Marijuana used to be a substance that was only available for sale on the black market. But with more countries and states making strides toward legalization, there is plenty of potential growth in legal cannabis markets. Some estimates have the legal cannabis market in the U.S. being worth as much as $29.7 billion by 2025. That is more than double 2019's expected sales of $13.6 billion. A big part of that growth will come from California, which had the largest market share of cannabis sales in the U.S. in 2018.
But as impressive as all that growth is, the problem is that the black market is still winning, and it the legal market isn't even close.
Legal market for cannabis is struggling
The black market is still likely to dominate the cannabis industry in 2020, according to projections from New Frontier Data. The markets in California and Michigan are expected to see demand for legal cannabis products climb to 30% of the total market, but those states are the exception rather than the norm. Florida, which is one of the hottest markets for medical marijuana, may see only one-fifth of its demand being for legal products.
That's a big problem for the industry, especially with health officials tracing vaping-related illnesses to black-market products, highlighting just how much risk there is for consumers who buy from the underground. As a result, vape sales have been down in multiple states. In Colorado, vape sales' share of the market have declined by 26% from July to October. Multiple states, including Massachusetts, have made moves to restrict the sale of vape products, at least for now. In Canada, some provinces have also said they will not allow vape sales, even before derivative products are set to hit store shelves later this month.
Given the headwinds facing the markets in Canada and the U.S., the legal market for cannabis could continue to struggle.
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Tax hike in California will worsen the situation
Some of the biggest obstacles to the industry's growth are a result of too many regulations and taxes. The more difficult and the more expensive it is to purchase pot from the legal market, the fewer customers who will opt for the legal route. That's why news that California's Department of Tax and Fee Administration was raising the state's tax rate on marijuana businesses came as a big shock to many in the industry. Local city and county taxes will cause some variations within the state, but according to Josh Drayton from the California Cannabis Industry Association (CCIA), consumers can expect to pay anywhere from $5 to $10 more for an eight-ounce bud, potentially reaching over $50 in tax. The increase will go into effect Jan. 1, and the CCIA is concerned it will send even more consumers to the black market.
It's a valid concern for the industry and it could undermine the success that cannabis has made in that part of the country. California has been arguably the hottest market for marijuana in the world and by making it less competitive on price, consumers may simply opt to make the drive up to Oregon, where an excess supply of cannabis has made pot very cheap. But for those looking for local options, there will be no shortage of black-market shops ready to fill the demand.
What does this mean for investors?
For cannabis companies like Harvest Health & Recreation (HRVSF) that operate pot shops in California, there's significant concern that sales will take a hit next year. The company has three locations currently open in the state and one that it recently acquired. However, with Harvest Health having operations in six states, it has many options to grow its business and will have even more as legalization continues to progress in other parts of the country. This is where multistate operators have advantages over cannabis companies that are only operating in one or two states and thus may be more vulnerable to regional issues weighing on their operations.
While California is still going to be a significant piece of the overall cannabis market, being versatile in this industry will be the key to success over the long term. That's why investors should look for companies with operations in multiple states but that aren't too aggressive in their growth plans. Harvest Health certainly falls into that category, but that doesn't mean the stock is risk-free. With losses of $39.5 million in its most recent quarter on revenue of $33.2 million, it's a stock that has potential but that investors should keep on a short leash if things get worse. Harvest Health, like many marijuana stocks, has struggled this year, losing more than half of its value thus far.
The danger for cannabis investors is that the worst may not be over for the industry, especially given the potential for concerns surrounding vaping and tax increases to continue to weigh on pot stocks and driving cannabis users away from legal purchasing avenues. After all, the black market still isn't available to invest in.
