Hemp Legalization Trend To Drive Tobacco Stocks

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Includes: BTI, IMBBY, LO, MO, PM, RAI
by: Lang Gibson

Summary

Tobacco stocks stand to benefit better than any other big business from the highest potential growth industry in America, that of hemp.

From production and packaging to marketing, Big Tobacco is already equipped to own and operate much of the promising and swiftly legalizing cannabis industry.

Hemp is a larger opportunity than legal marijuana because hemp has historically been the lifeblood of the world economy, including America from its colonial days to 1937 and then WWII.

Legislation filed in both houses of Congress would exclude hemp from the legal definition of marijuana, and end the prohibition of hemp since 1937.

PM is most in need of a strategy overhaul due to currency losses; a 5%-plus dividend in a low yield environment is an added enticement.

While tobacco stocks have relatively lofty valuations, they stand to benefit better than any other big business from the highest potential growth industry in America, that of hemp, cousin to legal marijuana, which had a 74% growth rate in 2014, to $2.7bn. The benefit of non-psychoactive industrial hemp and marijuana, both part of the cannabis species, is economic as well as health for people and planet. Some estimate that the global market for industrial hemp consists of more than an astounding 250,000 products. China, Russia and South Korea account for 70% of the world's industrial hemp supply, with 30 other nations accounting for the remaining 30% share. Meanwhile, due to Federal law, America is the only industrialized nation with no industrial hemp production (outside of research uses), and is therefore dependent on imports, with a negligible $620 million in annual retail sales.

From production and packaging to marketing, Big Tobacco is already equipped to own and operate much of the promising and swiftly legalizing cannabis industry. Further, tobacco has been researching and developing its entry into the market, once legalized on a national level, for decades. National legalization is now only a matter of time with over half of states already legalizing cannabis in some shape or form, including four states and DC in the recreational space, bills under discussion in Congress for national legalization, substantial lobbying and funding from the likes of George Soros, and over half of Americans voting for legalization, over 50% in virtually all recent polls. Cannabis legalization is as simple as a presidential order to the DEA, or a Congressional vote, to remove cannabis from the drug schedule. Indeed, in an interview with Vice News on 16th Mar., President Obama said, "At a certain point, if enough states end up decriminalizing, then Congress may then reschedule marijuana."

"Hemp is of first necessity for the wealth and protection of the nation." - Thomas Jefferson.

Tobacco researching hemp?

A piece in a recent issue of the Millbank Quarterly, a health policy journal, says:

"Policymakers and public health advocates must be aware that the tobacco industry or comparable multinational organizations (e.g., food and beverage industries) are prepared to enter the cannabis market with the intention of increasing its already widespread use,"

Representatives from various tobacco companies say they currently have no plans for expansion into the cannabis market. But the Millbank report - citing recently unearthed documents - found that major cigarette brands began researching cannabis opportunities in the late 1960s and early 1970s despite denying it at the time.

Hemp could be the lifeblood of the economy once again

While at least one Street analyst focuses on the marijuana opportunity for the tobacco companies, hemp is the more substantial opportunity because the miracle crop has historically been the lifeblood of the world economy, including America from its colonial days to 1937 and then during WW II. Since WW II, hemp has been illegal to grow in America under Federal law because of its relation to marijuana, and any imported hemp products must meet a zero tolerance level. For a short history of how hemp allegedly became illegal in 1937, following the introduction of revolutionary decortication technology for its processing, see this.

Twenty states have made the cultivation of industrial hemp legal, but farmers have not yet begun to grow it yet for commercial purposes because of resistance from the DEA, the cannabis banking impasse, lacking economies of scale and the near impossibility of shipping hemp seed across state lines. Still, according to Vote Hemp, "These states are able to take immediate advantage of the industrial research and pilot program provision, Section 7606 of the 2014 Farm Bill. Farmers in SE Colorado (2013), Vermont (2014), Oregon and Tennessee (2015) already have.

Crucially, legislation filed in both houses of Congress would exclude hemp from the legal definition of marijuana and end its prohibition. The major risk to the passage of national hemp legalization is that its efficiency and value threaten the models that Big Business have developed over the centuries, particularly since 1937, when hemp became illegal with marijuana, though hemp has less than 0.3% THC content, versus 5-30%+ in pot. No matter how much you smoke hemp, you will not get high, just a bad headache, experts say.

The diversity of hemp

Hemp is extremely unusual in the diversity of products for which it is or can be cultivated. As early as 1938, Popular Mechanics magazine touted hemp as "the new billion dollar crop," directly following the development of new hemp processing technologies. Today, the hemp products that hold the most promise for North America include food/nutrition, medicine, papers, biodegradable plastics, construction (including wood, fiberboard, "hempcrete" and insulation), linen-textured textiles, clothing, industrial and personal-use oils, alcohol, and bio-fuel.

Hemp is typically more efficient than competing materials. For instance, according to the US Department of Agriculture, one acre of hemp can produce 2-4 times more paper than one acre of trees; hemp is ten times stronger (and softer) than cotton; hemp requires no herbicides and few or no pesticides; most hemp derived products are nontoxic, biodegradable and renewable.

