This could be the best opportunity for marijuana legalization the industry has ever seen. President Joe Biden recently announced his intention to overhaul the government's policy on marijuana by pardoning thousands of people who were convicted of simple marijuana possession at the federal level. He also directed the attorney general to review how pot is classified and urged governors to issue state pardons, too.
While Biden did not fully endorse decriminalization, let alone legalization, his announcement gave hope to those who have pushed for it for years that cannabis legalization will finally become a reality. Investors felt the same way as they sent shares of pot stocks soaring.
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Cresco Labs shot 24% higher, Canopy Growth jumped 30%, Tilray (TLRY -18.22%) surged 40%, and Jushi Holdings rocketed 49% higher on the announcement. While some like Canopy gave back all of their gains and then some the very next day, many held onto most of their higher valuations even as the stocks continue to trade dramatically below where they started the year.
While legalization won't come right away, there still remain questions just how helpful it will be to their businesses as federal regulation and taxation could create a challenging labyrinth of red tape to negotiate.
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The high cost of selling weed
Marijuana is a Class I controlled dangerous substance nationally, putting it in the same category as heroin and cocaine, and its designation as a classified drug wouldn't necessarily change under Biden's review. While dozens of states have either decriminalized or legalized its use, the patchwork quilt of laws not only creates confusion, but also makes it difficult for pot companies to profit.
Companies such as real estate investment trust Innovative Industrial Properties, medical marijuana stock Trulieve Cannabis (TCNNF -17.19%), and Cresco are unable to deduct legitimate business expenses on their taxes like other businesses because the IRS doesn't recognize them as permissible expenses.
Marketing and advertising costs, health insurance premiums, interest, rent, and even employee salaries are not deductible for cannabis businesses, which leads to higher operating expenses and causes them to report losses.
Florida-based multi-state operator Trulieve saw revenue jump 49% to $320 million in the second quarter, but because operating expenses more than doubled year over year following its acquisition of Harvest Health & Recreation, it recorded an adjusted loss of $0.01 per share.
Companies face a similar hit-or-miss situation at the state level, where they are subject to county and local taxes -- sometimes depending upon the type of cannabis business they operate -- that lead to higher costs. California's Legislative Analyst's Office estimates that the average cumulative local tax rate over the entire supply chain is equivalent to a 15% tax on retail cannabis sales in the state.
Paving the way for growth
Federal legalization would allow for new investment opportunities. Current regulations prohibit banks and other financial institutions from lending to cannabis businesses, or even letting them open bank accounts, meaning they must operate as cash-based businesses. That creates an unsafe environment for staff.
The House of Representatives has passed the Secure and Fair Enforcement Banking Act -- aka the SAFE Banking Act -- on three separate occasions and introduced it for a fourth time in the current session, but the bill never advanced further. It would allow banks to establish relationships with marijuana businesses operating in states that have legalized cannabis for medicinal or recreational purposes.
Legalization would negate the necessity for such piecemeal bills and would even open up the opportunity for some Canadian pot stocks that have been sitting on the sidelines before moving into the U.S. to finally do so. For instance, because the Nasdaq Stock Market has rules against listing stocks trading in illegal substances, companies like Tilray are not permitted to have cannabis operations in the U.S.
Don't hold your breath
As close as Biden's announcement puts the industry to seeing marijuana legalized at the federal level, cannabis companies won't see any material benefit in the near term. It's a large part of the reason why pot stocks immediately gave back all of their gains.
Washington moves at a glacial pace, and with Biden not giving a full-throated endorsement for legalization or decriminalization, investors shouldn't make buy or sell decisions about pot stocks because of it. Little is likely to happen this year or maybe even next year, and cannabis stocks will need to be judged on their individual merits under existing law.
