By Carol Ryan
Soon, cannabis might no longer be lumped in with heavy-duty drugs such as heroin in America's classification of controlled substances. But most of the problems that have made pot stocks a lousy investment will stick around.
Cannabis stocks jumped Tuesday afternoon on reports that the Biden administration will relabel it as a less dangerous drug. The AdvisorShares Pure US Cannabis ETF, an exchange-traded fund that tracks a basket of American growers such as Green Thumb Industries and Trulieve, gained 25%. Marijuana could change from being a Schedule I substance, alongside heroin, to a Schedule III substance such as codeine and testosterone. Crucially, though, this wouldn't lift the federal ban on marijuana.
The development comes after the Biden administration launched a review of cannabis's classification in late 2022 and may be a nod to younger voters ahead of this year's presidential election. Marijuana is big business: U.S. sales are expected to exceed $30 billion in 2024, according to research firm BDSA, approaching one-third the size of America's tobacco industry.
But there are hurdles to turning the proposal into a reality. First, it needs to be reviewed by the White House; then the public will get a chance to comment. Groups that don't want to see the drug treated more leniently could mount a legal challenge, slowing matters down. Donald Trump could try to unpick the proposal if he wins back the presidency, although this would be a lengthy process.
The most concrete business benefit of reclassifying marijuana would be to dramatically improve the cash flows of American growers. Pot businesses currently pay effective tax rates of more than 70% because of the punitive treatment of cannabis under the so-called 280E tax code. Any company selling a Schedule I drug isn't allowed to deduct regular expenses such as travel and rent from their tax bill.
U.S. grower Verano estimated that it could have saved over $80 million from its roughly $149 million 2023 tax bill without this restriction. Lower tax bills would also help legitimate companies to compete more aggressively with underground rivals.
Declassification would send a signal that the industry is gaining legitimacy and revive a push to give cannabis companies access to regular banking services such as checking accounts through a bill called the Safer Banking Act.
But the proposal won't fix other challenges. As long as cannabis remains illegal at the federal level, major stock exchanges such as Nasdaq will probably remain reluctant to let U.S. pot companies list. This means U.S. cannabis companies must trade on less liquid exchanges in Canada, where the drug is fully legal.
The U.S. federal ban also makes it tricky for institutional investors to own cannabis stocks, which weighs on valuations. It is hard to get a bank to act as custodian for U.S. marijuana shares, so institutional ownership can be as low as 10% for even the best growers. The likes of BlackRock and Vanguard do have some exposure, but it tends to be through proxies such as cannabis real-estate investment trust Innovative Industrial Properties, which doesn't "touch the plant."
Trading cannabis across state lines will remain forbidden, creating huge inefficiencies for growers. They must build cultivation facilities in every state in which they sell, including those with a climate ill-suited to the heat-loving marijuana plant, such as New York. And companies facing a glut of produce in one part of the country can't get relief from falling prices by shipping their harvest elsewhere. Cannabis farmers in Oregon are currently struggling to unload the 9.6 million pounds of marijuana they harvested in 2023 -- equivalent to more than 2 pounds for every resident.
Although U.S. cannabis stocks have rallied this year, they have been a horrible long-term investment as investors have grown more cautious about the chances of full legalization. On average, the AdvisorShares index has lost 23% annually since its inception in late 2020. Shares of companies such as Trulieve, Curaleaf, GTI and Cresco now change hands for nearly 11 times their projected earnings before interest, taxes, depreciation and amortization, on average, down from a peak of 22 times in early 2021.
Declassification would provide a welcome boost for pot stocks. Even if it happens, they will remain a risky bet on the bigger prize of federal approval.
Write to Carol Ryan at carol.ryan@wsj.com
(END) Dow Jones Newswires
May 01, 2024 09:34 ET (13:34 GMT)
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