The marijuana industry is growing like a weed. Pardon the corny pun, but it’s the truth, regardless of which source you prefer.
ArcView, a leading cannabis research firm, suggests that the legal cannabis market in North America could to grow by 26% a year through 2021 to almost $22 billion. Meanwhile, Marijuana Business Daily‘s newest report, “Marijuana Business Factbook 2017,” expects legal U.S. sales to soar by 45% in 2018, likely as a result of California opening its doors to legal recreational weed sales. Investment firm Cowen & Co. has taken things even further by calling for a $50 billion U.S. market by 2026. Such a scenario likely assumes full legalization at the federal level.
The marijuana industry’s ceiling is pretty low in the U.S.
Yet despite these robust growth estimates, the U.S. marijuana industry has a low ceiling relative to its potential. That’s because pot is a Schedule I drug on Capitol Hill, which means it is wholly illegal, just like heroin and LSD, and has no recognized medical benefits. It’s also classified as a drug with a high potential for abuse.
This Schedule I classification creates a world of problems for marijuana companies. For instance, medical cannabis researchers are buried by red tape. While Congress has requested benefit-versus-risk studies be run, getting these trials off the ground with only one approved federal grow facility in the U.S. makes things challenging.
Additionally, there are financial concerns that marijuana stocks and companies face. First, weed-based companies have virtually no access to basic banking services, which includes a checking account. Since financial institutions report to the Federal Deposit Insurance Corporation (FDIC), and the FDIC is a federally created entity, any financial services provided to marijuana companies could be viewed as money laundering in the eyes of the Justice Department. That could leave banks exposed to possible fines or criminal charges.
Also, pot companies face an exceptionally high effective tax rate, should they be profitable. U.S. tax code 280E disallows businesses that sell federally illegal substances from taking normal corporate income-tax deductions. This can leave cannabis companies to pay an effective income tax of as high as 70% to 90% on their profits.
Americans overwhelmingly support legalizing cannabis
But, truth be told, the American public and the federal government are on separate sides of the aisle when it comes to marijuana.
Since April 2017, four national surveys have been released that examined Americans’ perception of marijuana. Here were the results:
April 2017: CBS News
“Marijuana should be…”
- Legal: 61%
- Not legal: 33%
August 2017: Quinnipiac University
“Do you think that the use of marijuana should be made legal in the United States, or not?”
- Yes: 61%
- No: 33%
October 2017: Gallup
“Do you think the use of marijuana should be made legal, or not?”
- Legal: 64%
- Illegal: 34%
January 2018: Pew Research Center
“Do you think the use of marijuana should be made legal, or not?”
- Legal: 61%
- Illegal: 37%
In each and every instance, this question yielded an all-time record number of respondents who wanted to see pot legal across the country in all four polls. In fact, support for legalization has jumped from just 40% to 61% since 2011 in the CBS News poll, while favorability toward legalization in Gallup’s national survey has catapulted from 25% in 1995, the year before California became the first state to legalize medical cannabis to medicinal use, to 64% as of October 2017.
Support for medical marijuana is considerably higher. The same independent Quinnipiac University poll from August 2017 showed that 94% of respondents favor legalizing medical weed, compared with a minuscule 4% who oppose the idea.
Two reasons the marijuana industry has little intermediate-term hope in the U.S.
Americans would like to think that Congress would alter the federal scheduling of pot considering that better than three-fifths of polled adults favor such a move. But this is far from the case. If anything, the federal government has dug in its heels deeper than ever, with the current administration likely to keep marijuana’s scheduling unchanged for years to come, for two key reasons.
One reason there’s not too much hope for change is that the legislative branch is dominated by Republicans. The October Gallup poll did show that 51% of respondents who identified with the GOP favored legalization, marking the first time ever that more Republicans favored expansion than opposed it. Still, the GOP has a much more negative view of cannabis than Democrats. Plus, the GOP has topics like healthcare reform and an infrastructure plan on its docket for 2018, offering little room for cannabis reform.
Adding to this point, the recently passed GOP tax law (the Tax Cuts and Jobs Act) is projected, by the Joint Committee on Taxation, to result in a 10-year federal deficit of around $1.5 trillion. As a result, it’s unlikely that efforts to reform U.S. tax code 280E to make the taxation of marijuana companies friendlier won’t work. Simply, the federal government needs as much tax revenue as it can get, which means the continuation of seemingly unfair tax practices on marijuana stocks and companies.
The second reason the weed industry should expect no solace in the U.S. is none other than Attorney General Jeff Sessions. A little over a week ago, Sessions announced that he’d be rescinding the Cole memo, which had loosely protected states that had legalized in some capacity from federal intervention. The “rules” presented by the Cole memo required states to keep adolescents away from pot, ensure that drivers who were under the influence of cannabis were dealt with harshly, and guarantee that weed grown within a legal state stayed within that state.
Pulling back the Cole memo opens the door for the prosecution of marijuana businesses operating in states that have chosen to legalize in some capacity. While it’s unclear if Sessions and the federal government will have the ability to prosecute marijuana businesses at some point, the rescinding of the Cole memo gives state prosecutors the authority to use their discretion in possibly bringing charges against marijuana-based businesses. It’s a potentially crushing blow to a fast-growing industry.
Investing in marijuana? Stay north, my friend
The announcement from Sessions was also a major blow to marijuana stock investors who’d been counting on growth in the U.S. market to push valuations ever higher. The U.S. might just have the greatest long-term sales potential of any weed market, but it’ll remain capped for the time being by Sessions and fellow Republicans.
If you’re looking to dip your toes into the water, so to speak, to get exposure to the pot industry, your best bet remains looking north to the Canadian market.
Canada wound up legalizing medical marijuana all the way back in 2001, and Health Canada has been overseeing the orderly expansion of this legal industry. Though growing capacity tends to be concentrated in a handful of Canadian companies — Canopy Growth Corp. (NASDAQOTH:TWMJF), Aurora Cannabis (NASDAQOTH:ACBFF), Aphria (NASDAQOTH:APHQF), and MedReleaf (NASDAQOTH:MEDFF) — medical sales alone have been enough to push a fewl of these pot stocks to profitability. Both Aphria and MedReleaf have reported full-year profits in each of the past two years.
What’s more, Prime Minister Justin Trudeau stuck to a campaign promise and introduced legislation in April 2017 designed to legalize recreational weed in Canada by July 1, 2018. With progressives firmly in control of Canada’s parliament, and a tax deal in place with each of the country’s provinces, the likelihood of legalization by this summer is growing. If approved, recreational weed could yield up to $5 billion in annual sales in Canada. This is precisely why Canopy Growth has 2.4 million square feet of grow capacity under construction or in development in British Columbia, and why Aurora Cannabis is working on a state-of-the-art 800,000 square foot facility known as Aurora Sky that’ll produce 100,000 kilograms of dried cannabis a year.
It’s Canada, not the U.S., that has the best chance of putting a smile on marijuana stock investors’ faces this year.
credit:fool.com
