By DataTrek Co-Founder Jessica Rabe
I just got back from a conference in Chicago, where I presented on the legal marijuana industry. Given that the audience included very senior investment managers who control billions of dollars, we thought it would be useful for me to share their questions and my answers about the cannabis market. Here they are:
Question #1 – When will recreational marijuana be legalized nationally?
Response: Currently there are ten – soon to be eleven – states where recreational cannabis is legal. Illinois will be the 11th starting in January 2020, the state’s governor just needs to sign it into law which he will do as he campaigned on the issue. That will make Illinois the first state to legalize sales of recreational marijuana legislatively (Vermont was the first to legalize just recreational cannabis use through its state legislature).
Industry advocates hope this will encourage other states to do the same, rather than wait for ballot initiatives as it has usually been done. So far, New Jersey, New York, Connecticut and New Mexico have failed to also pass retail cannabis sales legislation, despite their governors’ best efforts. Now, they’ll have to wait until next year to advance legislation or include the issue on the 2020 ballot.
Bottom line: 28% of the US population live in a state where recreational marijuana is legal (including Illinois). That percentage could meaningfully increase as more populous states, such as New York and New Jersey, legalize adult-use.
The closer we get to 40%, the more likely it will go national. There are also many Democratic presidential candidates already campaigning on the issue. Cory Booker, for example, has even introduced legislation to remove marijuana from the list of controlled substances and make it legal at the Federal level. A Democratic president in the White House in 2020 could speed up the legislative process, but it will be tough if the Republicans still control the Senate and likely not possible within the next five years if President Trump wins re-election.
Question #2 – Is the black market thriving even more now that US states have legalized the sale of recreational marijuana?
Response: This question was premised on my message that the way states regulate and tax recreational marijuana will determine the industry’s total addressable market. Taxes that are too high, such as in California, allow the black market to remain relevant as consumers opt to go underground so they can pay lower prices.
Moreover, the black market is a successful and efficient model with high margins and stable demand over the past few decades. It’s not so much a matter of whether it is thriving more or remains the same; the reality is it has been running at full steam for a long time. If states want higher tax revenue and to undercut the black market, they’ll have to be more competitive when it comes to taxes.
Question #3 – Which marijuana ETF should I invest in?
Response: There aren’t many marijuana-focused ETFs because it is very difficult to get a bank to agree to custody shares since the drug is still illegal federally. The most popular is the ETFMG Alternative Harvest ETF, or MJ, with $1.1 billion in assets under management. MJ holds top Canadian marijuana companies, such as Canopy Growth, Aurora Cannabis, Cronos Group, and Tilray, among others. That said, it isn’t necessarily a pure-play marijuana ETF, as it also holds tobacco (for their stakes/partnerships with marijuana companies) and pharmaceutical companies (CBD exposure), for example.
Bear in mind that MJ largely trades based off retail investor sentiment, in line with the individual cannabis companies it holds. It tanked in Q4 along with the rest of US equities and although it recovered some of its losses in 2019, it’s still down 25% from its all-time high back in September 2018. By contrast, the S&P 500 traded at record highs today.
Question #4 – Should I invest in marijuana companies that are downstream, midstream or upstream?
Response: Many of the largest public marijuana companies on US exchanges are Canadian cannabis growers (upstream). They typically operate at a loss, but are well capitalized. For example, Constellation Brands has a large stake in the biggest public marijuana company by market cap ($15.1 billion), Canadian marijuana producer Canopy Growth. It currently holds +$4.1 billion in cash and cash equivalents. Canadian marijuana producer, Cronos Group, is another example with +$2.4 billion in cash after Marlboro maker Altria took a large stake in the company.
That said, our biggest concern about upstream companies (i.e. producers) is price compression, as it is a very competitive market. Marijuana prices typically come down significantly the longer recreational marijuana sales are in place. This means that like any agricultural product, you need to produce at scale. The other threat: Columbia, which can grow cannabis more cost effectively with cheap labor. Once marijuana is fully legal in the US, dispensaries may be able to import the drug from that country.
As for retailers (downstream), this is obviously a lucrative area that has an edge when it comes to strong brands and high margins. They also have an opportunity in segmenting the market and creating new experiential formats that drive traffic, especially in tourist markets. As for midstream, we’d look for private equity and venture capital investments that will get bought up by the larger firms over the next ten years. This includes everything from testing labs to companies that make vape products or marijuana packaging.
From a big picture standpoint, the investment merits of the legal marijuana industry are more macro in nature. Its success will come down to broader legalization and finding more uses for the cannabis plant.
Question #5 – Can you get fired for testing positive with THC in your system in a US state where recreational marijuana is legal?
Response: For recreational marijuana, the short answer is yes because it is still classified as a Schedule I drug, on par with heroin. That said, some employers have loosened their marijuana testing policies in states where adult-use of the drug is legal. For example, recent surveys have shown the longer recreational sales have been in place in Colorado (+5 years now), the more companies there have relaxed their policies or even stopped screening for the drug.
As for medical marijuana, there have been mixed results depending on the state. Over the last few years, rulings went against medical marijuana users in employment cases by state supreme courts in California, Colorado, Oregon and Washington. Conversely, there have also been rulings that favored medical pot users in Massachusetts, Rhode Island and Connecticut. In the case of Connecticut, for example, a federal judge said that a nursing home rescinding a job offer from a medical marijuana user “violated an anti-discrimination provision of the Connecticut’s medical marijuana law.”
Lastly, we’d like to close on another topic we discussed heavily as it has huge implications for not just marijuana, but also the CBD market. As a quick refresher, THC is a compound in the cannabis plant that gets users high, whereas CBD is another non-psychoactive compound that many claim has therapeutic benefits. Those are just two among +100 cannabinoids in the marijuana plant. Now Canadian scientists mapped the cannabis genome after years of research, which will dramatically change marijuana and hemp production.
The upshot: knowing the genetic map of cannabis will enable breeders to create new varieties of strains with specific medicinal properties. That’s a major market opportunity for public companies that sell marijuana or CBD to create unique and diversified product offerings as they try to gain market share from competitors. It will also help producers grow the plant more efficiently, sustainably and resistant to disease, enabling companies to increase supply and lower costs. And very important for hemp farmers: it will help them stay compliant as CBD is legal under the 2018 Farm Bill.