3 Stocks To Consider In Canada Pot Market

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Includes: APHQF, GILD, OGRMF, TWMJF
by: Michael Hooper

Summary

Canada moves faster than USA toward full legalization of marijuana.

Canopy Growth and Aphria have shown profits in recent quarters.

A look at the U.S. Market and Donald Trump.

While U.S. states have been passing medical and recreational marijuana laws, Canada is moving along faster toward legalization of cannabis than in the United States. The legal framework in Canada is much more supportive of the Canadian companies operating there, while those in the U.S. may operate legally in their state, but fear the mighty hand of the U.S. federal government, which still considers cannabis to be a Schedule 1 drug "With no currently accepted medical use and a high potential for abuse."

Twenty-eight U.S. states have legalized medical marijuana. Eight U.S. states -- Nevada, Maine, Colorado, Washington, California, Massachusetts, Alaska and Oregon -- have approved the sale of medical and recreational use of cannabis, but timetables for implementation vary.

Jeff Sessions, Donald Trump's pick for Attorney General, does not appear to be a big fan of cannabis, but I think the Trump Administration has already made it clear that its top priorities are corporate tax reform, job growth, immigration and health care. I expect Trump to work on tax reform and health care in the first year. When faced with a decision on cannabis, I imagine Trump will see that new pot laws in over half of U.S. states have created tens of thousands jobs, hundreds of millions of dollars in tax revenue, helped the sick, and taken the pot trade away from Mexico. He probably would leave good alone, while pursuing other things that matter to him.

Meanwhile, Canada is allowing licensed producers to sell cannabis to customers who obtain a medical cannabis prescription. Canada's federal laws support medicinal benefits of marijuana. Canada approved passage of the Marijuana for Medical Purposes Regulations (MMPR). The law authorized licensed producers to grow and sell cannabis to registered users who obtained a medical cannabis prescription.

Canada is the leader in the reform of cannabis regulation. The system in place today has successfully introduced about 100,000 Canadians to a legal source of cannabis for medical purposes.

Industry experts say the success of the Access to Cannabis for Medical Purposes Regulations is evident in its growth, which has continued at a rate of approximately 10% per month for more than two straight years. That means the industry is on track to more than double in size in a year.

Pot advocates say the quality of product is improving across Canada, while average prices have come down. Patients in Canada now have cannabis oils and capsules to choose from, in addition to a variety of dried cannabis options.

The next step for Canada is passing laws to handle recreational use of cannabis. The Liberal government announced that it would be introducing new legislation April 20, with target implementation January 2018. Legislation will likely follow findings in the work of The Task Force on Cannabis Legalization and Regulation for Health Canada. The Task Force recently published A Framework For The Legalization and Regulation of Cannabis in Canada.

Some highlights

--Set a national minimum age of purchase of 18.

--Apply restrictions to the advertising and promotion of cannabis -- similar to restrictions on promotions of tobacco products.

--Prohibit mixed products, such as cannabis-infused alcoholic beverages. No co-location of alcohol or tobacco with cannabis sales.

--The Task Force recommends allowing personal cultivation of cannabis for non-medical purposes a limit of four plants per residence, maximum height 100 cm.

--The Task Force also recommends using licensing and production controls to encourage a diverse, competitive market that also includes small producers.

Among the licensed producers are Canopy Growth (OTCPK:TWMJF), Aphria (OTCQB:APHQF) and Organigram Holdings (OTCQB:OGRMF).

Canopy Growth's Tweed Farms Inc. is a Licensed Producer for Cultivation and Sale since Aug. 8, 2014.

Canopy has achieved tremendous gains over the past two and a half years. Most notably, the company had over 24,400 registered patients on Sept. 30, 2016, compared to 16,600 in the previous quarter. That's 46% growth quarter to quarter.

When second quarter fiscal 2017 ended Sept. 30, Canopy's revenue of $8,498,000 Canadian dollars was up 22% over the previous quarter, and up 245% over the second quarter of fiscal 2016 when revenue totaled $2,466,000. Canapy sold 1,169,000 grams of cannabis in the quarter, representing an increase of 19% over the first quarter of Fiscal 2017 and an increase of 267% over the second quarter of last year. The company reported $5.4 million net income or $0.05 per share.

