The marijuana industry has been a practically unstoppable force over the past couple of years, and so have marijuana stocks.
According to a recently published report from Marijuana Business Daily entitled "Marijuana Business Factbook 2017," sales of legal weed in the U.S. are expected to triple to more than $17 billion from a range of $5.1 billion to $6.1 billion between 2017 and 2021. Investment firm Cowen & Co. has taken it one step further by forecasting legal U.S. pot sales of $50 billion by 2026. There are few, if any, industries that can put up a sustainable 25% annual growth rate like legal marijuana.
Image source: Getty Images.
The result is that marijuana stocks have absolutely been on fire. Quite a few pot stocks have doubled or tripled in value over the trailing year, despite the fact that they're losing money or have unproven business models. Investors simply see the words "marijuana" or "cannabis" in the company's name and buy blindly.
Uh-oh! Nevada's recreational marijuana law has a problem
However, marijuana stocks could soon run into a bit of a brick wall.
Investors are counting on relatively smooth sailing when it comes to the expansion of recreational and medical marijuana throughout the United States. Despite residents in Nevada voting in favor of legalizing recreational cannabis in the Nov. 2016 election, implementing the law is proving far more challenging than expected. In fact, recreational licensing could be delayed.
According to the Las Vegas Review Journal, a district court judge on Tuesday, May 30, signed a restraining order that prohibits the Department of Taxation from enforcing a May 31 license application deadline for the state's early start program. This comes after the Independent Alcohol Distributors of Nevada filed a complaint that alleged liquor wholesalers get an unfair advantage as the sole distributors of recreational marijuana products for the first 18 months. According to the judge, "The statute clearly gives a priority and exclusive license to alcohol distributors, in order to promote the goal of regulating marijuana similar to alcohol."
Here's where things get even trickier: Very few of Nevada's licensed alcohol wholesalers have shown interest in distributing marijuana, which is defined as the transport of cannabis from grow facilities to dispensaries. As of the end of May, just one alcohol wholesaler had applied for a marijuana distribution license in the state. The reason is that liquor licenses are distributed from the federal government, but cannabis is still an illicit (schedule I) drug at the federal level. In other words, alcohol wholesalers that choose to distribute marijuana could risk having their federally-issued liquor distribution licenses revoked under a strict interpretation of the law.
Image source: Getty Images.
In a nutshell, Nevada needs more businesses to step up to distribute recreational marijuana, but the judge's order renders alcohol wholesalers the only businesses that can fill that role. That's a problem, and it may very well mean that Nevada's recreational pot industry fails to get off the ground in a timely manner. That's disappointing from a budgetary perspective for the state as well as for marijuana stock investors in general.
A reminder of the issues marijuana stocks face
The issues Nevada is facing with its recreational pot rollout are a good reminder of the uphill battle that marijuana stock investors are likely to face in the years to come.
In addition to state-level hiccups, investors have to realize that the federal government's schedule I categorization of cannabis really is a tough hurdle for these businesses to overcome. A schedule I drug is recognized as having no medical benefits and is illegal. Clinical studies involving marijuana are very difficult to conduct because of this strict status, and a number of businesses face tough regulatory restrictions. This includes tax disadvantages -- pot-based businesses are unable to take normal corporate income-tax deductions -- and the inability in many cases to obtain basic banking services. This even includes opening a checking account, which means weed businesses are stuck dealing solely in cash.
The other big problem is that marijuana stocks are predominantly losing money, and may continue to do so for years to come. And even if they show the promise of profits, or are already profitable, their valuations are astronomical even while factoring in their growth rate.
Image source: GW Pharmaceuticals.
For example, Corbus Pharmaceuticals (CRBP +1.32%), an entirely clinical-stage developer of endocannabinoid-mimetic therapies that target the CB2 receptors found on immune cells and fibroblasts, has just one drug in development, anabasum. Most of Corbus' valuation derives from its potential in treating cystic fibrosis (CF) as a general anti-inflammatory product. However, even though anabasum reduced the pulmonary exacerbation rate in phase 2 CF trials, it didn't lead to an improvement in forced expiratory volume in the first second (FEV1). That's disappointing considering that FEV1 improvement is often seen with approved CF drugs. If the CF trials comes up short, Corbus' valuation will take a major hit.
Even the star of the weed industry, GW Pharmaceuticals (GWPH +0.00%), has potential concerns. Phase 3 studies of lead drug Epidiolex hit the mark, with the experimental therapy providing a statistically significant reduction in seizure frequency for two rare types of childhood-onset epilepsy. If approved by the FDA, the drug could generate perhaps $600 million or more in annual sales by as early as 2021. But here's the catch: GW Pharmaceuticals is already valued at roughly five times the projected sales of its lead drug by 2021. That's exceptionally expensive simply for being associated with the marijuana industry.
Despite the industry's potentially rapid growth rate, your best bet remains staying on the sidelines when it comes to marijuana stocks.
