Growth industry

Growth industry

Growth industry Canada is not best known as a trailblazer. It generally suffers in comparison to its much larger neighbour, but there is one area where the Great White North is now leading the way. On April 17, the Trudeau government tabled legislation to legalize marijuana for recreational use, becoming the first G7 nation to do so. In the US, there are now 29 states where the drug is legal for either medicinal or recreational use, but possession and distribution of marijuana remains a federal crime.

Canada is therefore forging its own path on this issue, creating a new industry out of what was previously the preserve of the black market. That means new opportunities to invest, but is investing in a cannabis producer a smart move? That’s the question advisors across Canada are now asking themselves, and opinion is divided.

Canopy Growth is the heavyweight of the legal marijuana industry in Canada. Based in Smith Falls, Ontario, it became the world’s first publicly listed cannabis producer in 2014. Today it has a market cap of $1.7 billion and exports to Brazil and Germany. It currently serves the medical market, but its production facilities mean it is ideally placed to take advantage of the legalization of recreational marijuana. It’s not alone in this respect, either – other key names in the space include Aphria, Aurora Cannabis, OrganiGram Holdings, Supreme Pharmaceuticals and Emblem.

In March, Canaccord Genuity started coverage of the sector; analyst Neil Maruoka named Aurora Cannabis as his top pick. Maruoka identified the significant economies of scale for existing producers as a positive, but cautioned that making accurate valuations of cannabis companies is difficult.

Grant White of National Bank Financial is one advisor adopting a wait-and-see approach to this sector. “These stocks have shot up, but I don’t think there is a lot to justify where the valuations are,” he says. “Investors are going on a hope and a prayer on the valuations. I think there will be lots of demand for the products, but the fact of the matter is we still don’t know how it is all going to work.”

The announcement of the bill to legalize recreational marijuana use was short in detail as to how the drug will be distributed – a key factor in determining which companies will prosper under the new system. For that reason, White won’t be putting his clients’ money into cannabis stocks anytime soon.

“With a product like this, there are going to be restrictions on advertising, so that could limit a company’s ability to diversify their product and create a leading brand,” he says. “If there is limited ability to develop a brand, then you might run into trouble with the companies you own.”

Despite the reservations, this is undoubtedly an industry with huge growth potential. The North American medical marijuana market recorded US$6.7 billion in revenue in 2016 – a 30% increase on the previous year. Canaccord Genuity has predicted that Canada’s recreational marijuana market could reach $6 billion in annual retail revenue by 2021, and medical sales could drive that figure up to almost $8 billion.

Horizons ETFs is one company that clearly sees huge potential in this market. In April, the firm launched the world’s first ETF dedicated to the medical marijuana industry. The Horizons Medical Marijuana Life Sciences ETF is made up of North American-listed stocks, including licensed producers in Canada like Aurora and Canopy, as well as biopharmaceuticals, medical manufacturing, distribution, bioproducts and other ancillary businesses to the marijuana industry. Steve Hawkins, CEO of Horizons ETFs, outlines what this product offers investors.

“One of the benefits of having an ETF with a diverse portfolio is you are not dealing with the individual volatility of one specific stock,” he says. “We have Scotts and GW Pharmaceuticals in there, which are pretty stable companies. There is a lot of risk reward to get exposure to this industry, but the index we have built is diversified enough to provide a stable return going forward.”

Hawkins and his team at Horizons clearly believe the potential rewards far outweigh the risks, which is why the firm was so keen to become a pioneer in the space.

“The individual use of medical marijuana has grown by 400% to 500% in the past year alone in Canada,” he says. “We went from zero to a $250 million industry in a year and a half, and there’s potential to go over a billion dollars this year.”

 

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