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Cannabis' Federal Legal Status Is Not a Total Buzzkill

The industry still has significant growth potential.

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Karen Wallace: Hi, I'm Karen Wallace from Morningstar. There's a lot of talk about cannabis these days. U.S. Senate Democrats recently released a discussion draft of a bill that would deschedule cannabis on a federal level and recognize states' individual cannabis laws. Though cannabis is legal or set to become legal for both recreational and medical use in 19 states and medical use only in another 17 states, it's still illegal on a federal level. And that uncertainty has clouded this growing industry. I'm here with Kris Inton. He's an equity research strategist for ESG at Morningstar. Kris, what difference would it make if cannabis were no longer illegal on a federal level?

Kristoffer Inton: The removal of federal prohibition would be a massive boon to the industry, especially financially. First, at present, any industry that does business with or serves the cannabis industry could be considered aiding and abetting criminal activity. The ability to access financial services is one of the most notable limitations. U.S. cannabis companies are neither listed on major U.S. stock exchanges nor fully served by banks. So, change to federal law would open these up for the industry. Second, due to IRS laws, U.S. cannabis companies pay very high tax rates, as they're technically a federally illegal business. The removal of prohibition would bring rates into the 20% territory that every other industry pays. And then lastly, scientific research would be easier to conduct, including any studies on efficacy, potency, and safety. And this can help remove a lot of the misconceptions that have lingered.

Wallace: There's been a surge in states legalizing cannabis recently. Public support for cannabis legalization really seems to be growing. How likely do you think federal legalization is?

Inton: Unfortunately, not likely anytime soon. Any cannabis legislation is going to need 60 votes in the Senate because of the filibuster. So not only do Democrats need full alignment within their party, they're going to need 10 Republicans to support it as well. On top of that, President Biden favors decriminalization rather than removal of federal prohibition. So, he's unlikely to spend political capital on the issue.

Wallace: Kris, even with that legal overhang, you see some significant growth potential for the industry. What are you factoring in?

Inton: In the next year or so we expect a banking act to pass that would allow cannabis to access traditional financial services. And then by the end of 2023, we expect that the federal law would be changed to allow states to choose cannabis' legality within their borders. Nonetheless, with or without a change to federal law, we still see massive growth for the legal cannabis industry. Based on our state-by-state analysis, we forecast nearly 25% average annual growth for the U.S. recreational market and nearly 15% for the medical market through 2030.

Wallace: Where do you see opportunities among cannabis companies now?

Inton: We think that U.S. multistate operators offer the better risk-adjusted upside compared to their Canadian peers. So, we like Curaleaf and Green Thumb Industries. Four-star Curaleaf is currently trading at a price/fair value below 0.6. And 4-star Green Thumb is trading right around 0.6.

Wallace: That's really interesting. Thanks so much for being here to discuss these developments, Kris.

Inton: Thanks for having me.

Wallace: For Morningstar, I'm Karen Wallace. Thanks for tuning in.

Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.