BUY $4.00 Company Update · of the company’s recent $69MM financing, in this report we provide an update on key points of our investment thesis. Hydropothecary generated revenue

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

The Hydropothecary Corp.

(THCX-V)

Firing On All Cylinders December 11, 2017

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

[email protected]

We initiated coverage of Hydropothecary on April 14, 2017. On the back

of the company’s recent $69MM financing, in this report we provide an

update on key points of our investment thesis.

Hydropothecary generated revenue per gram of $9.00 last quarter

(Q4/FY17 – July), $0.55/g above the average of the “Big Five” LPs.

Hydropothecary won two of the three top spots for the Best New Cannabis

Product category at the recent Canadian Cannabis Awards. We believe

this validates the company’s strategy of continuously rolling out new

products, and with its Elixir No. 1 sublingual spray having launched right at

the end of July, we suspect the company may widen the gap vs its peers in

revenue / gram.

Simultaneously, the company ended Q4/FY17 with cash costs of goods in

finished inventory of just $1.05/g – suggesting a cost profile $0.27/g less

than the average of the “Big Five”. Looking forward, with minimum wage

rising to $15/hr in most large provinces (except Quebec) and with Quebec

having essentially the lowest power prices in the country, we believe

Hydropothecary will continue to outperform, supported by structural cost

advantages.

Earlier this month, Quebec Premier Philippe Couillard, declared in the

National Assembly that he prefers legal marijuana to be produced in

Quebec rather than imported from other provinces. Hydropothecary was

the only LP invited to give consultations to the Health and Social Services

Committee of the National Assembly. As the only Quebec-headquartered

LP (and 1 of just 2), we believe Hydropothecary is excellently positioned

benefit to disproportionately benefit from a potential SAQ contract. There is

the potential that an agreement may come with more ‘bells and whistles’

than just supplying cannabis (think grants, loans, capex contribution),

which could make a potential agreement even more lucrative for

Hydropothecary’s investors. We do not believe a potential contract is

priced into Hydropothecary’s share price at current levels.

Should its share price stay above $3.15 for another nine trading days,

Hydropothecary may choose to force conversion of its convertible

debentures – which would leave it with a market cap of $393MM and

$110MM of cash (with no debt) which could be used for subsequent

expansions. We calculate a fully diluted EV/2021E EBITDA for

Hydropothecary of 4.4x, while peers trade at a basic EV/2021E EBITDA

multiple of 11.4x.

Finally, we believe Hydropothecary could be ‘tucked in’ by most of the

“Big Five”.

We maintain our Buy recommendation. We are raising our target price to

$4.00 (from $3.00). With an above average revenue per gram, innovative

products where it can ‘own’ certain categories, lower than average cost

per gram, what we see as a preferential position in Canada’s second-

largest province (with a potential imminent catalyst), 25,000 kg of

production capabilities come the start of recreational sales, significant

room for expansion, and a potential takeout, we believe Hydropothecary

should be among investors’ largest cannabis positions.

BUY (Unch) $4.00 (From $3.00)

$3.21

$4.00

25%

$1.10 - $3.35

YE: Jul 31 FY18E FY19E FY20E

Revenue ($MM) $11.5 $40.6 $110.8

EBITDA ($MM) -$4.3 $9.7 $39.9

FD EPS -$0.14 $0.11 $0.59

FY18E FY19E FY20E

EV/Sales 22.5x 6.4x 2.3x

EV/EBITDA nmf 26.5x 6.5x

P/E nmf 28.5x 5.5x

Basic 93.3

FD 165.4

Market Cap

Basic $299.5

FD $530.9

Net Debt (Cash) -$41.3

Enterprise Value $258.2

About the Company

Hydropothecary is currently the only Quebec-headquartered Health

Canada Approved Licensed Producer. The company received the 14th

cultivation license from Health Canada on March 14, 2014, and has

been selling medical marijuana since July 2015.

All figures in C$ unless otherwise indicated.

Stock Performance

52 Week Price Range

Estimates

Valuation

Stock Data (MM)

Shares Outstanding

Company Update

Previous Close

12-month Target Price

Potential Return

mailto:[email protected]

December 11, 2017 |Page 2 Vahan Ajamian | Analyst | 416.643.3879 | [email protected]

theScore, Inc. The Hydropothecary Corp.

