Legal weed isn’t always greener for cannabis companies

Canada’s legal cannabis industry turns four on Monday. Its pitiful state is a reminder of the risks American gamers face if America follows its neighbor’s lead.

Earlier this month, President Biden said he would pardon federal cannabis offenses and order a review of the drug’s classification. This is unlikely to lead directly to an end to federal marijuana prohibition, but it could put the country on a path to further reforms that could benefit America’s pot growers, who operate in a bizarre legal vacuum. Today, they are not allowed to make deductions for normal business expenses, so effective tax rates can be as high as 70%. They are also largely barred from many financial services, which a bill called the SAFE Banking Act proposes to fix.

Canada is still one of the only developed countries U.S. politicians can turn to for advice on how to become fully legal. Official data shows that four years after opening on October 17, 2018, a third of cannabis sales in Canada are still on the black market. It’s not ideal, but the situation is improving as legal sellers are more successful in attracting customers. In Ontario, cannabis costs just 2% more than what is available on the illegal market, according to an EY report.

“It’s clear that legal cannabis can compete with illegal sellers if the stores are convenient, the prices competitive, and the products of good quality,” says Michael Armstrong, professor of operations research at Brock University in St. Catharines, Ont. .

Investors, however, were wiped out. Since enthusiasm for the cannabis industry peaked in 2019, approximately $35 billion has been wiped off the market value of seven major Canadian cannabis companies listed on the New York Stock Exchange, a decline of 85 %. Individual investors who used to support stock prices have mostly disappeared. Weekly net purchases of a basket of Canadian cannabis stocks by retailers total approximately $2.3 million today, up from a high of $429 million in February 2021, according to data from VandaTrack.

The initial argument was that these marijuana companies, with their access to deep pools of investor cash, would dominate the global cannabis market as one country after another became legal. “The dream didn’t work out,” says Andrew Carter, cannabis analyst at Stifel Financial. “Everyone got funding and they burned it all down.” Business victims include brewer Constellation Brands and tobacco giant Altria,

who rushed to buy stakes in pot Canadian stocks only to lose billions of dollars on their investments.

The lesson for investors is that competition will likely intensify if and when cannabis becomes legal nationwide in the United States. In a free market, there may be no limit to the number of licenses issued. In Canada, more than 700 facilities cultivate cannabis for a relatively small amount of C$4.3 billion, or the equivalent of approximately $3.1 billion, in annual adult retail sales. As more and more entrepreneurs arrive, large Canadian publicly traded stocks are losing market share. Advertising restrictions and plain packaging rules make it difficult to create brands that customers are loyal to because most products look alike.

Some U.S. cannabis growers have reason to worry that full legalization would allow exports across state lines, which is currently prohibited even in the more than 35 states that have at least partially legalized marijuana. . Well-stocked markets like Colorado and Oregon could flood other states with product and drive prices down. States that became legal early, such as California, are already experiencing the same price trend as Canada: in the three months ending in September, cannabis prices in California fell 23% compared to the same period of last year, according to data from HeadSet.

American companies also need Washington to avoid making the same mistakes as Ottawa. In Canada, federal excise taxes on cannabis are set at a minimum of one Canadian dollar per gram. This seemed reasonable to authorities, who assumed prices would remain at around C$10 per gram. However, competition has cut prices in half, doubling the tax burden on growers. A levy based on a percentage of retail sales would help US producers avoid this scenario, even if tax revenues would be volatile.

American pot companies have an efficiency advantage over their Canadian neighbors. Since they are not allowed to list on US stock exchanges, they have learned to be disciplined with money. Several names, including Green Thumb Industries, are already profitable, while no major Canadian player is yet generating positive cash flow.

Another bright spot is that expectations for cannabis stocks in the United States are already low. Growers who have facilities in multiple states have an average valuation, including debt equivalent to 7.8 times projected earnings before interest, taxes, depreciation and amortization, according to Stifel’s analysis. When Canada became legal in 2018, its listed producers were 27 times overpriced.

Four years after the legal cannabis experiment began in Canada, there is a clear winner: smokers today can enjoy a legal high for half of what it cost them in 2018. US cannabis investors, ending US federal prohibition would solve some headaches, but it frees up a lot of new ones too.

Write to Carol Ryan at [email protected]

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