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Why pot stocks in Canada are suddenly hot again

The federal government is aiming to legalize recreational marijuana on July 1, 2018.

Joe Mahoney/THE CANADIAN PRESS

Investors are once again bullish on cannabis stocks as governments unveil measures that move Canada closer to legalizing recreational marijuana.

Prime Minister Justin Trudeau is proposing a 10-per-cent federal tax on recreational cannabis and says Ottawa will split the expected new revenue 50-50 with the provinces. Alberta announced a draft framework for how it would handle legalized marijuana in the province on Wednesday, which comes weeks after Ontario unveiled its own plans. New Brunswick recently set up a Crown corporation to oversee the sale of recreational marijuana and signed deals with two suppliers.

Ottawa's 10-per-cent tax proposal came in lower than some analysts expected, and is well less than what's levied in most U.S. states where pot is legal for recreational use.

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While a lower tax is beneficial for licensed Canadian producers because it's competitive with the black market Ottawa is trying to stamp out, analysts say it's the certainty the tax proposal suggests that has investors snapping up more shares of marijuana companies.

"Stocks are responding to the bigger picture – a bit more certainty as to how the market will look once it is legalized," Echelon Wealth Partners analyst Russell Stanley said.

"Now investors can focus on what individual companies can produce in a legal market, rather than wondering what the market is going to look like," Mr. Stanley said. "It's that reduction of uncertainty that the market likes."

Shares of Canopy Growth Corp., Canada's largest marijuana producer, closed up 4 per cent on Wednesday. Other large producers also saw increases including Aphria Inc. and Aurora Cannabis Inc., which saw their shares rise 2.5 per cent and 2.1 per cent, respectively. The Horizons Marijuana Life Sciences Index ETF, Canada's first cannabis ETF, was up 2.6 per cent.

Beacon Securities analyst Vahan Ajamian said the tax proposal "shows how serious the federal government is regarding working through remaining details and pushing ahead with legalization."

While it is unclear whether GST and/or provincial taxes will also be levied on recreational marijuana, "the proposed excise tax is lower than we expected," he said in a note.

"Based on our calculations, and commentary from LP [licensed producer] executives, we believe LPs should be able to prosper under such a regime."

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Mr. Ajamian also said the marijuana sector has been "melting up" in recent weeks.

"On the back of several macro developments, such as rollout plans from many provinces, 23 out of 27 investments tracked have recorded double-digit gains since the end of August, 2017."

Marijuana stocks rallied in the weeks leading up to early April, when Ottawa tabled its legislation with a self-imposed deadline to legalize cannabis by July 1, 2018. Then marijuana stocks pulled back over the late spring and summer months, before starting to crawl back in recent weeks. One catalyst for the comeback was the Ontario government's announcement in early September about how it would manage the sale and use of marijuana, including government-run stores across the province and online sales of recreational cannabis when legal.

Canopy shares have increased by about 29 per cent since Ontario's announcement, for example, while Aurora stock is up around 13 per cent and Aphria has risen by about 22 per cent.

"Each time we have one of these announcements, it seems to add more conviction," said PI Financial analyst Jason Zandberg, noting that more institutional investors are also starting to buy in.

"I think there were a lot of investors that were still skeptical that we were going to get a legal market, that this was going to happen, even though the writing has been on the wall for a long time."

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Mr. Zandberg recommends investors be selective about which stocks they get into and recommends the big producers or companies with niche products in the market.

"Everything can go up, but only the good ones stay up, in my opinion," Mr. Zandberg said.

Bruce Campbell, a portfolio manager at StoneCastle Investment Management, significantly reduced his exposure to the sector ahead of the legislation being tabled last spring and started buying again in late August and September, anticipating more measures that would move the country closer to legalization.

He says investors should expect more volatility in the months ahead.

"One concern we have is getting all of this in place by July [of 2018]," Mr. Campbell said. "There is a potential we could see another pullback going into the winter," with another rally into 2018 as legalization gets closer to reality.

"We are nimble in this industry, but long term we think that this is going to be a huge growth business."

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About the Author
Contributor

Brenda Bouw is a freelance writer and editor based in Vancouver. She has more than 20 years of experience as a business reporter, including at The Globe and Mail, The Canadian Press, the Financial Post and was executive producer at BNN (formerly ROBTv). Brenda was also part of the Globe and Mail reporting team that won the 2010 National Newspaper Award for business journalism. More

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