Innovative Products Validated

On November 30, 2017, Hydropothecary took two of the top three

spots across the entire industry in the category of Best New Cannabis

Product at the Canadian Cannabis Awards in Toronto.

Voters selected Elixir No. 1, the company’s innovative medical

cannabis peppermint oil sublingual mist as the third best new product.

Decarb, Hydropothecary’s fine milled marijuana designed for oral

consumption, was named the best new product.

We see this as validation of the company’s strategy of constantly

staying ahead of the curve relative to its competitors in getting new

successful products to market. Hydropothecary has a number of

products in its R&D pipeline which it expects to release on a quarterly

basis. We believe this will allow the company to ‘own’ certain

categories of products when recreational sales start.

Exhibit 1. Hydropothecary’s Award Winning New Products

Source: Company reports.




Above Average Revenue Per Gram –

With The Stage Set For Increases

Hydropothecary realized revenue per gram of $9.00 in Q4/FY17 (July).

This compares quite favourably to many of the company’s peers

(Exhibit 2 below). In particular, we note that the “Big 5” averaged

$8.45/g last quarter.

We believe we may still be at the start of the company’s

outperformance relative to its peers. Hydropothecary launched its

Elixir No. 1 product on July 31, 2017, right at the end of the quarter. We

understand the product has been selling very well. As

Hydropothecary’s first oil product, we believe Elixir No. 1 has the

potential to further lift the company’s revenue per gram.

For reference, MedReleaf Corp. (LEAF-T, not covered), the only one of

the “Big 5” that posted a higher average revenue per gram last

quarter than Hydropothecary, generated $8.31/g selling dried flower,

but $13.97/g equivalent selling oil. Similarly, CanniMed Therapeutics

Inc. (CMED-T, not covered) generated $7.04/g selling dried flower, but

$14.16/g equivalent selling oil.

We calculate that Elixir No. 1 should generate revenue per gram

equivalent north of $11, and we believe the company can use trim or

less appealing bud for this product (i.e., does not have to use its

Grade A product which it sells in its Time Of Day line for $15/g). Also,

the company recently began offering certain of its decarb lines at

$3/g – a product with lower potency, positioned for microdosing. One

might think that this addition would be dilutive to financial metrics;

however, our understanding is that the company has been able to

essentially repurpose ‘waste’ from its other products (such as Elixir No.

1) and offer it for $3/g, as a decarb product, suggesting it has almost

no marginal cost to produce.

Exhibit 2. Average Revenue Per Gram Equivalent – LRQ

$7.00

$7.50

$8.00

$8.50

$9.00

$9.50

$10.00

APH WEED ACB EMC TRST THCX ABCN LEAF CMED

Source: Company reports, Beacon Securities.




Very Attractive Cost Profile – With

Structural Advantages

Hydropothecary reported cash costs of finished goods inventory of

$1.05/g in Q4/FY17. This “includes direct costs associate with the

growing, harvesting and processing of finished goods inventory, such

as labour, utilities, fertilizer costs, biological control costs, general

supplies and materials, curing, milling, quality assurance and testing.”

While comparisons between companies can be imprecise due to

variances in exactly what is included in costs, Exhibit 3 shows our best

attempt to line up definitions. The “Big 5” averaged $1.32/g last

quarter, with only Aphria Inc. (APH-T, not covered) coming in below

Hydropothecary. Most publicly traded LPs won’t even specifically

disclose their cost per gram (likely because it doesn’t fare well).

Exhibit 3. Costs To Produce Per Gram – Last Reported Quarter

Ticker Cost Definition

APH $0.95

"Cash costs to produce dried cannabis per gram is equal to cost of sales of dried cannabis less amortization and

packaging costs plus (minus) increase (decrease) in plant inventory divided by gram equivalents of cannabis sold

in the quarter."

THCX $1.05

"Cash cost of finished goods inventory includes direct costs associate with the growing, harvesting and

processing of finished goods inventory, such as labour, utilities, fertilizer costs, biological control costs, general

supplies and materials, curing, milling, quality assurance and testing."

TRST $1.21"Costs to harvest (from cloning to harvest) - includes all cash operating costs (primarily growing labour, utilities,

grow nutrients and rent)."

