2021 has turned out to be an unexpectedly challenging year for cannabis stocks. The sector just logged its ninth losing month in a row.
Today I am going to explain why cannabis stocks have struggled and what to expect moving forward.
Cannabis stocks started the year red hot after the democrats won the presidential election and both chambers of Congress – the Senate and the House.
Investors were anticipating quick and meaningful cannabis reform with the democrats taking control of Washington.
However, that big spike early in the year was short-lived.
The Advisorshares U.S. Cannabis ETF (MSOS) just finished its ninth losing month in a row and is down 50% from the February high and down 30% on the year.
Why are Cannabis Stocks Getting Slammed in 2021?
There is one big reason why cannabis stocks are struggling in 2021 – Senate Majority Leader Chuck Schumer (D-New York) has taken the U.S. cannabis industry hostage.
In July, Schumer introduced a bill to legalize cannabis at the federal level called the Cannabis Administration and Opportunity Act.
On the surface, this sounds like good news for the U.S. cannabis industry, right? A powerful politician introducing a bill to advance legalization sounds like a win. However, the devil lies in the details. This bill has really spooked cannabis investors.
That’s because, as written, Schumer’s cannabis bill would impose huge federal taxes on the cannabis industry that could seriously impair sales growth and profitability. Here are more details from Tax Foundation.
In CAOA, the proposed tax rate will grow from 10 percent of removal price (cost at producer level or removal from bonded premises) in the first two years to 25 percent of removal price in the fifth year. The tax also applies to illegally imported or otherwise unlawfully removed products.
While the proposed federal rates start at the lower end, they quickly become substantial. Since all states with recreational sales already tax either cultivation, wholesale, or retail sales, the federal government should err on the side of lower tax rates. Overtaxing cannabis could result in a competitive advantage to illicit sales, which are prevalent in most states—even in states that offer a licensed market.
chart from Tax Foundation
As you can see, Schumer’s cannabis bill would add another layer of federal taxes on an industry that’s already struggling with high state taxes.
Making matters worse for the cannabis industry, Schumer has also vowed to block all cannabis legislation until federal legalization happens, saying that passing smaller cannabis bills would make it more difficult to pass federal legalization.
And this is one promise Schumer has made good on. He is currently blocking the Secure and Fair Banking Enforcement Act (SAFE Act) – a much-needed bill that would make it legal for banks to work with the cannabis industry.
This bill has passed the house five times, but Schumer won’t bring the bill to the floor of the Senate for a vote. Here are some more details from Marijuana Moment.
Senate Majority Leader Chuck Schumer (D-NY) says he and colleagues working to advance a federal marijuana legalization bill have an “agreement” that the body will not take up cannabis banking legislation until more comprehensive reform advances.
“Senators Booker, Wyden and I have come to agreement that if we let [the banking bill] out, it’ll make it much harder and take longer to pass comprehensive reform,” Schumer replied. “We certainly want the provisions, similar to the SAFE Banking Act, in our bill. But to get more moderate people—to get some Republicans, to get the financial services industry—behind a comprehensive bill is the way to go. It’s the right thing to do.”
Passing the Safe Banking Act would be a huge win for the U.S. cannabis industry. But it doesn’t look like it’s going to happen any time soon with Schumer running the show in the Senate.
Schumer’s high-tax cannabis bill and his actions to block other cannabis bills have temporarily shifted sentiment in the cannabis sector. Federal legalization used to be viewed as a positive catalyst for the U.S. cannabis industry – the holy grail.
Now there are grey clouds around legalization. Will it ever happen? And even if it does, what are tax rates going to look like? These are always smart questions for investors to ask, and right now they are particularly relevant in the cannabis sector where outdated and inconsistent policies have caused mass confusion.
Here’s the Good News for Cannabis Investors
Yes, there is very good news on the ground.
Despite all the legal uncertainty, the U.S. cannabis industry is booming. Sales in 2020 hit a new record of $17.5 billion.
2021 sales are expected to top $24 billion. That would be an incredible 38% increase from 2020. Looking forward, the U.S. cannabis industry is projected to continue seeing huge growth for many years as more states go legal.
U.S. cannabis companies are capturing this growth. An exclusive group of industry leaders are reporting incredible sales growth that I don’t see happening in any other sector. Here are a few examples.
- Green Thumb Industries (OTC: GTBIF) Q2 revenue increased 85.4% from last year to $221.9 million.
- Columbia Care (OTC: CCHWF) reported Q2 revenue of $109.7 million, an increase of 232% from last year and 19% from last quarter.
The Cannabis Sector is Grossly Undervalued Compared to Other Growth Sectors
None of this incredible sales growth is priced into the cannabis sector. Cannabis stocks are dirt cheap right now compared to other growth sectors.
For example, Cresco Labs (OTC: CRLBF), an early cannabis industry leader, has a price-to-sales ratio of 2.7. By comparison, Tesla (NYSE: TSLA) trades with a price-to-sales ratio of 27.
If Cresco had the same valuation as Tesla, shares would trade around $80, a 900% increase from current levels. And Cresco is growing a lot faster than Tesla.
When you compare Cresco to technology stocks it gets even crazier. Snowflake (NASDAQ: SNOW) has been one of the best-performing tech IPOs in the last year. This is a good comparison because Snowflake and Cresco have a similar sales growth rate.
Snowflake has a price-to-sale ratio of 125. If Cresco had the same valuation as Snowflake, shares would be trading around $375 per share – more than a 4,000% increase from its current level of $8.
The bottom line is that the U.S. cannabis industry is booming on the ground and none of this growth is priced into shares. This is a sector that offers incredible value right now.
What Should We Expect Moving Forward?
The cannabis sector is stuck in a bear market right now because of uncertainty around federal legalization.
In the meantime, the industry is booming. The industry reported record revenue in 2020 and is expected to do the same for many years to come.
I expect more volatility in the short run. In the long run, if the cannabis industry can get some help on keeping federal taxes in line with other industries, cannabis stocks should do well because these stocks are grossly undervalued compared to other growth sectors. But, for the time being, this sector remains in desperate need of better support from policymakers.
Author Michael Vodicka owns shares of Cresco Labs (CRLBF) and Green Thumb Industries (GTBIF).
About the Author
Michael Vodicka is an equity analyst with more than 20 years of experience trading and investing. His research has been featured in some of the industry’s most respected publications. He has been investing and leading investors in the cannabis sector since 2013.