Todd Harrison on Wall Street’s Growing Cannabis Interest

CB1 Capital Management CIO Todd Harrison shares his interpretation of the market’s recent bullish turn. He points to Fed chair Jerome Powell walking back earlier comments on interest rate rises as a potential macro catalyst but also cautions the markets, including the cannabis space, need to work through the technical damage done in Q4 2018. Despite recent action, Harrison believes the current rebound is transitory. Harrison is more optimistic about the cannabis space and he suggests Wall Street’s increased interest in the cannabis sector is a precursor to greater institutional participation in the space, which will act as a catalyst for the industry. CB1 Capital is a long-term investor in the cannabis space and is particularly interested in efficacy-driven solutions developed by cannabis biotech companies. Harrison reminds investors to pay attention to the consumer side of the cannabis equation, as he expects the Farm Bill’s legalization of industrial hemp to have massive applications for wellness products.

Transcript:

James West:   Todd, how are you doing today?

Todd Harrison: Hey, how are you guys?

James West:   Happy New Year.

Ed Milewski:  Hey, Todd.

Todd Harrison: Happy New Year, we spoke last week. We had a conversation [laughter]

James West:   Well, that’s because I’m doing too much CB1 and CB2. Apparently, you know that they’ve found, they’re surmising, they’re pontificating in the research clinical sector that short-term memory loss was actually part of the survival strategy of people who consumed cannabis, it was sort of like a by-product of the symbiotic relationship between plants and humans. Short term memory loss, because if you lose your short-term memory, you’re relaxed and you have no anxiety and you sleep well, because you can’t remember what you were worried about by the time you go to bed.

Ed Milewski:  I think that’s true. I’m tired and I want to go to sleep.

James West:   I’m tired, and I want to go to bed. Uh, anyways, Todd, so since we chatted way back there last week, the market has gone into a decisively positive and, you know, bullish phase. Do you see this lasting, and is this something, if you were to point to the macro-catalysts that would be responsible for this sudden effusiveness in the first quarter of 2019, what would it be?

Todd Harrison: I think certainly if you’re talking about the macro tape I think Powell walking back some of his quantity of tightening language with the balance sheet certainly helps sentiment. It got pretty panicky the last week of the year, but now we’re back up; we talked about this, a lot of resistance levels here across the US indices, the sub-indices, and across the world. It doesn’t mean we can’t go higher, I just think there’s a fair amount of technical damage that was done in the fourth quarter that we need to work through.

But yeah, in the cannabis space, I think a lot of the tax loss selling we talked about last week is starting to unwind, and we’re seeing that being priced in as investors get some risk back on in the sector. So it was nice to see the US Cannabis Index or names, got to hand that baton over to the Canadian producers earlier this week. So we’ll see as we kind of get to some resistance levels in these sectors as well, how they act.

James West:   Yeah, you bet. So then, is the thesis at the end of 2018 still the same for 2019, in other words, the US operating Canadian-listed companies are still a discount relative to their Canadian peers?

Todd Harrison: Well, they are. They are, but it’s nice to see some bifurcation, nice to see some rotation. A lot of these names as we talked about, you know, from the last week in December up until, I guess, earlier this week, they’re up, some of these names, 50, 60, 70 percent. So as they sort of now started to catch their breath, I see Canopy get on a horse, and to see Aphria start to try to fill that gap in front of earnings tomorrow…

Some constructive action, for sure, but hopefully we see some backing and filling and get a better sense of tenor of these things. This one-way tapes are always tough to trade.

James West:   You bet. You bet. So on the macro side, do you think that the picture globally, the outlook globally, is sort of trending towards recession, or the opposite?

Todd Harrison: You know, I’m not an economist. You know, I’ll tell you that we’ve had a hell of a bull run for the last decade and certainly at a point we’re going to give some of that back. I actually think it’s, you know, it’d be a pretty bullish thing if we could sort of back test the S&P 2250 or thereabouts and then work on the next leg higher. You know, this is going to be transitory, ultimately, I think, but it could be painful for us. I don’t think you could forget the lessons of the fourth quarter because you had a good two-week rally here. Like the stocks too long, have some powder, we are loose grips on the handlebars, and there’s going to be some good opportunities.

I continue to think this year is going to be a big year for cannabis. I think we’re going to see some banking reform that’s going to lubricate the system and we’re going to see some real rotation of institutional capital into the space.

James West:   So you think the big money is coming in, in 2019? Like, sort of the more conservative capital pools are going to start to be more visible in the sector?

Todd Harrison: Well, I don’t know about the more conservative capital pools, but I certainly think if Wall Street has demonstrated anything over the course of history, it’s the ability to re-package and re-sell risk, and there’s a certain appetite in the marketplace. I think just this week you saw Piper Jaffrey come out and initiate Canopy and Tilray, you know, we’ve gotten some calls here about Wall Street firms that are looking to move into the space.