WEED $1.25

Includes "all of the cash operating costs including principally growing labour, utilities such as hydro and water,

grow nutrients, rent, and allocated overheads" and "cash operating costs related to the production of value

added products including cannabis oils and soft gel capsules. Post-harvest costs also include cash operating costs

associated with trimming, milling, drying, lab services and testing, and allocated overheads."

LEAF $1.46

"calculated by: removing from production costs incurred during the period, all non-cash based costs (including

amortization and inventory writedowns or impairments) and all post production costs; and dividing such amount

by the approximate number of grams of cannabis sold during the period".

ACB $1.73

"calculated by taking the total IFRS cost of sales and removing the effect of changes in fair value of biological

assets, non-cash production costs, oil conversion costs, cost of sales from service revenue, and purchases from

other Licensed Producers, all divided by the total number of grams of dried cannabis produced in the period"

and less "packaging costs".

Source: Company reports.

Each of these companies is in the middle of an expansion, and will

likely see costs per gram continue to decrease. However, we believe

Hydropothecary will remain among the industry leaders. The three

largest direct costs in marijuana production are power, labour and

materials – and by being in Quebec, we see structural advantages for

Hydropothecary in two of these items.

While it may vary by the type of consumption etc., Quebec is

generally accepted as having among the lowest power prices in the

country – if not the lowest (Exhibit 4).




Exhibit 4. Average Prices For Large Power Consumption (cents/kWh)

4

5

6

7

8

9

10

11

Note: Based on power demand of 10,000 kW, 17, 520,000 kWh of consumption, 120kV of

voltage and a load factor of 80%.

Source: Hydro Quebec.

Quebec is also set to have the lowest minimum wage of the “Big Four”

provinces.

o Quebec – Currently $11.25/hr, going to $11.75/hr in 2018,

$12.10/hr in 2019, and $12.45 by 2020. When asked about

other provinces’ plans to quickly reach $15/hr, Quebec’s

Employment Minister responded “It's not our plan”.

o Ontario – Will be $14.00/hr on January 1, 2018, rise to $15.00/hr

on January 1, 2019, and then be tied to inflation.

o British Columbia – Currently $11.35/hr. The NDP had pledged

to have it reach $15.00/hr by 2021. As a compromise with the

other parties, the government has removed the time limit, but

remains committed to reaching $15/hr.

o Alberta – Currently $13.60/hr, rising to $15.00/hr on October 1,

2018.




Quebec Seems Ready To Go

Provincial Framework

On November 16, 2017, Quebec rolled out its first formal

announcement and its initial provincial bill (Bill 157) for recreational

cannabis legalization. Highlights were as follows:

o Retail and distribution of cannabis products are to be done

exclusively through a crown corporation, operating as a

subsidiary of the SAQ, that will run under the banner of Societé

Québécoise du Cannabis (SQC). This was in line with our

expectations and prior leaked details from Radio Canada (see

our Hydropothecary note dated October 2, 2017, for more

details).

o The legal age of purchase in the province will be 18 (also

expected), in line with the provincial drinking age.

o There will be a zero tolerance policy for driving under the

influence of cannabis.

o Citizens of Quebec will not be permitted to grow their own

cannabis for personal use.

o The current restrictions applying to the consumption of

tobacco in public places will apply to marijuana.

Consumption in certain additional public areas will also be

prohibited (i.e. parks, bus shelters, CGEP campuses).

o Cannabis products will not be able to be marketed with the

use of slogans, text referring to real or fictional

characters/persons/animals, testimonials, endorsements.

o Advertising may not contain anything apart from text, with the

exception of an illustration of the package or packaging of

cannabis occupying not more than 10% of the surface area of

the advertising material.

o Advertising will only be permitted in printed newspapers and

magazines that have an adult readership of >85% and signage

that is only visible within a cannabis retail location.

o The SQC will not be able to offer price reductions on the basis

of volume “otherwise than as part of regular marketing

operations by the producer.”

o The SQC is to open 15 initial brick-and-mortar stores. The SQC

will also operate an online storefront for cannabis products

(delivery to be done by Canada Post).

