When it comes to the hottest industries on the planet, arguably nothing tops marijuana. Global sales for the green rush could grow 38% in 2019 to almost $17 billion, with investment banks on Wall Street calling for as much as $75 billion in annual worldwide sales by 2030.
We've also witnessed pot stock valuations shoot through the roof. Just since the year began, the Horizons Marijuana Life Sciences ETF, which is comprised of about four dozen pot stocks of various weightings, is up 60%. Push the bar out even further, and you'd find that most marijuana stocks are up a healthy triple-digit or quadruple-digit percentage since the beginning of 2016.
The black market remains a big concern
And yet, worries persist about the legal Canadian pot industry. In particular, the biggest concern might be how successful legal cannabis channels will be in encouraging consumers to switch over their purchases from illicit producers.
According to a research note in February from Scotiabank, the black market is expected to retain control of 71% of Canada's total sales in 2019, and then see this total drop to 37% in 2020. Sure, it's a pretty large year-over-year decline, but it still represents a massive portion of sales in a legal environment being conducted under the table.
One of the biggest impediments for the legal weed industry, aside from early supply side and packaging shortages, is Canada's excise tax. This tax, which imposes a duty of 1 Canadian dollar (CA$1) per gram on dried cannabis flower and cannabis oil, or 10% of the sale price of a product, pretty much ensures that legal weed is more expensive than black-market marijuana. Even though a 10% excise tax pales in comparison to the aggregate tax of up to 45% that some California consumers might be paying, it should be kept in mind that illicit producers aren't paying for (or waiting for) cultivation licenses or sales permits, and they aren't paying local, state, or federal income or excise taxes. This is what's allowed illegally produced marijuana to thrive in Canada and select U.S. states.
However, a big change could be on the way, according to the 2019 budget from Canada's federal government.
A major cannabis tax change will take effect in Canada by May
With Health Canada somewhat recently announcing that edibles, topicals, and cannabis-infused beverages would be legalized no later than the one-year anniversary of the commencement of adult-use sales (Oct. 17), Canada's 2019 budget recommended the following adjustment on the rules for cannabis taxation.
New classes of cannabis products, namely edible cannabis, cannabis extracts, and cannabis topicals, will be permitted for legal sale under the Cannabis Act later this year. The Government is proposing that the excise duty framework for cannabis products be amended to more effectively apply the excise duty on these new classes of cannabis products, as well as to cannabis oils, which are already legally available for sale. This proposed change will result in the framework better reflecting recommendations from the expert Task Force on Cannabis Legalization and Regulation and feedback received from the cannabis industry.
For most products, namely fresh and dried cannabis, and seeds and seedlings, there will be no changes to the current excise duty framework. However, for cannabis edibles, cannabis extracts (which will include cannabis oils), and cannabis topicals, excise duties will be imposed on the quantity of tetrahydrocannabinol (THC) contained in a final product.
In other words, the new proposal will tax alternative cannabis products, including cannabis oils, on the amount of THC they contain, rather than taxing the product itself in a general sense. THC is the psychoactive cannabinoid that gets a user high.
Furthermore, even though the budget doesn't get rid of the excise tax on medical marijuana, it would certainly be a boon for quite a few medical cannabis patients, who are far more willing to purchase alternatives with low THC content than recreational weed users. Additionally, Canadian medical patients with above-average medical or disability-related expenses may be eligible for a 15% tax credit, with the amount paid for cannabis products factoring into this credit.
Even though the dried flower excise tax rate remains unchanged, the lower tax rate based on THC content for alternative options is set to begin on May 1, 2019.
A mixed picture for the investment community
In many ways, this lower tax rate will be a boon for alternative consumption options, and it may even encourage a broader audience of recreational users to give them a try. But it's not great news for every cannabis company out there.
On one hand, pot stocks that are focusing on the medical cannabis community, and will therefore have a lineup of products high in cannabidiol (CBD) content, are bound to love this change. CBD is the nonpsychoactive cannabinoid best known for its perceived medical benefits.
For example, Tilray (NASDAQ:TLRY) has been, and is likely to remain, heavily focused on medical marijuana patients. In Tilray's recently released fourth-quarter and full-year earnings report, the company notes that 49% of aggregate sales were in extracts (i.e., oils) in 2018. Starting in May, this higher portion of sales devoted to extracts will potentially face a lower excise tax, making them more attractive relative to illicit cannabis products.
Tilray's CA$419 million purchase of hemp food company Manitoba Harvest is also now an added bonus, since the THC content in hemp is very low, while CBD content tends to be high. Any company that's moved into hemp production or processing, such as Emerald Health Therapeutics and Canopy Growth, is bound to like this revision.
On the other hand, marijuana stocks that focus on premium flower products and high-THC content oils aren't going to be big fans of this change. As an example, small-cap Flowr Corp. (NASDAQOTH:FLWPF) is using genetics to create an ultra-premium cannabis product. No publicly traded pot grower is expected to generate higher yields per square foot than Flowr. But the downside here is that Flowr's premium THC alternative products could face a higher excise tax. Although this is a product targeted at a more affluent clientele to begin with, premium product providers aren't likely going to favor this excise tax adjustment.