So we know for a fact that Wall Street is circling; we think that adoption is going to lead to this institutional participation, and again, you know, we talked about this, not to sound too pie-in-the-sky, but you know, if you’ve got a $300 billion market for cannabis and you contemplate that as an ingredient as opposed to the end product, you know, you could be talking about a couple trillion dollars in market cap in ten years versus about 40, 50 billion right now. So the scale is pretty massive; I don’t think people understand exactly what this is or how this is going to play out, but we’re pretty excited about it.

James West:   Sure. So is CB1 Capital then best characterized as a longer term, buy and hold investor, or do you trade opportunistically out of markets when you see valuation breakdowns?

Todd Harrison: That’s a great question. So you know, we’re looking for companies that we can hold off for the long term. Obviously we will rotate; we talked about it, I guess, last year, how we were pretty wide – I think we said 9 percent in Canada at one point, and then last week how we were starting to rotate back in. so we think there’s going to be certain capital for those, but the opportunities that we see right now that are most pervasive in the US side are these multi-state-operators, and also on the biotech side, particularly after some of the price movement we saw in the fourth quarter where biotech stocks lost about a third of their value on the aggregate; you know, cannabis biotech wasn’t immune. I think it presented some good opportunities, and I would continue to think that’s going to be the next phase as efficacy-driven solutions start to manifest through clinical trials.

Ed Milewski:  Todd, Tilray: it’s a volatile stock, what’s your thinking right now on Tilray?

Todd Harrison: We don’t have a position. You know, we thought about treating it earlier this week just because we like Canada, but we’re going to focus on the names that we feel a little bit better about from a fundamentals standpoint. We talked about Organigram, we talked about CannTrust setting up, Village Farms is a name that we like, you know, and then there are trades also. Canopy, we’ve been trading from the long side, Aphria, that we treat more like trades, but in terms of investment, I mean, I think we talked about Elixinol not too long ago, I mean, here’s a stock that’s based out of Australia that’s now rough justice trading at $3 versus trading about $1.40 in October.

So the opportunities are there. Wall Street is going to do the work, and a lot of these inefficiencies that exist in the cannabis market are going to be unearthed, and we think the more efficient markets are on their way into the marketplace, if that’s not too redundant.

James West:   Yeah, so would you say that – I mean, I’m looking at, you know, the next phase of the cannabis bull market that gets us towards a couple of trillion dollars, and I’m looking at the biotech sector in particular as, you know, potentially the real value multiplier of the space as opposed to, say, consumer beverages, consumer products on the rec side. Would you, from where you sit, Todd, do you think it’s the biotech side that is going to be the main value driver as they start to understand more the molecular applications for the various CBD components in the human genome?

Todd Harrison: Well, certainly the side that’s the most offsides – I mean, we were just talking about this in-house, here. Most secondary schools, medical schools, haven’t really studied the endocannabinoid system; it’s first discovered in 1990. So the parallels between the cannabis plant and the cannabinoids in the cannabis plant versus the endocannabinoids that our body produces, there’s not many people that are aware of that. So that offside is pretty massive, but don’t sleep on the consumer side. I mean, whether it’s going to be beverages or nutraceuticals or consumer packaged goods, cosmetics and vanity, the Farm Bill is going to open this up, we’re going to start seeing this all over the place, and I think the wellness applications on the consumer side are going to be huge.

I think it’s bifurcated a bit, and the way we positioned our book is that we have a bucket really for a consumer side, and we have that bucket for the more traditional biotech side. But I can tell you from looking at the price action, a lot of people, you know, they don’t even know that this is a space yet. So yeah, I think that’s the most under-appreciated upside.

James West:   Sure. So what percentage of your capital is committed to the rec/consumer packaged goods side versus the biotech side?

Todd Harrison: Got about, I would say about 30 percent of our book in biotech right now. We’re pretty heavy on the US side, but like I said earlier, I guess last week, we started to get a little bit more aggressive with Canada after that downdraft, and especially with all this tax loss selling starting to unwind. But you know, we want to leave powder here. I mean, this is a very volatile sector. Something that I don’t think we talked about last week, which I thought was pretty interesting: by my pen, the global cannabis market had 9 separate 20-percent declines last year; nine separate bear markets for the global cannabis index that we follow, which is a pretty amazing thing. I’ve never experienced anything like that before.

So coming into 2019, it’s like, what doesn’t kill you, you figure it’s going to make you stronger.

James West:   Hah! That’s a good attitude. All right, Todd, let’s leave it there. Again, thanks so much for your participation once again – great insight. We’ll come back to you soon.

Ed Milewski:  See you, Todd.

Todd Harrison: Yeah, thanks, guys.

Original article: Todd Harrison on Wall Street’s Growing Cannabis Interest

©2019 Midas Letter. All Rights Reserved.