Full text of the bill can be found here:

http://www2.publicationsduquebec.gouv.qc.ca/dynamicSearch/tele

charge.php?type=5&file=2000C38A.PDF


http://www2.publicationsduquebec.gouv.qc.ca/dynamicSearch/telecharge.php?type=5&file=2000C38A.PDF

http://www2.publicationsduquebec.gouv.qc.ca/dynamicSearch/telecharge.php?type=5&file=2000C38A.PDF



Clear Preference For Local Suppliers – There Are Only Two

Quebec officials have noted the need to secure sufficient product

supply come July 2018, and there has been a clear bias in favour of

local producers. There are only two currently – Hydropothecary, and

Aurora Cannabis Inc. (ACB-V, not covered). Aurora is headquartered

in western Canada.

On November 16, 2017, Carlos Leitão, the Quebec Finance Minister

was interviewed on BNN (following the announcement of Bill 157)

where he indicated that “There is I believe one, at least one, Quebec

based licensed producer, so we will be working with them but not

exclusively with them. We are open to having supply from wherever,

of course, licensed producers from whatever province it is. In order to

control costs, obviously it is preferable that that supplier will be based

in Quebec.” (emphasis ours)

On November 30, 2017, Hydropothecary’s CEO, Sebastien St-Louis,

and Terry Lake (VP of Corporate Social Responsibility – and the former

Health Minister in British Columbia) presented to the Health and Social

Services Committee of the National Assembly. Hydropothecary was

the only LP invited to give consultations.

Finally, on December 1, 2017, Quebec Premier Philippe Couillard,

stated in the National Assembly that “I prefer, as long as the product is

legal, that it be produced at home in Quebec, rather than import it

from neighboring provinces … I repeat that we want the product,

once legal, to be produced as much as possible at home, in Quebec

… There are several advantages to our greenhouse industry in

Quebec, where the issue of hydroelectricity compared to Ontario has

a huge competitive advantage in terms of hydroelectric rates. That's

something that should make people optimistic … Yes, we want to

produce in Quebec, we will produce in Quebec and especially in our

greenhouses.” (emphasis ours – source: Hansard and Google

Translate)

With just over six months to go before recreational marijuana is legal,

we believe the SAQ is currently looking to lock up supply. As the only

Quebec-headquartered licensed producer, we believe

Hydropothecary is excellently situated to capitalize on a bulk

purchase by the SAQ.

Using the three MOUs signed by the New Brunswick as a template (we

hear there is at least one more coming) and extrapolating by

population, we calculate the size of the Quebec market at 144,000 kg

with a retail value of $1.5B. With its new 250,000 sq. ft. greenhouse

expected to be ready for July 2017, and produce 25,000 kg, all of

Hydropothecary’s production won’t be enough to satisfy the

province. Accordingly, we envision there will be a handful of other

suppliers but that Hydropothecary could be the largest / preferred

supplier.




Could Be More Than A ‘Vanilla’ Purchase – ‘Bells And Whistles’ Could

Make An Announcement Even More Impactful

MTL Blog recently reported that the provincial government wants to

maintain local supply, stating (emphasis ours):

o “To ensure Quebec is ready to meet the marijuana-demand

come legalization, and ensure the money stays in the

province, the Couillard government wants to speed up the

licensed producer process.”

o “Bloc Québécois and Parti Quebecois members are on board,

with two MPs commenting that marijuana consumed in

Quebec should be produced in Quebec.”

o “Lucie Charlebois, Quebec’s Public Health Minister largely in

charge of the province’s marijuana regulatory framework, said

the province will offer support to local growers. As long as the

growers meet Health Canada’s criteria, the provincial

government ‘will be happy to support them’ said Charlebois.”

Given the Quebec Government’s intention to build an industry

essentially from scratch, we would not be surprised to see Quebec LPs

receive other ‘bells and whistles’ in support, such as grants and loans.

This would not be unprecedented in Quebec or in the cannabis

sector. Last Friday, Canopy Growth Corp. (WEED-T) announced an

agreement to supply up to 8,000 kg of cannabis to Newfoundland

And Labrador a year for at least two years. The agreement also

called for Canopy to build a 150,000 sq. ft. facility in the province at a

cost of $40MM which could produce 12,000 kg annually and that “the

Provincial Government will contribute to costs to construct the facility

through reduced sales remittances to the province until the

company’s investment is partially recouped”. “The agreement also

includes a $1 million cost-shared program on research and

development in the province over a five-year period. This investment

reflects a joint commitment to bringing value-add research and

development to the province, and is expected to leverage additional

funding and provide opportunities for researchers and academics.”

