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Can Marijuana Stocks Survive Legalization?

By Rich Duprey - Updated Jun 18, 2021 at 5:20PM

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Maybe regulation and taxation of cannabis isn't the best idea after all.

Federal marijuana legalization in the U.S. is seen as a potential catalyst for pot stocks achieving massive growth. Currently, 14 states allow recreational marijuana use and 36 have authorized medical marijuana; in those states, cannabis sales surged 46% in 2020 to a record $17.5 billion. Some outlets estimate sales may grow to nearly the size of the craft beer industry, or $41 billion, by 2026 -- and if marijuana were legalized, it could move in on $100 billion in annual black-market pot sales.

The Marijuana Opportunity Reinvestment and Expungement Act of 2021, or MORE Act, was introduced in the House of Representatives by Rep. Jerry Nadler, and a companion bill is expected to be introduced in the U.S. Senate by Sen. Chuck Schumer later this year. Both would decriminalize marijuana and expunge the records of individuals who were previously convicted of marijuana offenses, while setting up a regulatory framework for legalization. 

Yet the old adage to be careful of what you wish for applies to marijuana legalization. Regulation may not be the panacea you think.

Woman measuring marijuana buds in dispensary

Image source: Getty Images.

Not much green in pot stocks

Despite the legalization of recreational cannabis in Canada two years ago, most marijuana producers there continue to report multimillion-dollar losses.

Canopy Growth (CGC 21.48%) remains the largest marijuana stock by market capitalization and by flower market share in Canada, but fiscal 2021 fourth-quarter results were less than stellar. While the pot stock enjoyed sales growth of 38% as revenue hit $148.4 million Canadian, that fell short of analyst expectations of CA$151.8 million. It did narrow losses to CA$616.7 million, or CA$1.85 per share, from CA$1.3 billion, or CA$3.72 per share, a year ago, but that too missed forecasts of losses of CA$0.26 per share. 

Even on an adjusted EBITDA basis, Canopy Growth showed losses of CA$94 million, only slightly better than the CA$102 million recorded last year, though it maintains it will be adjusted-EBITDA-positive by the back half of fiscal 2022.

Tilray (TLRY 10.26%), which after its acquisition of Aphria in November had pro forma trailing revenue of $685 million, making it the world's largest pot stock by sales, also produced over $30.2 million in adjusted EBITDA losses last year. While that's about a third of what it saw in 2019, it's still a substantial amount two years after legalization.

Man cutting marijuana in field

Image source: Getty Images.

Incentivizing illegal behavior

The problem is that because of regulatory hurdles and delays in licensing, many cannabis companies still can't compete against the black market. 

When Canada legalized marijuana, Prime Minister Justin Trudeau said, "By controlling it, by legalizing it, we're going to ensure that criminal organizations and street gangs don't make millions, billions of dollars of profits every year."

That hasn't happened. While Canadians are obtaining less marijuana from illegal sources, the black market hasn't gone away. According to data from the government's National Cannabis Survey, after two years, 31% of Canadians still use a mix of illegal and legal cannabis suppliers, while 9% always use illegal suppliers.

Price was the primary factor in determining where someone purchased their marijuana, and more often than not illegal sources were cheaper than the regulated outlets. On average, buyers at legal shops spent $49 per month, but buyers from illegal sources spent $47 per month.

Depending on where they lived, illegal source prices could range from $31 to $76 per month, while legal sources were between $42 and $73 per month. All regulation did was drive up prices.

Marijuana farm

Image source: Getty Images.

California dreaming

California could offer a glimpse of what we could expect from regulated legal weed in the U.S. It's the world's largest market for legal cannabis with $4.3 billion in sales, and it's expected to grow to $7.4 billion by 2025 for a 16.7% compounded annual growth rate -- yet producers in the state still can't compete with the black market.

Legalization was expected to result in 6,000 licensed retail stores selling recreational and medical marijuana, but instead just over 700 cannabis shops and 300 state-approved delivery firms exist in California.

Taxes are just one of the many hurdles facing the industry, with industry site Leafly noting that $100 in pre-tax weed can end up costing a buyer anywhere from $125 to over $138 after city taxes are applied.

Costly regulation also inhibits marijuana farms from getting licensed by the state. As a result, pot companies can't operate profitably, and the state just approved a $100 million bailout of the industry. Los Angeles, which has the highest cannabis taxes in the state, will also get the lion's share of the bailout money. 

California has ultimately created a system whereby a flourishing industry is being brought to near ruin through exorbitant taxation and regulation to the point where it needs a bailout to survive.

Law of unintended consequences

Investors have been looking forward to federal legalization as a catalyst to jump-start growth for cannabis stocks, but in many of the biggest markets where it is playing out in real time, it is actually impeding industry expansion, causing even the biggest operators to run at perpetual multimillion-dollar losses.

As a result, investors might want to instead focus on smaller pot stocks with a more narrow focus. Multi-state operators like Trulieve Cannabis (TCNNF -0.08%), which is already profitable, or Jushi Holdings (JUSHF -0.97%) and Curaleaf Holdings (CURLF 1.97%), which are profitable on an adjusted basis, just might offer the sort of greener pastures investors are looking for, even if marijuana legalization becomes a reality.

Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Tilray Stock Quote
Tilray
TLRY
$4.30 (10.26%) $0.40
Canopy Growth Stock Quote
Canopy Growth
CGC
$3.28 (21.48%) $0.58
Curaleaf Holdings, Inc. Stock Quote
Curaleaf Holdings, Inc.
CURLF
$5.69 (1.97%) $0.11
Trulieve Cannabis Stock Quote
Trulieve Cannabis
TCNNF
$13.11 (-0.08%) $0.01
Jushi Holdings Inc. Stock Quote
Jushi Holdings Inc.
JUSHF
$2.03 (-0.97%) $0.02

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