Canada Leads the Global Cannabis Paradigm Shift

Canada Leads the Global Cannabis Paradigm Shift

Initiating Aphria and Canopy at Outperform

May 2018

Tamy Chen, CFA Cannabis Analyst BMO Nesbitt Burns Inc. (416) 359-5501 tamy.chen@

Peter Sklar, CPA, CA Retailing/Consumer Analyst BMO Nesbitt Burns Inc. (416) 359-5188 peter.sklar@

This report is intended for Canadian & EU distribution only. Unauthorized reproduction, transmission or publication without the prior written consent of BMO Capital Markets is strictly prohibited.

This report was prepared by an analyst(s) employed by BMO Nesbitt Burns Inc., and who is (are) not registered as a research analyst(s) under FINRA rules. For disclosure statements, including Analyst's Certification, please refer to pages 50 to 53. 16:00 ET~

This report is intended for Canadian & EU distribution only. Unauthorized reproduction, transmission or publication without the prior written consent of BMO Capital Markets is strictly prohibited.

Table of Contents

Initiating BMO Cannabis Coverage ................................................................................................................... 2 Executive Summary .......................................................................................................................................... 4 Legal Environment Favours Canadian LPs........................................................................................................6 Initial Recreational Market Outlook ................................................................................................................. 7 Current Medical Market in Canada: Opaque ..................................................................................................13 Near-Term International Medical Opportunity: Germany .............................................................................15 Long-Term Industry Outlook...........................................................................................................................16 Company Snapshot: Our Current Coverage Universe.....................................................................................24 Company Coverage: Aphria ............................................................................................................................25 Company Coverage: Canopy...........................................................................................................................35 Comparable Companies - Cannabis................................................................................................................46 Comparable Companies ? Alcohol & Tobacco ................................................................................................47 Glossary ...........................................................................................................................................................48

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May 28, 2018

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Initiating BMO Cannabis Coverage

Aphria: We are initiating coverage of Aphria (APH-TSX) with an Outperform rating.

First Mover Advantage: We believe Aphria will be one of the few licensed producers (LPs) with sufficient product to supply the initial recreational demand and we believe such a "first mover" advantage should enable the company to quickly capture significant share and generate attractive unit economics in an undersupplied market.

Leading Low-Cost Producer: We believe Aphria could emerge as a leading low-cost cannabis producer given the significant commercial-scale greenhouse cultivation expertise held by the management team, and the infrastructure and greenhouse culture that is inherent in the Leamington, Ontario community.

Scale Is Critical to Long-Term Growth: We believe Aphria's scale will facilitate meaningful investment in long-term growth opportunities such as brand development, value-add format manufacturing, the gradual legalization of international medical markets, and advanced pharmaceutical applications.

Valuation: Our target price of $17 is based on a projected enterprise value that is about 17x our Base Case fiscal 2020 EBITDA estimate. We note that our Base Case fiscal 2020 EBITDA estimate assumes that Aphria's facility expansions are only at 65% of full ramp potential versus management's expectation that the facilities will be close to 100% ramp by that time. If these facilities were to reach full ramp by fiscal 2020 and Aphria experiences firmer selling prices, our implied target multiple would be in the high-single-digit range. See Aphria company section for details.

Canopy: We are initiating coverage of Canopy (WEED-TSX) with an Outperform rating.

First Mover Advantage: We believe Canopy will be one of the few LPs with sufficient product to supply the initial recreational demand and we believe such a "first mover" advantage should enable the company to quickly capture significant share and generate attractive unit economics in an undersupplied market.

Head Start in International: We consider the company's current international operations to be more advanced versus most other players, and Canopy appears to be laying the groundwork in markets where medical is not yet legalized, but may soon be. The approach to develop cultivation in "hub" regions like Denmark for export to Germany and eventually Australia for export to the Asia-Pacific region provides the company longer-term access to these markets.

