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Pot stocks soaring: Why investors are willing to overlook the risks

While some investors caution marijuana is a highly speculative market, others are confident there’s a lot of money yet to be made.

Blair Gable/Reuters

Canadian pot stocks soared on Monday amid reports that Ottawa is readying to announce legislation to legalize the recreational use of marijuana before April 20, considered a celebratory day in cannabis culture.

Investors were certainly cheering, sending shares of Canopy Growth Corp., Canada's largest producer, as well as Aurora Cannabis Inc. and OrganiGram Holdings Inc., each up 11 per cent on Monday. Cronos Group Inc.'s stock rose 13 per cent, while Emerald Health Therapeutics Inc. was up nearly 9 per cent. Supreme Pharmaceuticals Inc. shares increased six per cent.

The legislation was expected this spring, but there were recent concerns about delays that caused marijuana stocks to sell off earlier this month. Pot stocks are known for their volatility and are considered high risk given it's a nascent industry and the uncertainties around how an untested legal recreational market would operate.

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Still, analysts say the more specific timeline, including a CBC report on Sunday that marijuana will be legal for recreational use by July 1, 2018, provides clarity and confidence for investors.

"The recreational market looks more real than it did 24 hours ago," Echelon Wealth Partners analyst Russell Stanley said in an interview on Monday.

Mr. Stanley covers Canopy and Emblem and has a "speculative buy" on both. His $14 target price on Canopy implies nearly 30-per-cent return from its current price around $11, while his $5.25 target on Emblem is double its price of around $2.50.

"We are still in the early innings in the development of the space," Mr. Stanley said.

He pegs the current value of Canada's medical marijuana sector at about $340-million, based on about 130,000 patients today, and expects that to grow to about 450,000 patients in the next couple of years, valuing the industry at around $1.2-billion. If cannabis is legalized for recreational use in Canada, Mr. Stanley forecasts the combined medical and recreational market to reach about $8.6-billion by 2021. For context, Canadians spend about $20-billion a year on alcohol.

Beacon Securities analyst Vahan Ajamian, who covers Canopy, Cronos, Supreme and iAnthus Capital Holdings Inc., says news of pending legislation "cements the fact that legalization is happening." He describes the market as a "once-in-a-generation opportunity" for investors.

Still, analysts warn it's risky play for investors, given that it's not yet clear what new regulations will look like and how well individual companies will grow and expand in a new recreational market to meet demand.

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"If legislation is tabled as expected this spring, we believe there could be significant lag time before legalization occurs; we therefore recommend that investors look for companies with differentiated strategies and stock-specific potential catalysts over the next year," Canaccord Genuity analyst Neil Maruoka said in a March 13 note, where he initiated coverage of five stocks, including a "hold" on Canopy and Aphria. "While fundamentals remain strong, we believe that valuations may be stretched amongst the larger players."

In December, a Liberal government task force proposed that Canada's recreational marijuana market be open to people over the age of 18 and include restrictions on quantities sold and where, as well as how it can be advertised. The task force also recommended the government move quickly to increase or create capacity for the production and sale of cannabis.

Canopy chief executive officer Bruce Linton expects the legislation to closely follow the proposed recommendations, which is good news for the industry.

"There's only good and better," Mr. Linton said in an interview on Monday. "They're doing what they said they would do, which is a significant political decision."

He expects four or five product routes that will be tightly regulated, price competitive and include measures to help educate consumers about responsible cannabis use.

Meantime, Mr. Linton says Canopy has been positioning the company for the rapid growth expected if marijuana is approved for recreational use. The company recently bought competitor Mettrum Health Corp., closed a $24.3-million private placement with one investor to help expand its capacity, and announced a 50-per-cent increase in flower production space and a tripling of capacity at its Tweed-brand operations in Smiths Falls, Ont. The company also recently graduated to the TSX, which  gives it broader exposure to investors.

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Mr. Linton said the company is on the hunt for more acquisitions to further expand and that its rising stock price, "as a currency, makes things less costly to buy, but I don't think it makes it a rush. You either have your selection now, or you don't."

Bruce Campbell, portfolio manager at StoneCastle Investment Management, added a handful of pot stocks when they sold off a few weeks ago, including Cronos and OrganiGram, and is waiting for a few names to go public this spring.

He sold his Canopy stock about a month ago, but plans to buy it back with his new fund, the StoneCastle New Era Cannabis Fund, set to launch later this spring.

In February, Horizons ETFs Management filed a proposal to list the Horizons Medical Marijuana Life Sciences ETF (HMMJ) on the Toronto Stock Exchange, to provide exposure to North American life sciences companies with "significant business activities in the marijuana industry."

Special to The Globe and Mail

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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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