BUY $15.00 Company Update & Q4 Preview · 2017. 6. 20. · June 20, 2017 Vahan Ajamian, CPA, CA, CFA Analyst - (416) 643-3879 [email protected] In this report we provide

Beacon Securities Ltd.| 66 Wellington Street West, Suite 4050, Toronto, Ontario, M5K 1H1 |416.643.3830|www.beaconsecurities.ca

Canopy Growth Corp. (WEED-T)

Seeds Planted Across The Garden

To Support Long-Term Growth

June 20, 2017

Vahan Ajamian, CPA, CA, CFA Analyst - (416) 643-3879

[email protected]

In this report we provide an update on the numerous significant updates

Canopy has recently disclosed. In summary, we feel that these initiatives

are in line with Canopy’s overall strategy and help cement its ability to win

the long game globally (dominating market share and production

capacity creating and/or offering multiple consumer facing brands,

focusing on higher value products as permitted by government

regulations, and pursuing international opportunities where federally legal).

Canopy launched Tweed Main Street in early April, providing a one-stop

shop for its 58+K registered patients to access inventory across all of its

wholly owned brands. Yesterday, the company released product from the

first of its four CraftGrow partners onto the site (Canada’s Island Garden).

The company further added to the diversity of its selection with the launch

of its Black Label brand of gel capsules.

Canopy Rivers, the company’s streaming vehicle had its capabilities

beefed up via a $36MM offering, bringing its total cash resources available

to $56MM. We look forward to receiving details regarding its first few

streaming contracts.

Canopy unveiled Spectrum Cannabis, its international medical brand and

disclosed expansion in both Germany and Chile.

The number of LPs licensed by Health Canada has jumped this month to

50. In this context, we define Canopy’s ‘sphere of influence’ as including

10 LPs and two applicants which it either owns or is partnered with via

CraftGrow – with more coming via Canopy Rivers. We believe this puts the

company in a very enviable position.

Being a ‘double outlier’ puts us in a tricky spot. In what may speak to the

inherent lack of clear visibility in the marijuana sector, and the variabilities

involved in constructing a DCF, we note that we have both the lowest

revenue and EBITDA forecasts for the coming quarter and fiscal year, yet

the second-highest price target on the Street.

Canopy will report Q4/FY17 (March) results on June 27, 2017. While clearly

an imperfect measure, we noted a significant dropoff in Tweed’s product

availability heading into the end of the quarter, which, particularly given

Q3/FY17’s experience, causes us some short-term concern. To be clear,

we still believe our $15.0MM (unchanged) forecast is still achievable;

however, even under such a scenario, revenue would be $2MM below the

Street. Looking forward, given the resurgence of availability of Tweed

strains over the past two months and the superior structure of Tweed Main

Street, we feel supply constraints may now be largely behind the

company.

We have made no changes to our estimates and we note that Canopy is

the best performing Canadian LP since the ‘sell on news’ began with the

introduction of legislation on April 13, 2017. We maintain our Buy

recommendation and $15.00 target price.

BUY (Unch) $15.00 (Unch)

$7.95

$15.00

89%

$2.62 - $17.86

YE: Mar 31 FY16A FY17E FY18E

Revenue ($MM) $12.7 $40.2 $99.4

FD EPS -$0.05 -$0.05 -$0.13

FY16A FY17E FY18E

EV/Sales 91.9x 29.0x 11.7x

P/E nmf nmf nmf

Basic 163.2

FD 172.9

Market Cap

Basic $1,297.8

FD $1,374.4

Net Debt -$130.5

Enterprise Value $1,167.2

Company Update & Q4 Preview

Previous Close

12-month Target Price

Potential Return

52 Week Price Range

Estimates

Valuation

Stock Data (MM)

Shares Outstanding

About the Company

Canopy Growth is in the business of producing and selling medical

marijuana in Canada and is positioning itself for the pending

legalization of the recreational market. The company's brands

include: Tweed; DNA Genetics; Leafs By Snoop; Mettrum and

Bedrocan. Canopy is headquartered in Smiths Falls, Ontario.

