Please ensure Javascript is enabled for purposes of website accessibility

1 Major Problem for the Marijuana Industry

By Sushree Mohanty - Aug 16, 2020 at 8:14AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Cannabis companies have broad scope for growth, but there is one major roadblock.

The demand for marijuana is high. Cannabis companies are ready with a variety of products. So what's preventing the legal cannabis market from reaching its full potential? Estimates by Grand View Research show that the global legal marijuana market could be worth $73.6 billion by 2027. And growth is quite evident from the surge in cannabis sales amid the coronavirus pandemic. 

The demand forced Canada and many states in the U.S. to deem cannabis an essential item, and sales have been rising ever since.

For medical patients, cannabis is known to help with various health issues like anxiety, depression, and chronic pain, all of which have become more prevalent during the pandemic. The cannabis industry also offers consumers a variety of products for recreational use and as substitutes for alcohol and tobacco, which aren't considered essential products.

As with any other evolving industry, there are factors at play that hinder growth. Let's take a look at some of them.

person holding shopping bag with marijuana leaf on it

Image Source: Getty Images.

What's stopping legal cannabis growth?

Factors thwarting the growth of the cannabis sector both in Canada and the U.S. include regulatory delays, supply issues, a fewer number of legal stores than initially expected, and tax concerns. But perhaps the biggest roadblock is black market sales.

Cannabis is a drug that contains THC (tetrahydrocannabinol), a psychoactive substance that causes a user to feel "high" when it's consumed. This makes it prone to strict regulations. Canada legalized medical cannabis in 2016; recreational cannabis legalization followed in 2018, with the second phase ("Cannabis 2.0," featuring vapes, edibles, and more) in 2019. But that didn't stop the black market from growing.

Consumers of marijuana products, like consumers of everything else, prefer to pay a lesser price if it's easy to do so. The black market makes that possible, and "Cannabis 2.0" derivatives were available on the black market all along, even as Canada took another year to legalize them.

Omar Khan, the national cannabis sector lead at Hill+Knowlton Strategies, stated the following:

The illicit market faces no costs related to regulatory oversight and is intentionally lowballing prices in order to retain market share ... combined with their ability to offer greater product variety and the slow rollout of licensed retail stores across Canada, [this] gives them a competitive edge with respect to the legal market. 

Cannabis companies paid the price

Supply issues stemming from the fewer-than-expected number of legal stores in Canada was one of the major reasons for the downfall of Canadian pot companies last year. Regulatory delays in some provinces were a major hindrance to the growth of the recreational cannabis market after nationwide legalization. The marijuana companies had burdened themselves with overproduction by then, as demand was never the problem. All these factors contributed to the rise of illicit market sales and lowered legal sales.

Once-hot pot stocks Aurora Cannabis (ACB -3.01%)Canopy Growth (CGC -4.25%), and HEXO (HEXO 2.05%) saw a drastic hit to their revenue numbers, which declined every quarter as losses kept mounting. Aurora Cannabis and HEXO even came close to being delisted from the NYSE. Canopy Growth fared a bit better thanks to its partnership with Constellation Brands, which kept it in a safe spot to survive the crisis. All three are trying hard to recover this year.

In their most recent quarters, Aurora saw a 16% year-over-year increase in revenue to CA$75.5 million, while HEXO saw a 70% rise to CA$22.1 million. Canopy reported a 22% increase, to CA$110 million

Shares of Aurora, Canopy, and Hexo have declined 60.7%, 17.8%, and 49% so far this year, while the SPDR S&P 500 ETF is up 4.6%.

ACB Chart

ACB data by YCharts

Meanwhile, higher taxes in the U.S. and the lack of federal legalization are boosting the black market for cannabis. California, which has the largest legal pot market, is also the largest for black market sales. Estimates by ArcView Market Research and BDS Analytics show that by 2024, legal spending in California could reach $7.2 billion, with illicit spending amounting to $6.4 billion. 

Besides affecting revenue for pot companies, illegal products were also a cause of the vaping crisis in the U.S. Many vape products that turned out to be causing "e-cigarette or vaping product use associated with lung injury," or EVALI, were the result of black-market operators using vitamin E acetate in their products

What can bring consumers to legal markets?

It's the responsibility of marijuana users to understand the importance of ensuring that the products they use are legal and safe. It is also imperative that cannabis companies advertise and display their products in a way that gives consumers clear information about safety, quality, and proper usage. And it's the government's responsibility to ease restrictions on the legality of marijuana (and enforce regulations on quality) so that safe pot products can reach consumers easily and efficiently. State-level and federal legalization in the U.S. can further advance the industry.

As these things begin to happen, black market sales should decline and legal sales should start to increase. That will be when we see cannabis companies achieving their full potential.

Sushree Mohanty has no position in any of the stocks mentioned. The Motley Fool recommends HEXO. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Aurora Cannabis Stock Quote
Aurora Cannabis
$1.61 (-3.01%) $0.05
Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
$239.84 (-0.95%) $-2.29
Canopy Growth Stock Quote
Canopy Growth
$3.15 (-4.25%) $0.14
HEXO Stock Quote
$0.22 (2.05%) $0.00

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/11/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.