The marijuana industry has seemingly been breaking down barriers at every turn in 2018. Just to provide a quick overview, investors have thus far witnessed:
- Canada become the first industrialized country in the world to legalize recreational cannabis on Oct. 17, opening the door to $5 billion in added annual sales.
- Vermont become the first U.S. state to legalize adult-use pot entirely through the legislative process.
- The U.S. Food and Drug Administration approve a cannabis-derived drug.
- A Canadian-based company go the initial public offering route on a major U.S. exchange.
- Two additional states legalize medical marijuana (Utah and Missouri), with Michigan becoming the 10th overall states to green-light recreational weed.
- Around a half-dozen pot stocks uplist to major U.S. exchanges.
Again, this is just a partial list of the industry's accomplishments this year, but it's nevertheless impressive.
Image source: Getty Images.
Cannabis shortages could continue until at least 2020
Unfortunately, despite lofty sales growth expectations, investors are learning that the marijuana industry isn't without its faults. For instance, in the U.S., Section 280E of the U.S. tax code disallows businesses that sell a federally illicit substance (as defined by the Controlled Substances Act) from taking normal corporate income tax deductions. This has reduced the ability of U.S.-based pot companies to hang onto and reinvest their profits. It's one of the many risks that investors in U.S. marijuana stocks have contended with.
However, the greatest risk of all just might be marijuana shortages to the north. Even with regulators confident that there would be enough cannabis to meet demand come Oct. 17, it took just hours before a dispensary in Winnipeg, Manitoba, ran out of product and was forced to close its doors. The SDQC in Quebec also pulled around half of the products from its online store after web-based orders quickly exhausted supply. To date, Quebec, Manitoba, New Brunswick, British Columbia, Alberta, Nova Scotia, and Saskatchewan are all reporting cannabis shortages. That's more than half of all Canadian provinces and territories.
And it gets worse. In an interview with Canada's Global News, as reported by Newsweek, Khurram Malik, the CEO of Ontario-based diversified cannabis company Biome Grow, suggests that stringent federal regulations could push this shortage into at least the next decade. In Malik's view, perhaps by 2020, supply will be adequate to meet demand.
Image source: Getty Images.
Why is there a weed shortage in the first place?
It probably comes as little surprise to investors that Canadian consumers have a high demand for cannabis. So you're probably wondering how it's possible that growers and regulators didn't foresee this coming. The onus of blame lies with both parties.
With regard to pot growers, these companies had to be absolutely certain that the Cannabis Act would be signed into law before they began undertaking projects that cost perhaps $100 million or more. Since financing has been exceptionally difficult to come by for marijuana companies, they had to be absolutely sure that the drug would be legalized before going full bore on capacity expansion. Thus, we didn't even see production expansion really kick into high gear until the first quarter of this year. It's going to take a good year or two before cannabis growers are operating at anywhere near their full capacity.
For example, The Green Organic Dutchman (TGODF +0.00%) is expected to be a top-five producer when running on all cylinders. Management has forecast 195,000 kilograms of annual production, which includes 40,000 kilogram-equivalents from edibles and cannabis-infused beverages (once these alternatives are made legal). However, The Green Organic Dutchman hasn't sold a single bud of cannabis yet and isn't even expected to log its first sale until the first half of next year. Like most of its peers, The Green Organic Dutchman will need years to bring its production up to its peak forecast.
The other problem, which was cited by Malik in his interview with Global News, relates to Health Canada, which oversees the legal-weed industry. Back in May, per Marijuana Business Daily, the agency had more than 500 cultivation licensing applications to pore over. On average, these applications take a few months to years to approve or deny. Then, once growers get the green light to grow marijuana, they have to apply for a sales permit. On average, sales permits were taking 341 days to approve as of May 2018. This regulatory red tape is limiting the ability of growers to bring product to market.
Image source: Getty Images.
It's time to adjust your expectations for pot stocks
As much as you might hate to hear this, with shortages potentially looming for more than a year to come, it's time to lower your near-term expectations for marijuana stocks. Select Wall Street firms are already doing so, and you'd be wise to tone down your expectations, too.
So where does that leave marijuana stocks moving forward? For starters, we're still liable to see strong sales growth, since many of these companies are building from a base of just a few million in annual sales. On the other side of the coin, it means near-term sales are probably going to be on the lower end of estimates, meaning operating losses could be substantial. As growers continue their capacity expansion, as well as work on product diversification, branding, and marketing, losses from their recurring business may mount. That means shareholders of top producers like the aforementioned Green Organic Dutchman may not be too happy.
Investors' best bet at this point would be to hang onto these companies for at least a couple of years. It's far too early to tell which will separate themselves from the pack. But, as with all fast-growing industries, there will eventually be winners. In the interim, though, keep those expectations in check.
