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The 5 Biggest Concerns for U.S. Pot Stocks

By Sean Williams - Oct 23, 2019 at 6:51AM

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Marijuana growing pains aren't limited to the Canadian market.

Although it may not seem like it at the moment, with cannabis stocks going up in smoke of late, legal marijuana offers some of the brightest growth prospects of any industry over the next decade. Depending on your preferred forecast, worldwide weed sales could grow fivefold to 18-fold over the next decade.

At the heart of this growth trend is the United States. The cannabis industry's crown jewel is expected to account for anywhere from roughly a third to a little more than half of all global pot sales. That's why Canadian marijuana stocks have been so eager to enter the U.S. marketplace, and why U.S.-based pot stocks have been expanding so rapidly.

But just as Canadian weed companies have faced a bounty of growing pains, so will U.S. pot stocks. Here are the five biggest worries for U.S. cannabis stocks moving forward.

A black silhouette of the United States, partially filled in by baggies of cannabis, rolled joints, and a scale.

Image source: Getty Images.

1. The federal government is no hurry to take up cannabis reform

There's no question that the 800-pound gorilla in the room for the U.S. pot industry is the federal government. Despite support for cannabis reaching an all-time high last October, with two-thirds of Americans now favoring a nationwide legalization of marijuana, the federal government has made little to no attempt to alter marijuana's existing classification as a Schedule I drug. As a schedule I drug, it means cannabis is entirely illegal, prone to abuse, and not recognized as having any medical benefits.

On the bright side, the weed industry has benefited from the federal government approaching regulation in a hands-off manner. In other words, with 33 states having passed medical marijuana laws (11 of which also allow adult consumption), the federal government is allowing these states the opportunity to regulate their own industries.

The problem with this approach, however, is that no interstate transport of cannabis is allowed. This has required vertically integrated multistate operators to set up redundant growing and/or processing operations in each and every state they have a retail store in. In effect, it's increasing business expenses and likely reducing operating margins in the process.

A handful of cannabis buds lying atop a messy pile of cash.

Image source: Getty Images.

2. Financing remains dicey, at best

Another problem for the U.S. pot industry, which builds off the fact that marijuana remains illicit at the federal level, is that non-dilutive forms of financing are few and far between. Banks and credit unions fear the possibility of criminal and/or financial penalties for aiding cannabis companies by offering loans, lines of credit, or even a checking account, leading many to deal solely in cash. And that's a problem, because dealing with cash creates security and growth concerns.

Furthermore, when U.S. pot stocks do need capital, they often turn to issuing common stock to raise it. This share-based dilution has become a hallmark of the North American weed industry, and it's significantly weighed on long-term shareholders.

A green highway sign that reads, Welcome to California, with a cannabis leaf in the upper-right corner.

Image source: Getty Images.

3. High tax rates encourage the black market

Certain legalized states have also made life difficult for the legalized pot industry because of their desire to bridge budget deficits with cannabis tax revenue.

When California legalized recreational marijuana by passing Proposition 64 in Nov. 2016, it looked as if the Golden State would see sales ramp up quickly, with $1 billion in annual tax revenue veritably around the corner. But in the first year of recreational weed sales, tax revenue came in about 50% below initial expectations. In fact, aggregate legal marijuana sales in California fell $500 million in 2018 from the previous year (when only medical cannabis was legal). The reason? California's exorbitant tax rate on marijuana.

In California, consumers are paying a state tax, local sales tax, an excise tax on marijuana, and a wholesale tax on either dried cannabis flower or whole leaves. Depending on the municipality, the tax on legal weed in California might be up to 45%. This makes it impossible for legal product to compete with the black market on price, and is a big reason why legal sales have badly missed the mark in the Golden State.

A person holding a magnifying glass over a company's balance sheet.

Image source: Getty Images.

4. Rising goodwill on balance sheets

A fourth issue for U.S. pot stocks to be concerned with is the very real possibility that they're grossly overpaying for acquisitions in order to gobble up early stage market share. In recent quarters, we've witnessed the amount of goodwill being recorded on pot stock balance sheets soaring, which may indicate that writedowns could be in the not-so-distant future for a number of U.S. marijuana stocks.

For example, multistate operator iAnthus Capital Holdings (ITHUF 7.14%) completed one of the largest U.S. cannabis deals earlier this year when it acquired MPX Bioceutical in an all-stock deal. Following the closing of this deal, iAnthus Capital wound up recording a large chunk of the deal's value as goodwill. As of iAnthus Capital's latest report, 440.7 million Canadian dollars of its CA$811 million in total assets was goodwill. That's well over half of the company's total assets dependent on the "hope" that iAnthus will recoup the full value of its acquisition, which at the momentum looks to have been far too pricey. More than likely, a writedown is in iAnthus Capital's future.

A bearded young man wearing sunglasses who's exhaling vape smoke while outside.

Image source: Getty Images.

5. Health concerns surrounding vaping

Finally, U.S. pot stocks have been hammered in recent weeks by concerns regarding vaping. The U.S. Centers for Disease Control and Prevention (CDC) had 1,479 confirmed or probable cases of vape-related lung illnesses as of Oct. 15, to go along with 33 deaths. Although the CDC is still unclear as to what's causing these mystery lung illnesses, they have recommended that consumers not vape tetrahydrocannabinol (THC)-containing liquids. THC being the cannabinoid responsible for getting users high. 

These vape-related health concerns could hit pot stocks from numerous fronts. For instance, ancillary company KushCo Holdings (KSHB) generates a majority of its revenue, for the time being, from vaporizer sales. KushCo anticipates a ramp-up in revenue from its packaging and branding operations, as well as its hydrocarbon gas supply division in the future, but the near-term remains dicey with the company so reliant on vaporizer sales. As the icing on the cake, trade war tariffs have also hit KushCo since many of its vaporizer products are imported from China.

Vape concerns are also a threat to direct players, such as Altria Group (MO 2.09%). While Altria isn't exactly a pot stock in the same sense as iAnthus, it did invest $1.8 billion into Canadian marijuana stock Cronos Group for a 45% non-diluted stake in the company. Down the road, the idea is that Altria and Cronos will offer vape products in the U.S., after the federal government has changed its tune on cannabis. But for the time being, Altria is hoping to capitalize on it 35% stake ownership in vape device giant Juul, as well as the Canadian market. As vape concerns ramp up, Altria's hope for health growth in its ancillary revenue streams could (pardon the pun) take a hit.

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Stocks Mentioned

Altria Group, Inc. Stock Quote
Altria Group, Inc.
$43.40 (2.09%) $0.89
Kush Bottles, Inc. Stock Quote
Kush Bottles, Inc.
iAnthus Capital Stock Quote
iAnthus Capital
$0.07 (7.14%) $0.01

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