Over the past 22 years, the green rush has engulfed North America. In 2001, Canada legalized medical marijuana, and it's fully expected to become the first developed country in the world to OK the sale of adult-use recreational cannabis by this summer. In June 2017, Mexico legalized medical cannabis. And between 1996 and 2018, 29 states in the U.S. have passed legislation allowing for medical marijuana to be prescribed by physicians, with nine other states allowing the use of recreational pot by adults ages 21 and up. It's been quite the shift in a relatively short amount of time.
Expansion within the U.S. has been made possible because of the American public's growing acceptance of marijuana. When Gallup questioned the public in 1995, just 25% favored the idea of national legalization. However, by October 2017, support had jumped to an all-time high of 64%. Even though pot remains a Schedule I drug at the federal level, it's put pressure on more progressive states to legalize the drug in some capacity.
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California's cannabis sales limp out of the gate
The crown jewel of legalizations for the pot industry was that of California in the November 2016 election. Prop 64 in California passed by a wide margin, with 57% of voters in favor of allowing recreational cannabis to be sold. Considering that California recently surpassed the U.K. to become the fifth-largest economy in the world, and given its more progressive nature, expectations have been high that marijuana sales would rocket out of the gate. However, they've done no such thing.
According to a press release from the California Department of Tax and Fee Administration, tax revenue from the cannabis industry hit just $60.9 million during the first quarter of 2018 (sales began on Jan. 1, 2018). This included a $1.6 million in cultivation tax revenue (made up of a $9.25-per-ounce tax on dried cannabis flower, and $2.75-per-ounce tax on cannabis leaves), $32 million in excise tax revenue (a 15% tax on the retail price of the product), and $27.3 million from existing state and local sales tax.
Following the release of this data, the state's independent Legislative Analyst's Office (LAO) lowered its forecast for excise-tax collection in 2018-2019 -- i.e., the state's first full fiscal year of operations, which begins July 1, 2018. The LAO reduced California's expected full-year excise tax haul to $630 million between July 1, 2018, and June 30, 2019, down from a previous projection of about $643 million.
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Here's why California's marijuana industry is struggling mightily in the early going
With strong public support and a mammoth economy, it would seem to make little sense that California's pot industry is struggling. But dig beneath the surface and you'll find quite a few reasons why.
To begin with, California's regulators have been slow in issuing licenses to retailers. In an interview with CNBC, Bureau of Cannabis Control (BCC) spokesperson Alex Traverso noted that about 400 shops were now licensed. This is still a far cry from the number of shops that should be licensed, based on the size of California and its economy. Sales will likely ramp up as licenses are issued, but it won't happen overnight. Similar licensing issues have occurred in states that preceded California in recreational pot sales.
Another issue is the existence of black market cannabis. Even though the BCC warned approximately 900 unlicensed pot stores that they'd need to shut down their operations in March, many appear not to have done so. What's worse, black market and unlicensed operators don't have the same overhead expenses or tax liability that licensed dispensaries that are following the rules have to contend with. In some instances, California's pot tax can reach as high as 45%, according to Fitch Ratings. This means legally operating dispensaries are either losing out to considerably cheaper black market pot, or they're eating some (or all) of the difference and lowering their prices to be competitive. Either way, it would result in less excise tax revenue for the state.
Finally, there's the problem of piecemeal legalization within the state. Similar to Colorado, each jurisdiction has the right to choose whether or not to allow recreational marijuana dispensaries. In Colorado, three-quarters of all jurisdictions banned recreational pot stores, which initially put a crimp on sales of the product. In California, 85% of all cities in the state have banned recreational cannabis retailers. This includes storefront and delivery businesses, per Chris Beals, president of Weedmaps.
None of these issues can be resolved with quick fixes, which means California's pot industry could underperform for many quarters to come.
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Investors should keep their distance
It also means that investors who want to take advantage of the presumed billions of dollars a year in sales that California has to offer should probably keep their money tucked safely in their wallets for the time being.
Yes, the slow rate of license approvals and piecemeal, city-based legalizations are worrisome, but the real concern here is the influence that the black market is still wielding over the legal industry. If regulators can't find a way to effectively drive out illegal participants, the incentive for consumers to purchase marijuana at a considerably cheaper rate is going to be too great, eventually constraining legally operating businesses and growers. That's a fancy way of saying that margins could be impacted up and down California's supply chain -- and that's bad news for any would-be investors.
It is early, so there's still plenty of time for California's pot industry to mature. But until it resolves its black market issues, it (and other U.S. pot stocks, for that matter) should remain off-limits for investors.
