Of all the stories gaining press in 2019, perhaps none will prove more important or impact more American lives and pocketbooks than the ongoing trade war between the United States and China.
Talks about working out a new trade deal have ebbed and flowed between the two sides for more than a year. President Trump believes that China has raked the U.S. over the coals, so to speak, for far too long and wants to end the substantial annual trade deficit the U.S. has with its Far East neighbor. Meanwhile, Chinese President Xi Jinping is unwilling to give up too many key advantages his country possesses to appease the United States. Thus, we stand on the precipice of seeing hundreds of billions of dollars' worth of goods being hit with tariffs ranging between 5% and 25%.
The cannabis industry is a casualty of the trade war, too
With trade talks more or less at an impasse at the moment, certain industries have really taken it on the chin. Tech companies, for instance, could see the biggest hit in the U.S., with many components and finished products being imported from China expected to face the maximum 25% tariff rate. Though the taxation is designed to make American-made goods more attractive, it'll ultimately hit consumers in the pocketbooks -- unless, of course, businesses are willing to eat the added costs of the tariffs.
But it's not just the tech sector that'll feel the pinch. The marijuana industry will also be somewhat impacted by the trade war with China.
Now, I know what you're probably thinking, and generally speaking, no, companies that directly deal with cannabis aren't expected to feel much of a margin squeeze from the trade war. Since marijuana isn't being exported or imported, there's no concern about tariff imposition. However, growers could see added costs if the growing or extraction equipment they purchase is made with Chinese steel or aluminum.
Likewise, ancillary players that deal with growers could feel the effects of the trade war. Everything from growing solutions to packaging could be impacted, which in turn could make legal marijuana products pricier to consumers. Mind you, black-market cannabis is already a big problem in California, with some locales paying up to an aggregate 45% tax rate, so you can imagine what might happen if tariffs coerce legal producers and retailers to lift their prices even further.
These marijuana stocks could feel a trade war margin pinch
Here are four pot stocks that look to be most directly impacted by the ongoing trade war with China.
Scotts Miracle-Gro (NYSE:SMG) is a company most people are probably familiar with for making our gardens look greener or removing weeds from our lawns. In 2018, Scotts generated about 87% of its sales from its core lawn and garden business, which caters to residential consumers and enterprises looking to improve crop yields.
But what you might not realize is that Scotts Miracle-Gro's subsidiary Hawthorne Gardening is specifically focused on helping to provide growing solutions to the North American medical marijuana industry. This includes hydroponic solutions (i.e., growing plants in a nutrient-rich water solvent), as well as lighting, soil, and nutrients.
In 2018, Scotts acquired Ohio-based Sunlight Supply for $450 million to broaden Hawthorne's hydroponic products portfolio, as well as snag more small- and medium-sized enterprise customers. The thing is, Sunlight Supply moved away from making a lot of its lighting solutions in-house and has instead turned to China for its lower-priced production and labor costs. Even though the company still brands imported Chinese products under the Sunlight Supply name, it could be in line to face tariffs on these lighting solutions.
Speaking of lighting systems and solutions, another "pot stock" that could soon be contending with higher expenses is Cree (NASDAQ:CREE). I very loosely lump Cree in as an ancillary cannabis play given the role its LED lights and lighting systems can play for U.S.-based marijuana growers.
Traditionally, cannabis plants are grown under high-pressure sodium (HPS) lights. All things considered, HPS lights are reasonably inexpensive, and they produce highly predictable yields per square foot of growing space. On the other hand, they use a boatload of electricity, and they generate a lot of heat, often requiring an expensive cooling system to regulate indoor temperature to maximize yield. Comparatively, Cree's LED lights produce very little heat and use far less electricity. In turn, they do cost more up front, but they're expected to be more than worth the up-front cost over the long run, since they also last longer than HPS bulbs.
The issue is that Cree has an LED production factory in China, which allows the company to take advantage of substantially lower labor costs. With tariffs going into effect, Cree's margin outlook could dim if it chooses to eat these higher expenses.
Middlemen in the cannabis industry are the likeliest to contend with higher expenses associated with tariffs on imports from China. KushCo Holdings (NASDAQOTH:KSHB), which sells vaporizer products, as well as packaging solutions for growers, could be hit on both fronts.
First, there's KushCo's vaporizer business, which sells everything from cartridges to the heating elements and batteries required to make these devices work. With a laundry list of technology items being hit with import tariffs, KushCo should expect components of its vaporizer business to cost more. Then again, with Canada on the verge of legalizing a number of new consumption options by October, higher costs in the U.S. could easily be offset in Canada and foreign markets.
And second, part of KushCo's packaging line could be hit with tariffs. For example, its Value Line packaging products are purchased from China. These generally cheaper packaging products are used in markets where packaging regulations aren't as strict. So far, KushCo has been absorbing these added tariff costs. But if this trade war becomes protracted, KushCo will have little choice but to pass along higher costs to its customers to avoid further margin erosion.
Greenlane is a pot paraphernalia giant that sells more than 5,000 individual products, many of which are involved in the vaporization, cleaning, or consumption process. Aside from having its products in an estimated 9,700 retailers throughout North America, Greenlane also runs two very popular e-commerce websites, VaporNation.com and VapeWorld.com.
The issue for Greenlane, which is similar to that for KushCo, is that a handful of products it's bringing in from China, mostly revolving around its vape line, are already or are expected to be hit with additional tariffs. In the company's S-1 prospectus, filed with the Securities and Exchange Commission on March 20, Greenlane had this to say about the ongoing trade war under its risks section:
These new tariffs and the evolving trade policy dispute between the United States and China may have a significant impact on the industries in which we participate. A "trade war" between the United States and China or other governmental action related to tariffs or international trade agreements or policies has the potential to adversely impact demand for our products, our costs, customers, suppliers and/or the United States economy or certain sectors thereof and, thus, to adversely impact our businesses and results of operations.
With most marijuana companies unwilling to state whether they'll be impacted by a protracted trade spat between the U.S. and China, this is about as transparent a statement as you'll get from a pot stock.