All figures in C$ unless otherwise indicated.

Stock Performance

mailto:[email protected]

June 20, 2017 |Page 2 Vahan Ajamian | Analyst | 416.643.3879 | [email protected]

theScore, Inc. Canopy Growth Corp.

Major Domestic Developments

Tweed Main Street Selling Product Of Its First Partner LP & Gel Capsules

In early April Canopy launched Tweed Main Street, a consolidated

one-stop-shop, e-commerce site for all of Canopy’s owned brands as

well as those of a few third party cannabis licensed producers. To the

extent of our knowledge, the only other LP/applicant looking to sell

other producers’ marijuana online is Namaste Technologies Inc. (N-C,

not covered) via its CannMart subsidiary (which, as an applicant is

well behind Canopy).

Prior to the launch of Tweed Main Street, Canopy’s LP subsidiaries were

completely separate businesses with distinct retail stores.

Accordingly, a patient that had signed up with Tweed could not

access any of Bedrocan or Mettrum’s inventory. Now Canopy’s

58,000+ customers can access the availability of all of Canopy’s

brands, as well as those of its partners, in one location.

The platform includes CraftGrow, a collection of “distinct small batch

cannabis” strains grown by smaller (craft) producers. In our opinion,

this arrangement allows these smaller operators to focus on what they

would like to do most (grow high quality marijuana), without having to

deal with much of ‘the business side of things’ (finding customers,

setting up a call centre, fulfillment etc.), all while allowing access to

Canopy’s immense resources and customer base. Canopy will

receive a revenue share on these products, and enforce its high

standards of quality / operating procedures on them.

Three CraftGrow LP partners have been announced to date: AB

Laboratories (part of Invictus MD Strategies Corp. (IMH-V, not

covered)); JWC Ltd.; and Canada’s Island Garden – as well as PUF

Ventures Inc. (PUF-V, not covered), a late stage applicant.

Yesterday, Canopy announced two meaningful additions to Tweed

Main Street.

o It started selling product of its first CraftGrow partner, Canada’s

Island Garden – three strains selling for $9/g each, with THC

levels ranging from 5% to 21% (CBD ranging from 0% to 7%).

o The company launched Black Label, its line of soft gel

capsules.




Exhibit 1. Availability – Canada’s Island Garden (top) & Black Label Soft Gel Capsules (bottom)

Source: Tweedmainstreet.com

On April 20, 2017, Canopy’s Tweed subsidiary expanded its product

offering to include FORIA, a cannabis-infused personal lubricant,

largely marketed as an intimacy oil. The product has “over 20,000

registered individuals in the online FORIA network” and has seen strong

consumer interest with “daily inquiries coming in from women and their

partners across the globe”. In our view, such additions really serve to

cement Canopy’s status as a one-stop shop for various marijuana

derived products from various producers.




Canopy Rivers’ Resources Tripled

On April 27, 2017, Canopy established Canopy Rivers Corporation, a

seed capital fund to invest in and support ACMPR applicants and

licensed producers.

Canopy Rivers will operate as a joint venture to Canopy Growth Corp.

and will offer “growth capital and strategic support to selected

partners in exchange for a contracted stream of future cannabis

production”, providing a source of additional and diversified cannabis

supply.

Streams entered into by Canopy Rivers “will be priced and structured

consistently with the risks, value proposition, and requirements of our

counterparties. Capital invested in each streaming partner may

involve an upfront payment, may include additional license or

production based milestones payments, and may also involve equity

or and/or equity linked securities.”

Canopy initially seeded Canopy Rivers with $20MM of its own funds.

The company announced yesterday that it raised a further $36.2MM

via a syndicate. Canopy Rivers now has $~56MM of capital on hand,

which puts it essentially equal to the financing announced by

Cannabis Wheaton Income Corp. (CBW-V, not covered).