Canopy's Tweed Farms greenhouse grows a variety of high quality cannabis strains that sell, through Tweed, across multiple price points, from value strains, priced at $6 per gram, to premium strains, priced at $12 per gram.

In the quarter ended Sept. 30, Canopy sold 1,169 kilograms or 1,169,000 grams. At an average price of $7.01 per gram, that would generate $8.19 million in one quarter. I expect that number to double, triple in the next two years.

Tweed is housed in a former Hershey chocolate factory at 1 Hershey Drive, Smith Falls, Ontario. the campus comprises 40 acres of land with over 500,000 square feet of available space. Tweed occupies 168,000 square feet of licensed production space, plus office space where Canopy's head office drives the vision forward. It is a data-driven, automated and lean operation, housing an R&D facility, oil extraction infrastructure, and in-house lab. Precise climate controlled spaces for each stage of cannabis production, from clone to cured bud, allows for the highest quality and widest variety of product in the sector.

Canopy stock is up 278% in the past 12 months. Aphria stock is up 374% in the past 12 months. Aphria considers itself a low-cost producer, supplier and seller of medical cannabis. Located in Leamington, Ontario, the greenhouse capital of Canada. Aphria is truly powered by sunlight, allowing for the most natural growing conditions available. The company is committed to providing pharma grade medical cannabis, superior patient care while balancing patient economics and returns to shareholders. "We are the first public licensed producer to report positive cash flow from operations and the first to report positive earnings in consecutive quarters," Aphria says.

Because there is the legal framework for licensed cannabis businesses in Canada, companies like Canopy, Organigram and Aphria make their headquarters there, but also can operate in other markets like the United States, Germany and Brazil. Organigram Holdings has a market cap of $280 million and is operating in Canada and Colorado with plans to open other shops in Illinois, Oregon, Florida and Maryland. Organigram stock is up 249% in the past 12 months.

Stock markets tend to run in cycles. We had the tech sector run-up in the 1990s followed by the tech crash in 2000-01. We had real estate bubble in the mid 2000s, that blew up, followed by the big stock market crash in 2008-09. Then we entered the longest recovery, it was steady about 2% GDP growth annually during the Obama years, not bad, really. Biotech/drug stock sector is now the disenfranchised and unloved, some of these stocks, like Gilead Sciences (NASDAQ:GILD) are trading at 7 times earnings. If you are looking for deals, you might consider the biotech/drug sector.

By comparison, Canadian pot stocks are trading at very high valuations already. Canopy Growth's market capitalization of $1.2 billion is an extremely high valuation for a company that had about $8 million in revenue in its most recent quarter.

Aphria's market cap is $500 million; the company only had $4.3 million revenue, with $895,000 income, in quarter ended in August 2016.

The cannabis industry is creating thousands of jobs in Canada and the United States. This is a multi-billion dollar industry, with job growth at all levels, from production to processing to sales, plus so many jobs supporting the industry, like companies that make grow lights.

Canada has 36 million people. About 28 million are older than 19. About 12% of Canada's population aged 15-64 use marijuana. That's a pot market of about 3.3 million.

I think prospects for growth in cannabis sales look more attractive in Canada compared to Kansas. I plan to acquire shares in two or three Canadian companies in the cannabis business, and will be looking for opportunities in 2017. I recently purchased a few hundred shares in Canopy Growth and Aphria. I am buying these Canadian pot stocks at very high valuations, but they are making money, the pot industry in Canada will likely double this year in the medicinal arena and then triple when there is full legalization of recreational marijuana in 2018. The stocks may double with the growth in sales, but the stocks could also go down substantially, depending on what happens with federal regulation. The risk/reward ratio is high on this trade. Valuations are high. Since there is so little volume in pot stocks some days, the prices tend to swing widely. But what if this pot industry explodes into 10 times what it is today? Companies that supply legal weed to the masses will do well.

Disclosure: I am/we are long TWMJF, APHQF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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