Legal Risk Takes 6% Bite Out Of Canadian Cannabis Index

It’s normal for high-growth industries to have huge swings. One day it’s a big win and then the next day its a step or two back.

2017 has been another big step forward for the Canadian cannabis industry. Canada officially announced recreational cannabis will be legal in the summer of 2018.

And after some weakness this spring, the Canadian cannabis stock index is up 23% in the last month.

However, what you can also see in the chart is that cannabis stocks took a sharp turn lower early this week.

What caused the sudden break in upward momentum?

It looks like an important regulatory battle is brewing in the Canadian cannabis industry.

In the short run, it spooked cannabis investors. But in the long run, it’s actually creating a great investment opportunity.

Toronto Stock Exchange Just Issued a Warning to Canadian Companies operating in the United States

Yesterday, the Toronto Stock Exchange TSX released an important regulatory reminder to the cannabis industry.

TSX said that Canadian cannabis companies doing business in the US are breaking US federal law and could be delisted from the Toronto Stock Exchange for no compliance.

Here’s a direct quote from the Star.

“The Toronto Stock Exchange will contact all companies that cultivate, distribute or possess marijuana, or offer services related to the drug in any jurisdiction, by the end of the year. If they’re found to be in violation of U.S. federal law, they could ultimately be delisted, said Ungad Chadda, president of capital formation for equity capital markets at TMX Group Ltd., the parent company for bourses Toronto Stock Exchange and TSX Venture Exchange.

“There may be issuers on our market that are not in compliance with the requirements. We will only come to find that out through the process of our review,” Chadda said in a briefing with reporters at TMX’s offices in Toronto. “If you’re violating federal law, you’re out.”

Ouch. Not very friendly.

In the short run, the news rattled cannabis stocks, triggering broad weakness across the entire sector.

The Canadian cannabis index fell 6%.

Cannabis companies with operations in the US were hit the hardest.

Aphria Corp OTC: APHQF), one of Canada’s largest and most successful cannabis companies, fell 13%. In April Aphria announced a deal in Florida.

In the short run, I see this as a chance to buy on a dip. In the long run, I see it as strengthening the Canadian cannabis industry.

Worst Case Scenario Wouldn’t Have a Big Impact on Industry Revenue or Growth

If Canadian cannabis companies were forced to divest out of US operations it would have little impact on current revenue or future growth.

Right now Canadian cannabis industry isn’t doing much business in the US.

There are about 50 stocks on the TSX with cannabis-related operations. From that group, only about 12 have operations in the US and account for around 10% of TSX cannabis trading volume.

The other worst case scenario is downlisting to a smaller exchange with looser regulations.

For example to the smaller and more cannabis friendly Canadian Securities Exchange.

Early this week Canadian Securities Administrators announced it would allow cannabis companies with US operations to list on the exchange with a few extra regulatory filings.

My opinion on exchange listing is there’s no way the Toronto Stock Exchange is going to let a company like Aphria walk away.

The TSX is a for-profit exchange and Aphria is great business.

Aphria has been a pioneer and early industry leader.

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It became the second cannabis company to list on TSX after Canopy.

It’s one of the most heavily traded stocks.

And it’s generated more than $215 million in capital.

Bottom line here is that Aprhia’s listing stuffs a lot of cash into the TSX.

I see virtually no chance of Aphria and other TSX listed cannabis companies getting booted off the exchange.

Best Case Scenario is Buy the Dip and the Cannabis Industry Gets Stronger

I am hearing whispers on the Street that this little dust-up could be fixed very easily.

Rumor has it that Aphria and other cannabis companies could simply file a new regulatory disclosure to stay compliant.

It’s also important to understand that Aphria is prepared to fight for its listing.

Aphria’s CEO Vic Neufeld said the TSX knew about its plans to invest in the US.

He didn’t stop there.

“This is very irresponsible of the TSX. How in the world are they going to adjudicate and apply a very broad statement like that?”

The cannabis industry has become powerful and influential. The industry has tens of millions of dollars to fight legal battle. It’s not going to curl into the fetal position and beg for mercy.

Aphria is intent on keeping its listing on the TSX.

How do We Proceed from Here?

I think today’s weakness was an overreaction and I view the pullback as an opportunity to buy.

Particularly because:

Canadian cannabis stocks are up huge in the last few months. many back to the all-time high.

That includes Aphria. Shares are up 78% in the last few months. Take a look below.

When you see these big gains in the last few months this 13% decline doesn’t look significant. A lot of investors were sitting on some quick and easy gains and they simply said, “let’s take a little profit on the news.”

My plan is to continue adding shares for my wealth management clients and use this weakness to buy the dip.

Bigger Picture this is exactly what progress looks like.

It’s not always glamorous. Sometimes it’s ugly and sometimes it involves lawsuits. But sometimes that’s just the price an industry or company has to pay for growth.

This latest clash will ultimately strengthen the regulatory environment. That’s good for the cannabis industry.

Michael Vodicka owns shares of Aphria at time of writing.