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Inside the Market Investors are trading Second Cup like a cannabis stock - and some are getting burned

Second Cup Ltd. is discovering that the stock market’s madness for marijuana comes with a downside.

The Mississauga-based coffee chain, which has suffered from declining sales in recent years as it battles multinational behemoths such as Starbucks Corp. and McDonalds Corp., struck a deal in the spring to convert some of its cafés into cannabis dispensaries.

Its stock price quickly shot up to their highest point in years. Within days, the shares had gone up nearly 50 per cent, to more than $4, a level they had not seen since early 2015.

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And since then? Investors have lost all of those gains, amid a volatile ride for the entire cannabis sector as the country edges toward legalization of the drug in October.



“It’s one of those stocks where it’s getting priced like a marijuana stock,” said Ryan Modesto, chief executive of the independent 5i Research. “If the marijuana industry continues to run … Second Cup could benefit from that, but it works both ways.”

There has been other corporate news since Second Cup announced in April that it had an agreement with marijuana clinic operator National Access Cannabis (NAC) to develop and operate recreational cannabis stores and lounges, starting in Western Canada, once the product is legalized.

On April 17, the company announced a $10-million bought-deal offering to pay part of the cost of setting up the cannabis locations. On May 11, it reported a 2.2-per-cent drop in first-quarter same-store sales, while reporting a negligible loss of $138,000 in the quarter.

Still, the cannabis connection appears to be giving the stock its latest jolt, which could either be a benefit or burden for its long-suffering shareholders. The shares closed on Tuesday at $2.76. They were as high as $8.65 in 2011.

Second Cup has faltered in recent years in the face of increased competition from Tim Hortons, Starbucks, McDonald’s and smaller coffee chains.

“On the core business, the coffee shops, we don’t find it to be the most intriguing investment opportunity,” Mr. Modesto said. He is also skeptical of the broader marijuana sector and its soaring valuations.

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For investors seeking a similarly diversified cannabis play, Mr. Modesto prefers Alcanna Inc. (formerly Liquor Stores N.A.), which plans to launch cannabis retail outlets in Western Canada. He says the stock is cheaper based on a few metrics, and has more experience with government regulation, given its core alcohol business.

Still, Mr. Modesto acknowledges Second Cup needs a new strategy to remain competitive and has some advantages compared to larger competitors.

“There’s less at risk, in theory, for them in making this change – because they need to change something,” he said. “They have more upside than someone like Starbucks, which could damage their brand if it’s not the right move at the right time.”

Second Cup chief executive officer Garry Macdonald said in an e-mail that coffee and cannabis will not be sold in the same retail outlets.

“[The] dispensaries will not be Second Cup cafés, nor will they feature any Second Cup branding – they’ll be stand-alone stores, with a new name and a new brand … Similarly, there will be no cannabis or cannabis-related products sold at any Second Cup cafés,” said Mr. Macdonald, who was named interim CEO in May, 2017, and had the interim part removed in January.

He said the alliance with NAC is a way to leverage its real estate assets and “to drive value for our shareholders and franchisees.” Mr. Macdonald said the coffee chain plans to grow through new products and by opening new cafés.

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Same-store sales at Second Cup fell 0.2 per cent in 2017, an improvement from a 1.1-per-cent drop in 2016, and Mr. Macdonald said increasing the key retail measure “remains a priority.” He also said “expanding Second Cup access is a key initiative.” Second Cup had 279 cafés at the end of the first quarter, down from 293 a year ago, according to its first-quarter results.

Some investors aren’t on board with Second Cup’s new strategy, in particular, the move into cannabis.

Norman Levine, managing director at Portfolio Management Corp., said the stock has always been too risky for him to buy for his clients, but he became personally interested having known Second Cup chairman Michael Bregman since both were waterskiing instructors at a summer camp in 1971. He bought the stock in his personal portfolio in early 2014.

“When Michael bought a chunk of stock ... and brought in [former CEO Alix Box], I said to myself that he is a smart guy who started the company and knows it and the business well and I would put some of my money up along with his,” Mr. Levine said.

It has been rough waters for Second Cup stock ever since. Mr. Levine sold his stock when the price surged on the cannabis announcement.

“I woke up one morning a few months ago and discovered [Second Cup] is now in the marijuana business. … It gave me the chance to get out of it,” said Mr. Levine, who believes the pot sector is risky and overvalued.

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