Canopy will also be eligible to receive up to four retail licenses in the

province.

In terms of what a potential contract could mean for

Hydropothecary’s valuation, we point to two agreements as

precedent. We note that Organigram Holdings Inc.’s (OGI-V, not

covered) market cap rose by 24% over two days after announcing its

MOU with the New Brunswick Government – or $11.28 of market cap

per the number of total grams stated in the company’s press release.

The Canopy agreement with Newfoundland And Labrador, which had

more ‘bells and whistles’ saw the company’s shares rise 6% – or $13.42

in market cap per the number of total grams stated in the company’s

press release (Exhibit 5). Hydropothecary’s market cap is currently

$300MM.

We do not believe a potential SAQ contract is priced into

Hydropothecary’s share price. For reference, since our report dated

October 2, 2017, when we first highlighted this potential,




Hydropothecary’s share price is up 78%, while the average Canadian

LP is up 68%.

Exhibit 5. Reaction To Two Government Supply Contracts

NB NL

Organigram Canopy

Volume Stated (g) 5,000,000 8,000,000

Number Of Years Stated 1 2

Total Volume (g) 5,000,000 16,000,000

1-Day Increase In Market Cap (%) 17% 6%

1-Day Increase In Market Cap (MM) $39.0 $214.7

1-Day Increase In Market Cap / Annual Volume (MM) $7.79 $26.84

1-Day Increase In Market Cap / Total Volume ($/g) $7.79 $13.42

2-Day Increase In Market Cap (%) 24% N/A

2-Day Increase In Market Cap (MM) $56.4 N/A

2-Day Increase In Market Cap / Annual Volume (MM) $11.28 N/A

2-Day Increase In Market Cap / Total Volume ($/g) $11.28 N/A

Source: Provincial governments, company reports, ThomsonReuters, Beacon Securities.

$3.15 Is The Magic Number To Be Debt

Free – Still More Than A Double Needed

To Catch Up To Peers

Hydropothecary recently closed a $69MM financing of convertible

debentures and announced a forced conversion of its $25.1MM

convertible debentures from July 2017. We have updated our model

to account for these developments, as well as other items.

The $69MM convertible debentures pay 7% interest and can be

converted at $2.20/share anytime up to November 24, 2020.

However, the company may force conversion should the shares’ daily

VWAP be greater than $3.15 for 10 consecutive trading days.

Should this happen, we calculate that immediately after conversion,

Hydropothecary would have a market cap of $393MM and $110MM of

cash with no debt, for an EV of $282MM. Assuming all warrants and

options are exercised, we calculate a fully-diluted market cap of

$524MM with $188MM of cash with no debt, for an EV of just $337MM.

We are modelling Hydropothecary to reach a $76.8MM EBITDA run

rate in the quarter ending October 2020, which at a share price of

$3.15 would put the company’s shares trading at an EV/2021E EBITDA

of just 4.4x on a fully diluted basis (4.9x using consensus). We note that

Canopy, Aphria and MedReleaf currently trade at an average

EV/2021E EBITDA multiple of 16.0x using only current shares outstanding

(i.e., not fully diluted) – and that all LPs with 2021 estimates trade at an

average of 11.4x (again only using current shares outstanding).

Applying an EV/2021E EBITDA multiple to our EBITDA forecast for




Hydropothecary would require a share price of $6.40 (again on a fully

diluted basis).

We note that these calculations also assume the company does

nothing with its pro forma net cash of $188MM. In reality, we believe

management is well aware that 1MM sq. ft. is becoming table stakes

in this industry, and it has 65 acres to build on.