Long-Term Global Branded Leader: Canopy could emerge as a leader over the long term given that the company's scale will facilitate meaningful investment in long-term growth opportunities such as brand development, value-add format manufacturing, the gradual legalization of international medical markets, and advanced pharmaceutical applications. We believe Canopy's strategic alliance with Constellation Brands (STZ-NYSE; US$216.81; Outperform rated by Amit Sharma, BMO Capital Markets Corp.) could prove to be a significant advantage as the industry evolves into value-add formats, and particularly, into cannabis-infused beverages.

Valuation: Our target price of $45 is based on a projected enterprise value that is about 20x our Base Case fiscal 2020 EBITDA estimate. Our target multiple reflects our view that Canopy has a relative head start in brand development and international expansion, and could emerge as a leading global-branded company in the long term. We note that our Base Case fiscal 2020 EBITDA estimate assumes that Canopy's facility expansions are only at 65% of full ramp potential versus management's expectation that the facilities will be close to 100% ramp by that time. If these facilities were to reach full ramp by fiscal 2020 and Canopy experiences firmer selling prices, our implied target multiple would be 11x. See Canopy company section for details.

May 28, 2018

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Relative Positioning

Canopy Growth

Aphria

? Could emerge as a large, branded player

? Strategic alliance with Constellation Brands could prove to be a significant advantage as the industry evolves into valueadd formats

? Current international operations appear more advanced versus other LPs; strategy to develop cultivation hubs abroad for international export could provide longer-term market access

? Potential to gain "first mover" advantage in initial recreational market

? Scale should facilitate meaningful investment in long-term opportunities

? Could emerge as a leading lowcost contract cultivator

? Continues to establish strategic relationships in international markets, but appears slightly behind compared to Canopy

? Supply agreement with Shoppers Drug Mart broadens medical distribution reach

? Pressure on the stock following controversy with Nuuvera acquisition, resulting in lower valuation vs. other LPs and provides better return opportunity

Source: BMO Capital Markets.

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Executive Summary

Near-Term Outlook

First Mover Advantage for Larger LPs: Initially, demand/supply dynamics will favour the larger LPs. Anticipated demand from the initial recreational market in Canada is expected to considerably exceed industry production as only a handful of the larger LPs will have sufficient cannabis output at that time to meaningfully fill the distribution channels. As a result, this "first mover" advantage should enable the larger LPs to benefit from the favourable pricing dynamics expected in an initially undersupplied market. See Exhibit 3.

In addition, this "first mover" advantage should enable the larger LPs to initially dominate retail shelf space in the recreational market, which would provide a head start for brand development.

Value-Add Formats Will Mitigate Dried Flower Price Compression: We anticipate in year two of our forecast that supply will begin to catch up to demand, which will result in some pricing pressure on dried flower. However, our Base Case projections anticipate that in year two, federal regulators will begin legalizing value-add product formats, which should carry much higher pricing on a grams-equivalent basis and mitigate the pricing pressure that arises in dried flower (see Exhibits 3 and 4).

Our Base Case forecast assumes that the industry growth rate for medical patient acquisition slows when the recreational market is legalized. Some existing medical patients, and potential future patients, could prefer the recreational market when legalized. However, this may be more than offset if more employers begin to include medicinal cannabis under insurance coverage plans.

Near-Term International Opportunity Favours Larger LPs: For the international export opportunity, we expect that only a handful of the larger LPs will be able to secure the licensing and certification requirements, and develop the necessary distribution infrastructure in those regions.

Longer-Term Outlook

Supply Catches Up in Year Two of Recreational Legalization: We project that dried flower supply will begin to catch up with demand in year two, and potentially exceed demand in the third or fourth year following recreational legalization in Canada.

It is not clear if this projected supply/demand imbalance will weigh on the cannabis prices realized by the LPs as there will be the opportunity to export increasing volumes of medical cannabis to international markets, and the introduction of additional value-add product formats should provide higher pricing to compensate for price compression in dried flower.

Evolution Into Either Branded Players or Low-Cost Cultivators: As dried flower prices continue to settle, we believe the Canadian market will rationalize into a handful of larger, branded players and a handful of low-cost contract cultivators. Beyond the branded companies and lowcost contract growers, it is not clear to us how the many other LPs, outside of niche brands, will survive under this pricing environment.

May 28, 2018

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