While we will have to see the specifics of deals Canopy Rivers enters

into, as a concept, we believe it has the potential to add meaningful

value for the company as well as its partners, which can benefit from

Canopy’s ‘oomph’ (regulatory know-how, financial resources,

standard operating procedures, and patient count). We expect

Canopy Rivers to add to the diversity of Canopy’s supply and further

broaden its influence within the sector.

With its financing having just closed, we look forward to the company

announcing its first few streaming partners – and we foresee them

turning into CraftGrow partners sold via Tweed Main Street.

Tweed HomeGrow Collection

In March Canopy launched Tweed HomeGrow, a seedbank,

containing a diverse collection of imported cannabis seeds from

around the world for sale to authorized home growers under ACMPR

regulations in Canada.

Seeds from 10 different strains are available for sale under Canopy’s

HomeGrow collection ($30 to $55 for three seeds). We note that only

2 of the 50 LPs sell seeds (Tweed and CannTrust), and only 10 have any

starting materials for sale.




Exhibit 2. Tweed’s HomeGrow Offerings

Source: Company website.

The number of active patients registered to produce their own

medicine at home jumped 68% sequentially to 3,422. 93% of these

patients have elected to produce their own medicine directly, while

7% have designated another person to grow it.

Exhibit 3. Personal And Dedicated Production Active Registrations

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Jun-16 Sep-16 Dec-16 Mar-17Production for own medical purposes Production by a designated person

Source: Health Canada.




Under proposed legislation, Canadians will be legally allowed to grow

up to four marijuana plants (not more than one metre high) per

residence for personal use. While we view this as a niche market

(represents 2% of patients which buy from LPs), we are encouraged to

see Canopy appear to have a good hold on this market – and we

believe it could drive more patients/users to the Tweed brand in

general.

Canopy announced yesterday that medical patients registered by

July 1, 2018, “will receive priority over future recreational customers” in

terms of supply. We believe LPs which may end up being supply

constrained and sell to recreational customers over patients may

suffer significant negative PR.

Now Almost Has A Coast To Coast Production Platform

Last Friday, Canopy’s subsidiary rTrees Producers Limited (aka Tweed

Grasslands) was issued its cultivation license. Tweed Grasslands will

operate a 90,000 sq. ft. facility in Yorkton, Saskatchewan with the

capacity to expand operations to over 300,000 sq. ft. as the markets

for medical and recreational cannabis develop.

This development makes Canopy and Cronos Group Inc. (MJN-V) the

only two LPs which own licenses in multiple provinces – although

Canopy may promptly enter the Quebec market via its Vert subsidiary

(an applicant in the province).

We believe Canopy continues to look west of Saskatchewan for more

production capability. In our view, the acquisition of another late

stage applicant in British Columbia and/or Alberta is the company’s

most likely route.

Major International Developments

Spectrum Cannabis – A New International Brand Unveiled

Canopy announced yesterday that it has unveiled Spectrum

Cannabis, its physician and patient-facing identity in strictly medical

markets outside North America.

The name piggybacks off of Mettrum Spectrum, a well received,

colour coded system for identifying strains with certain characteristics.

“Spectrum will focus on physician interactions, stakeholder outreach,

and patient education”.




Number Of German Pharmacies Reached Keeps Growing; Canopy To Be

Growing Domestically As Well?

Keeping with the international branding above, Canopy’s Germany

subsidiary has been renamed Spektrum Cannabis.

The number of pharmacies Spektrum Cannabis reached has jumped

to over 480 currently, versus 200 in April 2017.

Tender bids for the first 10 licenses to cultivate medical marijuana in

Germany were due earlier this month. Being one of just two Canadian

LPs (again, with Cronos) currently exporting from Canada, we believe

Canopy is well positioned to acquire one of these licenses.

Yesterday, Canopy announced that both its Tweed and Tweed Farms

facilities received GMP certification. We believe this will help the

company make the most of its international potential. Spektrum

Cannabis’ facility is, to the company’s knowledge, the only GMP-

certified cannabis processing facility in the country.