Exhibit 6. Highlights From Our Model

Oct-17 Jan-18 Apr-18 Jul-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Jul-20 Jul-21

Q1/F18E Q2/F18E Q3/F18E Q4/F18E FY2018E Q1/F19E Q2/F19E Q3/F19E Q4/F19E FY2019E Q1/F20E Q2/F20E Q3/F20E Q4/F20E FY2020E FY2021E

Revenue Drivers

Production Sold (kg)

From B2 & B5 125 275 425 550 1,375 675 750 750 750 2,925 800 875 875 875 3,425 3,500

From B6 0 0 0 0 0 0 0 750 1,250 2,000 1,750 2,250 2,750 3,250 10,000 18,000

kg and kg equivalents sold 125 275 425 550 1,375 675 750 1,500 2,000 4,925 2,550 3,125 3,625 4,125 13,425 21,500

Realized Price ($/g) $8.75 $8.50 $8.25 $8.25 $8.35 $8.25 $8.25 $8.25 $8.25 $8.25 $8.25 $8.25 $8.25 $8.25 $8.25 $8.25

Revenue (000s') $1,094 $2,338 $3,506 $4,538 $11,475 $5,569 $6,188 $12,375 $16,500 $40,631 $21,038 $25,781 $29,906 $34,031 $110,756 $177,375

Adj. EPS - Fully Diluted -$0.04 -$0.04 -$0.03 -$0.02 -$0.14 $0.00 $0.01 $0.04 $0.06 $0.11 $0.09 $0.13 $0.16 $0.20 $0.59 $1.14

Adjusted EBITDA (000's) -$2,063 -$1,456 -$769 -$41 -$4,329 $820 $1,011 $3,272 $4,628 $9,730 $6,343 $8,896 $11,099 $13,517 $39,856 $76,849

Key Operational Data

kg sold - Y/Y % Change 55% 204% 210% 475% 240% 440% 173% 253% 264% 258% 278% 317% 142% 106% 173% 60%

Revenue - Y/Y % Change -4% 156% 197% 427% 180% 409% 165% 253% 264% 254% 278% 317% 142% 106% 173% 60%

Adjusted Gross Margin % 71% 71% 71% 72% 71% 73% 73% 74% 75% 74% 75% 76% 76% 77% 76% 78%

EBITDA Margin % - - - - - 15% 16% 26% 28% 24% 30% 35% 37% 40% 36% 43%

As a Percentage of Revenue

Marketing & Promotion 137% 71% 47% 30% 56% 29% 28% 27% 26% 27% 25% 24% 23% 22% 23% 21%

General & Administrative 119% 60% 43% 26% 50% 26% 26% 18% 18% 20% 18% 15% 14% 13% 15% 11%

Research & Development 4% 3% 3% 3% 3% 3% 3% 3% 3% 3% 3% 2% 2% 2% 2% 2%

Source: Beacon Securities.

Takeout Potential – We See A Good Fit

For Most Of The “Big Five”

With a relatively small market cap ($300MM) and 25,000 kg of high

value / low cost production ready to come online in July 2017, 65

acres to build on and potentially no debt soon, we believe

Hydropothecary could be a takeout candidate. We don’t expect

any potential suitors to make a move before the SAQ outlines its rollout

plans. While such comments are extremely speculative in nature, we

see the following possibilities:

MedReleaf – There has been market chatter that MedReleaf is looking

to add greenhouses to its roster, the production from which would be

aimed at extraction and the recreational market. Hydropothecary

could be MedReleaf’s ‘greenhouse strategy’, while offering innovative

products to maintain its leading revenue / gram economics.

Hydropothecary’s EV is currently just 19% of MedReleaf’s.

Aphria – In its latest prospectus, Aphria named “Construction or

acquisition of domestic production facilities, if required to support

provincialism within the Cannabis Act” as the first use of proceeds,

expanding that “It has become clear that in order to participate in

future adult recreational cannabis-use markets in Canada at levels

attractive to the Company, it may need to make investments in




individual provinces in Canada … It is not the Company’s intention to

make these investments in each province, but rather on a select basis

where the demands in that province support the Company’s

investment. These investments could take the form of acquisitions,

purchased greenhouses, purchase land for development including

newly built state-of-the-art greenhouses and extraction and/or

processing facilities.” (emphasis ours) Obtaining a license from

scratch in Quebec has proven very difficult across the board.

Acquiring Hydropothecary could be Aphria’s ‘Quebec strategy’ to

ensure the company isn’t shut out of Canada’s second largest

province. Acquiring another greenhouse in a lower cost province

would be consistent with the company’s low cost approach. Finally,

Aphria may be able to time a potential acquisition to occur after a

potential SAQ announcement – but before construction of

Hydropothecary’s 250K sq. ft. greenhouse has passed the point of no

return, so that it can still be modified to be built ‘the Aphria way’ – as

well as subsequent expansions. Hydropothecary’s EV is currently just

13% of Aphria’s.

