edibles' popularity due to DEA restrictions on delta-8 drugs.
• Possible comeback opportunities include increased research on cannabis benefits and financial catalysts like the SAFE Banking Act, which could provide better access to traditional financial services for cannabis businesses.
• I rate the Amplify Seymour Cannabis ETF (CNBS) a Sell due to ongoing regulatory scrutiny, economic downturn, and social stigma surrounding the cannabis industry.

Recreational marijuana legalization in the United States has been providing business opportunities since 2012. Legalization, however, was only the first step to financial freedom for these cannabis businesses. Since then, recreational marijuana companies have been trudging along the subsequent steps, which have involved numerous financial and legal battles. I believe cannabis startups were outcasts during this time, which limited their ability to grow healthily as many banks and agencies did not cater to them. This remains the case in 2023, as regulatory scrutiny and economic downturn continue to take a toll on the cannabis industry. For this reason, I rate the Amplify Seymour Cannabis ETF ( CNBS ) a Sell.

The Federal Reserve remains quite far from its goal of 2% inflation, increasing the likelihood that the United States economy is due for more rate hikes. As cannabis companies are already struggling immensely to get the right funding, a recession could only make this problem worse. Furthermore, as many popular forms of marijuana are recreational in nature, persistently high inflation could shift consumers away from recreational goods and more towards necessities. Thus far, worsened economic conditions have left many marijuana businesses with heaps of debt . Expansion is therefore harder than ever for these companies and is showing little sign of becoming easier anytime soon.

The recreational marijuana industry is also fundamentally at a disadvantage as its vulnerable to sentiment related to the biological safety of its products. This distinguishes it in a negative way from many industries I have covered in the past. Furthermore, health and safety have also become a more salient topic since the COVID-19 pandemic, which didn't shed a positive light on cannabis. In particular, marijuana use was associated with respiratory shortcomings that made COVID symptoms more severe . Though many cannabis institutions have since diversified beyond traditional inhalant methods , the stigma is still strong and poses a serious threat to ETFs like CNBS.

Strategy

CNBS does not track a specific index. This ETF is instead actively managed and seeks to continuously capitalize on trends and opportunities in the realm of marijuana. Companies of interest are primarily those involved in the cannabis and hemp ecosystem. At least 90% of United States-based holdings must have a market capitalization of at least $75mm, while non-U.S. holdings must have a market cap of at least $100mm. CNBS typically consists of 20-45 stocks and is considered "non-diversified", per the Investment Company Act of 1940.

Holdings Analysis

This ETF invests primarily in healthcare stocks, sparing just over a third of total holdings to non-healthcare names.

The United States is the most prominent nation in this ETF and accounts for over 90% of the fund. Though CNBS is technically not mononational, this ETF is not a significant source of geographical diversification either.

The top 10 holdings in CNBS comprise 80% of this fund. Furthermore, the top five holdings alone account for over half of this ETF. The recreational marijuana space is quite volatile as is, so investors might want to consider how CNBS may add fuel to that fire.

Cautionary Notes

Key Metrics

Uncertainty and regulatory scrutiny have brought greater risk and volatility to cannabis-focused ETFs like CNBS. Some similarly-affected funds include the Global X Cannabis ETF ( POTX ) and the AdvisorShares Pure Cannabis ETF ( YOLO ), both of which I have covered. CNBS' high risk is visualized below.

CNBS is also quite expensive and doesn't really offer performance of the same caliber.

This could become a serious problem, especially as prices are on the rise in the United States. Furthermore, this ETF does not pay a dividend, making it deficient in the value aspect as well.

Past Performance

CNBS has struggled significantly against the rest of the market for the better part of a year at this point, as seen in the chart below.

Evidently, cannabis companies don't currently have the same ability to profit when compared to the broader market, which is likely to turn more and more people away from CNBS and similar funds.

Loss After Loss: Downturn In The Cannabis Space

Meanwhile in California

The cannabis market in California is facing a possible extinction event as recreational marijuana companies fall victim to excessive debt and looming taxes. Amid the numerous barriers to profitability and declining sales , regular payments have become a burden for cannabis companies. Concurrently, collectors are becoming less tolerant of missed payments by these institutions and are less hesitant to shut them down if they can't pay their dues. With time, unprofitable ventures and unforgiving tax laws could make for a lethal combination.

Meanwhile in Texas

The medical marijuana market has been fighting an uphill battle recently just like the recreational marijuana space. For example, a proposal to expand Texas' medical marijuana program was halted at the house, despite advocates outlining the various benefits of using marijuana for medical reasons. I believe the fact that even medicinal cannabis struggles to gain social support outlines how the coming periods are likely to be an uphill battle for cannabis companies of all sorts.

Negative Outlook: Future Challenges

Ongoing Regulatory Changes

Innovation in the cannabis space has introduced new forms of marijuana consumption like edibles and THC-infused beverages that use delta-8 THC. Such products were primarily invented to make cannabis safer to consume, as seen in how edibles and THC-infused beverages don't harm your lungs in the same way as smoking. This new ease of consumption may have spared users from respiratory dangers, but it has made overdosing a bigger concern. For this reason, the DEA recently cracked down on delta-8 drugs, which could be bad news for many dispensaries. I believe edibles' popularity could decline just as fast as it arose, which could harm the cannabis market and CNBS alike.

Advertising and Scaling

Censorship and inappropriate content restrictions on social media apps could become a serious problem for those trying to scale their cannabis business. Social media has become an effective tool for advertising startups. At the same time, social media names like Twitter , Instagram, and TikTok have become weary and intolerant of questionable content, such as that involving drugs . Marijuana institutions may in the long-term have to resort to alternative, less traditional forms of advertising , which could set them behind competitors in different industries.

Comeback Opportunities and Prospects

Greater Research

An ample amount of research and social momentum is going to be needed to offset the persistent social stigma around marijuana. Though hope is scarce in this regard, I don't believe it's nonexistent. For example, cannabis has displayed healing and numbing competencies , as well as the ability to mitigate deadly opioid use in some. Though such claims are mostly buried under the various calamities in various legal and social bodies, these claims could in the long-term, still emerge with greater power.

Financial Catalysts

Many cannabis companies' access to traditional financial services is limited, but advocates have by no means thrown in the towel in getting these companies the right funding. For example, the Secure and Fair Enforcement ((SAFE)) Banking Act is still moving forward after having failed numerous times within the past few years. Most recently, members of the U.S. Senate Committee of Banking, Housing, and Urban Affairs were advised to move swiftly on the SAFE Banking Act as marijuana businesses continue to go under. With time, more could realize how social stigma and slowness in Congress have imperiled many small businesses whose intentions are not to undermine the legal system, but to provide in-demand products and services to customers. This could reduce social stigma and break the financial barriers faced by companies held in CNBS, opening more avenues for profit.

Conclusion

The last few years have brought a number of hurdles to cannabis companies, and worsening economic conditions in the short to medium-term are only going to make these hurdles harder to jump. High expenses and health concerns centered around the plant are also likely to hinder the profitability of marijuana businesses for time to come. For these reasons, I rate CNBS a Sell.

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