Expansion In Chile

Yesterday, Canopy announced a further, complementary expansion

into South America with the establishment of Spectrum Chile SpA.

“Medical markets in Chile are emerging and Canopy Growth plans to

enter the market aggressively in order to position itself as a leader in

the Chilean market. Through a strategic partnership with a domestic

Chilean medical cannabis company, Spectrum Chile will work to

ensure Chilean patients have access to high-quality cannabis

products.”

Looking Forward

Teaser Re Hemp

Via the acquisitions of Mettrum and Vert, Canopy has inherited a

hemp business (Mettrum Originals and Groupe Hemp brands).

“Management believes hemp markets are poised for great growth in

the areas of food, textiles, industrial products, and daily preventative

health & nutrition. Canopy has placed a significant emphasis on

growing and expanding our hemp capabilities, which to date include

twenty-eight products on 1,525 store shelves across Canada and the

United States.”

We look forward to hearing the company’s plans for this subset of the

market, which is becoming more and more in vogue.




We Are The Low On The Street For Q4/FY17 Results

Exhibit 4. Q4/FY17 Forecasts

Beacon Est.

Quarter Q4/FY17E Q4/FY16 Q3/FY17 % Change

Ended Mar-17 Mar-16 Dec-16 Y/Y Q/Q

Registered Patients 53,279 11,630 29,000 358.1% 83.7%

kg Sold 1,998 700 1,245 185.3% 60.5%

Price Realized / g $7.50 $7.16 $7.36 4.7% 1.9%

Revenue From Marijuana Sales (000's) $14,985 $5,015 $9,164 198.8% 63.5%

Consolidated Revenue (000's) $14,985 $5,042 $9,752 197.2% 53.7%

Adjusted COGS / g $2.50 $2.69 $2.47 -7.1% 1.2%

Adjusted Gross Margin % 67% 63% 68% 403 bps -180 bps

Adjusted Gross Margin (000's) $9,990 $3,158 $6,677 216.3% 49.6%

Sales and Marketing (000's) $5,814 $2,399 $3,780 142.4% 53.8%

Research and Development (000's) $712 $281 $439 153.3% 62.1%

General and Administration (000's) $6,593 $2,561 $4,043 157.4% 63.1%

Overhead / Revenue 88% 104% 85% -1640 bps 283 bps

Source: Company reports, Beacon Securities estimates.

Canopy will be releasing Q4/FY17 (March) results on June 27, 2017

(tentative date).

We are forecasting Q4/FY17 revenue of $15.0MM (consensus is

$16.9MM) and EBITDA of $-3.1MM (consensus is $-1.3MM).

Background

Recall that Canopy reported Q3/FY17 results (December) of $9.8MM –

below our estimate and consensus of $10.9MM.

The miss in the previous quarter appeared to be a matter of timing –

the company ‘only’ sold 1,245 kg in the quarter, but harvested a

record 5,264 kg. Much of this (~3,700 kg) came from the seasonally

large harvest at Tweed Farms. It took a long time to process the

record harvest and push it to market (harvesting, trimming, drying, in

house testing, third party testing, packaging etc.).

The company disclosed that it pushed 10 new products to the Tweed

store on February 1, 2017, and generated $1MM in revenue that day –

highlighting the pent up demand from customers.

Thoughts Re The Quarter

On the Q3/FY17 call on February 14, 2017, CEO Bruce Linton disclosed

that “January felt like a continuation of Q3 … a pretty nice growth

rate, but the rocket fuel wasn’t there”. However, after its $1MM day

on February 1, 2017, it “now it feels like we’re back to the rate of

growth that we kind of expect for the Canopy Group.”




Analyzing the published availability of product by industry website Lift

(lift.co) as well as regularly monitoring website availability ourselves

suggests that the company may still have had issues getting product

to market beyond February 1, 2017.

For example, for three dates published by Lift (February 22, March 17,

and March 27) Tweed only had 3 or 4 strains of dried flower available

for sale. When we visited the Tweed store the morning of March 30,

2017, there were no dried flower products available – and only one oil

product. We believe Tweed is the main growth driver of Canopy.