Canopy – Canopy has been very successful in leveraging its status as

a ‘local’ producer in other provinces. However, more than a year

after acquiring an applicant in Quebec (Vert), it has not received its

license. Should this continue, Canopy may look to fast-track Quebec

production and acquire Hydropothecary. Hydropothecary’s EV is

currently just 8% of Canopy’s.

Aurora – Aurora owns the only other LP in the province, as well as an

applicant. One might think that this would be enough of a presence

in the province. However, Aurora is clearly on a buying spree, and a

potential acquisition could allow it to corner the Quebec market – as

well as provide sufficient land on which to build a second Aurora Sky

greenhouse. Hydropothecary’s EV is currently just 9% of Aurora’s.

CannTrust Holdings Inc. (TRST-C, not covered) – CannTrust is shifting its

focus away from indoor production. However, we suspect the

company is focused on ramping up its new greenhouse in Niagara

and expanding its global network for now. Hydropothecary’s EV is

currently 38% of CannTrust’s.

Q1/FY18 Preview

We expect Hydropothecary to report Q1/FY18 (October) results just

before Christmas.

We are forecasting the company to sell 125 kg (up 31% sequentially)

at an average price of $8.75/g for revenue of $1.1MM (up 27%

sequentially). We are forecasting EBITDA of $-2.1MM.




Maintaining Buy Rating; Raising Target To

$4.00 (From $3.00)

We use a DCF approach in determining our target price for

Hydropothecary. Highlights from our DCF include: achieving 3%

market share by FY21 (based on the PBO’s midpoint estimate of 734

mt); revenue realized per gram stabilizing at $8.25 in Q3/FY18 (April

2018) and beyond; all-in costs of goods sold falling to reach $1.85/g in

Q1/FY21 (October 2020) and beyond; a discount rate of 10%; and a

0% terminal growth rate post FY21. After taking account dilution from

in the money options and warrants which mature after the valuation

date (October 30, 2018), this approach results in a total value of

$771MM or $4.00 per share (rounded).

Exhibit 7. Justification of Target Price

Jan-19 Apr-19 Jul-19 Jul-20 Jul-21

Q2/F19E Q3/F19E Q4/F19E FY2020E FY2021E Terminal Value

Production Sold (kg) 750 1,500 2,000 13,425 21,500

Revenue $6,187,500 $12,375,000 $16,500,000 $110,756,250 $177,375,000

Adjusted Gross Margin $4,537,500 $9,150,000 $12,300,000 $84,372,500 $137,600,000

EBITDA $1,010,625 $3,271,875 $4,627,500 $39,856,016 $76,849,063

Net Income $474,231 $2,711,826 $4,085,644 $39,600,255 $77,196,872

Free Cash Flow -$2,410,929 $2,193,228 $3,778,608 $36,842,127 $75,177,619 $751,776,192

PV of Free Cash Flow -$2,354,162 $2,091,161 $3,517,931 $32,072,759 $59,936,914 $525,854,989

Price Realized / g $8.25 $8.25 $8.25 $8.25 $8.25

COGS / g (all in) $2.20 $2.15 $2.10 $1.97 $1.85

Per DCF Adjustments Fully Diluted

Discount Rate 10%

Total PV of FCF $621,119,592

Net Cash (Debt) as at Valuation Date (Q1/FY19) $74,237,383

Total Value $695,356,976 $75,733,087 $771,090,063

Shares outstanding at Valuation Date 125,899,258 70,853,088 196,752,347

Value per Share (Rounded) $4.00

Current Price $3.21

Return 25%

Source: Thomson Reuters, Company reports, Beacon Securities.




