The legal cannabis industry had itself a year to remember in 2018. Although marijuana stocks were a mixed bag, the weed industry gained validation like never before following the legalization of recreational marijuana in Canada. Rolling out the red carpet for cannabis will mean billions of dollars in added annual revenue, and it demonstrates that the cannabis industry is in no danger of disappearing.
There was plenty to cheer about in the United States, too. President Trump signed the Farm Bill into law in December, giving the green light to hemp and hemp-based cannabidiol, while the Food and Drug Administration approved its very first cannabis-derived drug, and a handful of states legalized cannabis in some capacity. Today, roughly two-thirds of U.S. states have legalized medical marijuana, with 10 also allowing adult-use pot.
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Calls for cannabis reform in the U.S. pick up steam
Despite all of this progress, marijuana remains a Schedule I drug at the federal level. That means it's wholly illegal, defined as being prone to abuse, and not recognized as having any medical benefits. The big question is, when does this classification change?
On the surface, there appears to be a ton of momentum behind reform at the federal level. An October 2018 survey from Gallup found that two out of three adults now favor legalizing weed nationally, up from just 33% as recently as 2005. In fact, a half-dozen major polls conducted since January 2018 have found overwhelming support for reforming the current cannabis policy.
State-level legalizations have also put the infrastructure in place in numerous states that would allow a seamless transition between an illicit and legal environment. A handful of states have been retailing adult-use cannabis for multiple years (e.g., Washington and Colorado), with more than half of all states having had medical marijuana legal for at least two years. Reform at the federal level wouldn't require a lot of effort from most states to amend their infrastructure.
In addition, online publication Marijuana Moment reported this past Tuesday that the chair of the House Judiciary Committee, Rep. Jerry Nadler (D-N.Y.), foresees reform coming sooner rather than later. Said Nadley, "Let me just observe on your time that we may be discussing that [cannabis reform] fairly soon."
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Marijuana legalization is highly unlikely this year
So is this the year that we finally see the veil of prohibition lifted on the U.S. pot industry? The honest answer is that it's unlikely.
1. Congress isn't currently friendly toward reform
First, consider the current make-up of our government. Although Democrats recently won back a majority in the House for the first time in eight years, the Senate and presidency are still controlled by Republicans. That's meaningful for one reason: Republicans have historically had a more negative view of cannabis than people who identify as Democrats or independents.
Even with Gallup finding in its October survey that 53% of self-identified Republicans favored legalization, that's still well below the percentage of folks who identify as Democrat (75%) or independent (71%) and support legalization. That suggests that Republicans may shun any attempts at federal reform, even if a Democratic-backed bill passes the House. With the GOP laser-focused on border reform, a federal cannabis bill doesn't look to have a good shot at passing in 2019.
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2. Marijuana isn't a polarizing enough issue to make a difference... yet
The second issue is that even though support for marijuana has steadily improved over the past two decades, its relevance in Washington hasn't budged much.
For example, the independent Quinnipiac University released a poll in April 2018 that, among other things, questioned respondents on their perception of cannabis. Here is what I believe is the most telling question asked by Quinnipiac:
"If you agreed with a political candidate on their issues, but not on the issue of legalizing marijuana, do you think you could still vote for that candidate or not?"
Essentially, this question gets to the heart of the issue of whether elected officials have to worry about their seat in Washington if they don't agree with the majority opinion of legalizing weed. Just 13% of respondents said "no" to the question, with 82% saying "yes." That means marijuana doesn't yet have enough sway on Capitol Hill to cause dissenting politicians from losing their elected seats in the House or Senate. That would have to change before there's any chance of cannabis reform at the federal level.
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3. It's a money issue
And, of course, you knew it would come down to money.
Since marijuana is a Schedule I substance, businesses selling cannabis in the U.S. are subject to Section 280E of the U.S. tax code. The gist of the code is that it disallows businesses selling a federally illicit substance, as defined by the Controlled Substances Act, from taking normal corporate income tax deductions, save for costs of goods sold. Unfortunately, costs of goods sold typically represents a small percentage of revenue. This exposes profitable weed companies to effective corporate rates that could be as high as 90%.
If cannabis were reformed at the federal level, either through a rescheduling or removal from the controlled-substances list, it would no longer expose pot-based businesses to Section 280E. That would be excellent news for investors and the businesses themselves, but it would lead to less tax revenue for the federal government -- an estimated $5 billion reduction over a 10-year period. Adding a federal excise tax may not be the answer, either. Californians are already paying up to a 45% in-state tax on retail marijuana sales, and pushing a federal excise tax on top of that could further drive consumers to the black market.
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Keep your eyes on the global prize
In short, legalization doesn't look to be on the table in 2019 -- but it is possible that 2020 may be the year, especially considering it'll be an election year for the presidency. For investors, that means focusing your attention on marijuana stocks that have global appeal, rather than just appeal within a single market.
A perfect example is KushCo Holdings (KSHB), a company most investors know best for its packaging and branding solutions. KushCo provides child- and tamper-resistant packaging for more than 5,000 marijuana growers worldwide, including businesses in legal U.S. states. Since federal, state, and local laws can differ, KushCo bears the burden of ensuring that packaging meets regulatory spec. As a branding company, it also works with growers to make their packaging unique so as to stand out in an increasingly crowded field.
KushCo also stands to benefit from its role as a supplier of hydrocarbon gases and solvents. The former is used in the production of cannabis oils, whereas the latter is crucial for cannabis concentrate production. These high-margin alternative consumption products are expected to come into focus worldwide, since they're considerably more resistant to pricing pressure than dried cannabis flower.
Investing in the marijuana space doesn't have to be an adventure if you focus on diversified business models like KushCo.
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