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Nevada's Recreational Marijuana Industry Is in Complete Disarray

By Sean Williams – Aug 18, 2017 at 9:18AM

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Success is not guaranteed for the cannabis industry -- nor for marijuana stocks.

In many respects, the marijuana industry has been practically unstoppable. As we stand today, 29 states have legalized medical cannabis since 1996, and voters in eight states have approved the sale of cannabis for recreational use to adults over the age of 21 since 2012. With the exception of voters in Arizona, who voted against a recreational legalization proposition in November, the most recent election cycle would have been a "green" sweep at the polls.

Expansion efforts have derived from a major shift in how the public views weed. During the 1980s and 1990s, when the war on drugs was in full swing, somewhere around a quarter of respondents to Gallup's sporadic surveys wanted marijuana to be legal across the country. However, Gallup's 2016 survey showed that an all-time record 60% of respondents want pot legalized nationally. A separate study from Quinnipiac University found that nearly 19 out of 20 people want medical cannabis to be federally legalized. 

A jar of cannabis buds sitting atop a pile of cash.

Image source: Getty Images.

The dollar figures behind the legal marijuana industry have also enticed industry expansion and investment (both direct and via the stock market). According to Marijuana Business Daily's recent report, "Marijuana Business Factbook 2017," legal pot sales in the U.S. are expected to grow from a range of $5.1 billion to $6.1 billion this year to around $17 billion by 2021. This has weed businesses excited for their prospects, and marijuana stock investors chomping at the bit to throw their hard-earned money into the pot (pun fully intended). Not surprisingly, the average marijuana stock, among the one dozen largest by market cap, has more than doubled over the trailing year.

Nevada's marijuana industry is a mess

Yet, in spite of the marijuana industry's rapid growth, it's not a model of perfection by any means. We only need to take a closer look at Nevada's recreational marijuana rollout to see what sort of snafus can arise in what should be a rapidly growing and profitable industry.

For those who may not recall, Nevadans voted pretty decisively to legalize recreational pot in the November elections. Unfortunately, based on how the law was written, it's set the recreational marijuana industry up for what could be an 18-month headache.

Under Nevada's law, liquor wholesalers are the sole distributors of recreational marijuana for the first 18 months after it goes on sale (beginning July 1, 2017). Liquor wholesalers, fearing the loss of alcohol sales to the cannabis industry, lobbied aggressively to be this indispensable middleman that would transport cannabis between from grow farms to licensed dispensaries within the state.

Jars of cannabis buds stacked on each other.

Image source: Getty Images.

But there are two major issues. To begin with, a majority of liquor wholesalers haven't applied for the necessarily licensing to become marijuana distributors. As of Aug. 13, just six wholesalers out of nearly 70 in the state were already licensed. The second problem is that liquor wholesaler licenses are handed down by the federal government, therefore these businesses fear possible repercussion from the latter (in the form of liquor wholesaler license revocation) if they do wind up being the pot industry's middleman.

On July 10, just 10 days after recreational weed first went on sale in Nevada, Gov. Brian Sandoval (R) declared a state of emergency given the lack of available legal pot for sale. There simply wasn't a way to get cannabis from Point A to B without the liquor wholesalers. This state of emergency declaration was a means to open up a gamut of options for Nevada's Tax Commission to approve new channels to get legal marijuana into dispensaries. However, those actions were again struck down this past week.

As reported by the Associated Press via the Las Vegas Review-Journal, a federal judge on Friday, Aug. 11, sided with the Independent Alcohol Distributors of Nevada and upheld the exclusive rights of liquor wholesalers to deliver recreational marijuana to retailers for a period of 18 months, as is written in the law residents voted on in November. The decision from the judge came just a day after the Nevada Department of Taxation had decided to open up distribution options since supply has struggled to meet demand since the doors opened for business on July 1.

A judge's gavel next to a pile of cannabis buds.

Image source: Getty Images.

So what might happen in Nevada? No one is exactly sure, but if there's a severe supply issue created by a lack of middlemen, it will likely boost legal market prices and allow the black market to continue thriving. That could mean lost revenue for the state of Nevada and continued struggles for legal businesses within the state.

Lessons learned

If Nevada's issues teach investors anything, it's that the marijuana industry is no sure thing to succeed. We have to remember that there is no precedent to a legal recreational industry prior to the 2014 launch of recreational weed in Colorado and Washington state. A lot of these businesses and state lawmakers are essentially flying by the seat of their pants and don't fully understand the repercussions of their actions yet. That means bumps in the roads are fully expected.

The federal government isn't going to make things easier anytime soon, either. Its Schedule I categorization of pot means the drug is entirely illegal and doesn't have any recognized medical benefits. Clinical researchers are eager to prove that latter point wrong, but they've been halted by a sea of red tape in their efforts to run broad-based medical studies.

Likewise, businesses that operate in the marijuana industry are liable to face a handful of disadvantages. These include an inability to obtain basic banking services, including something as simple as a checking account, as well as tax disadvantages. U.S tax code 280E disallows businesses that sell a federally illegal substance from taking normal corporate income tax deductions.

A businessman holding his hands up as if to say "no thanks."

Image source: Getty Images.

Altogether, we're talking about the strong likelihood of slower growth prospects for weed companies than many investors are predicting, and probably a continuation of steep losses. For instance, U.S.-based pot companies like Medical Marijuana, Inc. (MJNA 2.50%) are relying on expansion opportunities for medical and recreational weed to push their cannabidiol-based oils and products. If Nevada's launch is subpar, which it could very well be if supply is constrained, Medical Marijuana, Inc.'s efforts to further infiltrate the Nevada market may be slower than expected. But as noted above, Nevada represents just one of many possible speed bumps for Medical Marijuana, Inc. and its peers.

Your best bet as an investor is to stick to the sidelines and let the marijuana industry mature for the time being.

Sean Williams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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