On the one hand, hemp is a panacea, even a miracle crop, while on the other hand, it is a threat to the status quo of business in America. Hemp threatens to change the flow of money in a country that is well-controlled by corporate interests. However, once the genie of hemp is unleashed, those same corporate interests will change the flow of money gladly to their own benefit.

The USDA suggests hemp as a substitute for tobacco farm production

Production starts on the farm, and in tobacco-producing states like Kentucky and North Carolina, there has been an increasing interest in alternative crops since at least the 1990s. Tobacco producers have wanted to diversify due to the uncertainty in the future of their crop. Between the 1970s and 1990s, the US share of global tobacco production fell from 16-17% to 9-10%. Likewise, given rising health concerns and retail tobacco costs, per capita cigarette consumption fell from 7 pounds to 4.5 pounds of tobacco, over this period.

According to the US Department of Agriculture's 1995 whitepaper on Hemp:

"Although few alternative crops can be expected to yield high returns comparable to tobacco, industrial hemp fiber for paper and textile production has been suggested as a possibility. Industrial hemp is a bast fiber similar to flax, jute and kenaf. Bast fibers tend to have high production costs because they are only a small portion of the plant stem and must be separated from the rest of the stem before they can be used in textile or paper production."

Therefore, even today, research is required to bring down the cost of hemp production, which is somewhat labor intensive otherwise, despite decortication technology introduced in the decades preceding prohibition:

"For hemp, crop and fiber yields would have to be increased to bring down costs. Research would be needed to develop modern hemp fiber harvesting and processing methods. Now, hemp fibers are generally quite labor intensive in the harvesting and processing stage. For example, hemp fiber is produced in China, Hungary, Rumania and Spain where labor costs are low."

Tobacco Takeover Post-Legalization

As soon as marijuana and hemp are legalized, Tobacco and other industries will most likely immediately takeover the more legitimate cannabis penny-stock companies already in existence. On the hemp side, national legalization is probably required to get critical mass. On the marijuana side, since most of these recent start-ups aren't even directly tied to high-THC content production but to non-intoxicating derivatives, due to Federal prohibition, the true business of marijuana production hasn't been started yet on a large scale. Companies like Philip Morris (NYSE:PM) can kick-start manufacturing and production operations for both hemp and marijuana virtually overnight.

Crucially, the trend of flat-lining corporate revenues and profits, which is exacerbated by the surge in the dollar and related currency translation losses, only serves to spur Big Industry's plans for participation in the hemp and overall cannabis business. This potential panacea to unhealthy corporate profit trends is what will likely drive national legalization sooner rather than later.

PM is most in need of a strategy overhaul due to currency losses

In the case of tobacco companies, sales volume is fairly flat largely due to consumer health consciousness, rising tobacco taxes, and regulatory/legal costs. As PM is largely dependent on international sales, the company is taking an increasingly large hit from currency translation costs, pushing its valuation well below its peers. Thus, its dividend, at 5.14%, is attractive once again to dividend funds and investors. Although its competitors' dividends are well below 5%, where they have been historically, 3.5-4.2% dividend yields are certainly attractive compared to bond yields today. As sin stocks have historically beaten the market over the long-term, there is probably little downside in owning these stocks, short of another 2008-like financial crisis, especially given the relatively attractive yields.

Other Big Tobacco stocks that stand to benefit from hemp legalization include: Reynolds American (NYSE:RAI), Altria (NYSE:MO), British American Tobacco (NYSEMKT:BTI), Imperial Tobacco Group (ITYBY) and Lorillard (NYSE:LO).

Momentum Builds in Legalization Process

Absent the potential upside from hemp legalization, I would probably be market-weighted in these names. However, the increasing momentum in cannabis legalization is simply going to make these stocks more attractive as legalization headlines print at an accelerating pace. I am not advocating trading tobacco and other stocks potentially associated with cannabis strictly on legalization news because this is the kind of trading that has burned a whole lot of penny-stock investors in marijuana stocks. For instance, marijuana stocks surged when Colorado went recreationally legal in Jan. 2014, but then crashed and burned after the hype about one state's legalization settled. What I am suggesting is that you can get a sense of the probability and timing of national legalization by following significant developments, which come on a weekly basis, given disparate stories in many of the 50 states.

Like anything in politics, there is always a lot of back-and-forth and grandstanding from Democrats that want legalization and Republicans that generally do not. But if you followed what happened in DC over the last few months, you would have gotten a sense for how fast cannabis can be legalized. Strictly one of the many medical marijuana territories only a year ago, DC decriminalized last summer and legalized on 26th Feb. In the run-up to legalization, the DC Council and mayor were threatened by significant jail time and heavy fines for violating national prohibition, for example, but in the end, it was clear that this was probably all political theatre designed to assuage the minority of Americans who remain opposed to legalization. The move to legalize cannabis in the city that our national government occupies is emblematic for where the movement is going. It is difficult to imagine a legalized DC for very long without a legalized nation.

Legalization of hemp (and marijuana, which has established the larger nationwide movement, given its more immediate gratification) will happen. It's just a matter of time. While there may potentially be opportunity in some of the more legitimate cannabis stocks, viewed as low-cost call options, the best risk-adjusted returns should be sought in established industries, especially tobacco, which is on record for researching the business for decades and stands to profit more and faster than any other industry due to its established and directly relevant model.

"Make the most of the Indian Hemp seed and sow it everywhere" - George Washington

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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