Legal marijuana: ‘You ain’t seen nothin’ yet!’

Investor’s Digest of Canada contributors Doug Cooper and David Kideckel, Toronto-based Beacon Securities equity analysts, argue the United States is in the midst of a pot revolution. Americans are hankering for some marijuana (well, at least 60 per cent of them are) according to surveys on support for full legalization. This November, 12 more states in America are voting for full-scale or medical marijuana legalization.

By Doug Cooper and David Kideckel

Legal_marijuanaUntil recently, most investor attention has been on the Canadian cannabis market and the primary cultivators therein. This was a natural place on which to focus as Canada is the first G10 country to federally legalize recreational cannabis and without initial product, there is no product to legally sell. A recent poll found that 39 per cent of Canadians will use marijuana once it is legalized recreationally. That would imply a Canadian target market of 14 million users of some form, a figure that, while not quite as robust as alcohol (approximately 22 million users), is very strong.

Canadians spent $22.1 billion on alcohol in 2016, which pegs the per capita consumption at $630 or $1,000 per average consumer. Using this as a starting point and understanding that per capita spend on cannabis is estimated to be roughly 50 per cent that of alcohol (or $315 or $500 per user), we can arrive at a potential cannabis market size in Canada of $7 billion to $10.5 billion, assuming 100 per cent conversion from the black market.

With such a greenfield opportunity, it is no wonder that Canadian licensed producers have performed well. Nevertheless, with a sizable aggregate market capitalization, those Canadian players likely reflect the mature market opportunity, albeit within that aggregate, there will be some who could see further gains at the expense of others.

US support growing for medical cannabis

An easier opportunity than trying to pick the Canadian winners and losers, in our opinion, is to look south of the border—a cannabis market that is rapidly gaining momentum from a regulatory perspective with more states legalizing medical and/or adult use and thus should attract increasing investor attention. To date, 29 states plus Washington, DC have legalized medical cannabis while nine states plus DC have done so for adult use. Thus, around 200 million people live in a US region with some form of legalization.

Furthermore, we believe the momentum is building for all of the United States to formally legalize cannabis as changing public opinion (61 per cent of the population believes recreational should be legal with 81 per cent favouring medical use) should give the government the ‘cover’ to legalize cannabis and take the substantial tax windfall.

Using similar metrics as above, US alcohol sales were $221 billion in 2017 or $650 per capita. A potential cannabis market of 50 per cent that of alcohol (US$325 per capita) would imply a $100-billion market. As recreational cannabis at this point remains a domestic market, we ask a simple question: would investors rather buy a consumer packaged goods company with a focus on the United States and its 325 million population or Canada and its 35 million?

The legal landscape of US cannabis federal laws has shifted significantly over the past century, beginning with the enactment of the Marijuana Tax Act in 1937, which effectively prohibited cannabis at the federal level.

Wide-spread marijuana usage began in the 1960s

Cannabis then remained relatively obscure until the 1960s, when its use became a mainstay of the ‘hippie’ lifestyle and it became trendy among adolescents and young adults. In 1970, the Marijuana Tax Act was expanded into the Controlled Substances Act (CSA) as Title II of the Comprehensive Drug Abuse Prevention and Control Act, which classified drugs on four different schedules or categories of seriousness (the start of President Nixon’s infamous War on Drugs as he saw marijuana as tied to ‘radical demonstrators’).

Marijuana was listed as a Schedule I drug with no health benefits and a high potential for abuse, deeming it a greater risk than cocaine and fentanyl which are classified as Schedule II drugs. This period lasted for 26 years until 1996 when California became the first state to legalize medical cannabis with the approval of Proposition 215, California’s Compassionate Use Act. A number of states began to legalize medical cannabis between 1996 and 2012.

Major states such as New York, New Jersey, Michigan and Ohio, also seem imminent on the recreational side—states that make up approximately 15 per cent of the US population. Perhaps driven by the growing public acceptance or the growing evidence of hard dollar tax revenue, Senate Minority Leader Chuck Schumer (D-New York) announced a plan in April 2018 to decriminalize marijuana at the federal level. Not to be outdone, President Trump indicated on June 8 that he was inclined to support a bipartisan effort in Congress led by Senator Cory Gardner (R-Colorado) and Senator Elizabeth Warren (D-Massachusetts) to ease the US ban on marijuana. It seems all sides are poised to get a deal done.

According to the ACLU, states spent $3.6 billion enforcing marijuana possession laws in 2010. Additionally, reports found that the New York Police Department spent one million hours enforcing low-level marijuana offenses between 2002 and 2012, and that in 2012, a marijuana-related arrest was made every 42 seconds in the United States.

Politicians drawn to revenues and jobs

Tax receipts from states with legal recreational use markets (e.g. Colorado, Washington, and Oregon) show that those state governments have generated US$1.3 billion in excess revenue. Currently, the US cannabis sector employs an estimated 125,000 to 160,000 full time workers, primarily consisting of workers directly employed by cannabis businesses as well those employed by ancillary companies.

The industry will continue to be a significant job creator and is expected to generate as many as 340,000 full time opportunities by 2022, with an estimated growth of 21 per cent per year, which is significantly higher than official estimates for other industries and professions. A recent study from New Frontier Data indicates that a federally legal cannabis market can potentially generate $132 billion in tax revenue and more than 1 million in new jobs over the next decade—two things about which the government cares deeply. Rarely can the government find new sources of such significant revenue and we believe it is unlikely to pass up such an opportunity.

Doug Cooper and David Kideckel are Beacon Securities analysts.

This is an edited version of an article that was originally published for subscribers in the August 10, 2018, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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