Bedrocan was described by Mr. Linton as being “sort of like the quiet

little steady one” on the company’s last call. Availability of

Bedrocan’s products seems to have generally held in well during the

quarter (although still down modestly).

Canopy acquired Mettrum on February 1, 2017. Mettrum appears to

have had weaker availability in February, but strong availability

throughout March (~6 strains).

We acknowledge that simply taking regular snapshots of availability is

clearly an imperfect way to determine revenue levels (i.e., there could

be few products available but selling tremendously well – products

may go to market regularly but quickly sell out before detected etc.).

However, we feel it can be useful in gauging the company’s ability to

bring the large harvest to market – particularly given the experience

last quarter.

To be clear, notwithstanding the potential availability concerns

above, we still believe our revenue forecast is achievable. However,

even if the company were to hit our number, it would still be $2MM

below the Street.

Two Reasons We Believe Supply Constrains May Now Be Significantly

Mitigated – For Real This Time

From a practical standpoint, more product is getting to market. While

April was a little slower, the number of Tweed strains available

throughout May and June averaged a very healthy eight – including

nine available yesterday. It certainly feels like Canopy’s flagship

brand is humming along again.

From a structural perspective, as discussed above, Tweed customers

are now no longer limited to just Tweed’s availability. Having

consolidated the store among wholly owned brands and now selling

others’, inventory shortages in some banners can be offset by

availability at others. For example, total availability on Tweed Main

Street yesterday included: 16 types of flower (13 owned by Canopy,

plus three by Canada’s Island Garden); one oil (definitely an area

where availability needs to improve); three gel capsules; and FORIA.




Longer-Term Outlook

Given the multitude of factors (how the recreational landscape looks

regarding distribution, ability of Canopy to produce enough supply to

meet demand, success of expansion plans at existing facilities, ramp

up at Tweed Grasslands / Vert / other sites, industry pricing dynamics,

variety of products allowed for sale, the degree to which international

opportunities are available / how well Canopy can capitalize etc.) it is

extremely difficult to have a clear sense of visibility on revenue figures

a few years out. For reference, we note that Street estimates for

FY2019 (March 2019) are as low as $173MM and as high as $464MM.

Our FY2018 revenue and EBITDA forecasts are the lowest on the Street

and we are also meaningfully below consensus for FY2019. By FY2021

(when the company could conceivably be selling more marijuana

outside Canada than in it), we are ahead of consensus of revenue but

still below on EBITDA.

There is a risk that should the company miss Street expectations for

Q4/FY17 results, longer-term Street forecasts could be lowered towards

our estimates.

Exhibit 5. Our Longer-Term Outlook Versus Consensus

Q4/FY17E 2018E 2019E 2020E 2021E 2022E 2023E 2024E

Revenue

Beacon $15.0 $99.4 $209.4 $417.1 $761.7 $1,383.1 $1,843.9 $2,002.5

Consensus $16.9 $122.7 $301.3 $441.7 $647.2 N/A N/A N/A

Difference -11% -19% -31% -6% 18% N/A N/A N/A

EBITDA

Beacon -$3.1 -$9.1 $2.9 $41.6 $137.8 $317.2 $477.0 $540.7

Consensus -$1.3 $16.1 $34.4 $80.0 $168.7 N/A N/A N/A

Difference nmf (neg) nmf (neg) -92% -48% -18% N/A N/A N/A

EBITDA Margin %

Beacon -21% -9% 1% 10% 18% 23% 26% 27%

Consensus -8% 13% 11% 18% 26% N/A N/A N/A

Difference (bps) -1,297 -2,223 -1,002 -815 -798 N/A N/A N/A

Source: Company reports, Beacon Securities estimates.




Maintaining Buy And $15.00 Target Our $15.00 target price for Canopy is derived by a DCF. Highlights from

our DCF include: achieving 24% market share by FY22 (i.e., 176 mt,

using the midpoint of the Parliamentary Budget Officer’s estimate);

revenue realized per gram rising to $8.50 shortly after legalization, then

falling to $7.00 longer-term; adjusted cost of goods sold falling to $2.10

longer term; a discount rate of 10%; and a zero terminal growth rate

post FY24.

Exhibit 6. Highlights Of Our DCF

Mar-18 Mar-19 Mar-20 Mar-21 Mar-22 Mar-23 Mar-24

Q4/F18E F2019E F2020E F2021E F2022E F2023E F2024E Terminal Value

(000's - expect share prices and share count)

Revenue $29,922 $209,353 $417,114 $761,747 $1,383,105 $1,843,925 $2,002,508

Adjusted Gross Margin $21,241 $151,473 $304,248 $553,998 $995,810 $1,305,931 $1,401,756

EBITDA -$1,709 $2,897 $41,607 $137,836 $317,190 $476,972 $540,677

Net Income -$4,753 -$9,901 $21,419 $93,045 $227,556 $348,180 $397,554

Free Cash Flow -$13,118 -$49,531 -$24,055 $38,951 $163,894 $316,341 $381,314 $3,813,136

PV of Free Cash Flow -$13,118 -$46,786 -$20,868 $29,730 $115,261 $203,228 $223,002 $2,052,248

Discount Rate 10%

Total PV of FCF $2,542,697

Net Cash as at Valuation Date (Q3/FY18) $89,422

Total Value $2,632,119

Shares outstanding at Valuation Date 176,041,399

Value per Share (Rounded) $15.00

Current Price $7.95

Return 89% Source: Beacon Securities estimates.


Beacon Securities Ltd.| 66 Wellington Street West, Suite 4050, Toronto, Ontario, M5K 1H1 |416.643.3830|www.beaconsecurities.ca

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Has any director, partner, or officer of Beacon Securities, or the analyst involved in the preparation of the research report, received remuneration for

any services provided to the securities issuer during the preceding 12 months?

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this issuer in the past 12 months? Yes No

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Department? Yes No

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All information contained herein has been collected and compiled by Beacon Securities Limited, an independently owned and operated member of

the Investment Industry Regulatory Organization of Canada (IIROC). All facts and statistical data have been obtained or ascertained from sources,

which we believe to be reliable, but are not warranted as accurate or complete.

All projections and estimates are the expressed opinion of Beacon Securities Limited, and are subject to change without notice. Beacon Securities

Limited takes no responsibility for any errors or omissions contained herein, and accepts no legal responsibility from any losses resulting from investment

decisions based on the content of this report.

This report is provided for informational purposes only and does not constitute an offer or solicitation to buy or sell securities discussed herein. Based on

their volatility, income structure, or eligibility for sale, the securities mentioned herein may not be suitable or available for all investors in all countries.

As at May 31, 2017 #Stocks Distribution

Buy 68 75% Buy Total 12-month return expected to be > 15%

Speculative Buy 10 11% Speculative Buy Potential 12-month return is high (>15%) but given elevated risk, investment could result in a material loss

Hold 6 7% Hold Total 12-month return is expected to be between 0% and 15%

Sell 0 0% Sell Total 12-month return is expected to be negative

Under Review 5 5%

Tender 2 2% Tender Clients are advised to tender their shares to a takeover bid or similar offer

Total 91 100%

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The Beacon Securities Analyst named on the report hereby certifies that the recommendations and/or opinions expressed herein accurately

reflect such research analyst’s personal views about the company and securities that are the subject of the report; or any other companies

mentioned in the report that are also covered by the named analyst. In addition, no part of the research analyst’s compensation is, or will

be, directly or indirectly, related to the specific recommendations or views expressed by such research analyst in this report.

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Documents

BUY $15.00 Company Update & Q4 Preview · 2017. 6. 20. · June 20, 2017 Vahan Ajamian, CPA, CA, CFA Analyst - (416) 643-3879 [email protected] In this report we provide