Exhibit 8. Market Comparables

Marijuana Comparables

EV/Sales EV/EBITDA

Year End

The Hydropothecary Corp THCX.V JUL $3.21 $300 $41 $258 22.5x 6.4x 2.3x 1.5x - 26.5x 6.5x 3.4x

Other Public Companies

Canopy Growth Corp WEED.TO MAR $19.42 $3,564 $345 $3,219 39.7x 17.4x 7.4x 3.7x - - 100.5x 22.7x

Aurora Cannabis Inc ACB.TO JUN $7.09 $3,191 $340 $2,851 38.8x 10.5x 8.7x - 133.8x 26.3x 13.1x -

Aphria Inc APH.TO MAY $13.47 $2,213 $178 $2,035 46.5x 12.2x 6.0x - 142.9x 33.7x 16.9x 15.6x

Cronos Group Inc MJN.V DEC $4.50 $669 $28 $640 27.4x 7.5x 2.8x 2.0x 150.8x 21.5x 6.1x 3.7x

Supreme Pharmaceuticals Inc FIRE.V JUN $1.90 $359 $39 $319 36.7x 4.1x 2.0x 1.7x - 10.8x 4.1x 3.1x

MedReleaf Corp LEAF.TO MAR $15.50 $1,553 $165 $1,389 29.6x 9.1x 5.1x 4.2x 183.5x 26.9x 14.1x 9.9x

CannTrust Holdings Inc TRST.CD DEC $7.70 $700 $27 $673 8.5x 3.8x 5.7x - 26.3x 9.0x 10.2x -

OrganiGram Holdings Inc OGI.V AUG $3.79 $443 $95 $348 10.5x 3.4x 2.8x - 43.9x 9.9x 7.6x 5.8x

CanniMed Therapeutics Inc CMED.TO OCT $19.93 $458 $40 $417 10.9x 5.5x 4.0x - 49.8x 13.7x 7.6x -

Group Average $1,461 $140 $1,321 27.6x 8.2x 5.0x 2.9x 104.4x 18.9x 20.0x 10.1x

2019E2018E 2018E2020E 2021E Company Ticker Last Price

Market

Cap.

(MM)

Net Cash

(MM)2021E

EV

(MM)2020E2019E

Marijuana Comparables

Sales (MM) Sales Growth EBITDA (MM) EBITDA Growth EBITDA Margin %

The Hydropothecary Corp $4.1 $11.5 $40.6 $110.8 $177.4 180% 254% 173% 60% -$4.3 $9.7 $39.9 $76.8 - 309.6% 92.8% - 23.9% 36.0% 43.3%

Other Public Companies

Canopy Growth Corp $39.9 $81.1 $185.3 $433.2 $867.6 103% 128% 134% 100% -$15.1 -$4.6 $32.0 $142.1 - - 343.7% - - 7.4% 16.4%

Aurora Cannabis Inc $19.9 $73.5 $270.6 $326.3 - 269% 268% 21% NA $21.3 $108.5 $218.3 - 409.6% 101.1% - 29.0% 40.1% 66.9% -

Aphria Inc $20.1 $43.7 $167.3 $339.7 - 117% 283% 103% NA $14.2 $60.4 $120.6 $130.3 324.3% 99.5% 8.1% 32.6% 36.1% 35.5% -

Cronos Group Inc $4.3 $23.4 $85.5 $225.1 $328.2 450% 266% 163% 46% $4.2 $29.8 $105.1 $174.0 603.0% 252.2% 65.6% 18.1% 34.9% 46.7% 53.0%

Supreme Pharmaceuticals Inc $0.5 $8.7 $78.1 $160.9 $191.9 1793% 798% 106% 19% -$6.1 $29.6 $77.5 $101.5 - 161.9% 31.0% - 37.9% 48.2% 52.9%

MedReleaf Corp $40.4 $46.9 $152.4 $272.0 $331.2 16% 225% 78% 22% $7.6 $51.7 $98.7 $140.8 583.0% 91.0% 42.6% 16.1% 33.9% 36.3% 42.5%

CannTrust Holdings Inc $20.8 $79.4 $178.7 $118.3 - 282% 125% -34% NA $25.6 $74.9 $65.7 - 193.0% -12.4% - 32.2% 41.9% 55.5% -

OrganiGram Holdings Inc $7.6 $33.1 $103.7 $126.2 - 337% 213% 22% NA $7.9 $35.3 $45.9 $60.1 345.2% 30.2% 30.9% 23.9% 34.0% 36.4% -

CanniMed Therapeutics Inc $17.1 $38.3 $75.5 $104.0 - 124% 97% 38% NA $8.4 $30.5 $54.7 - 263.7% 79.3% - 21.9% 40.4% 52.6% -

Group Average 388% 267% 70% 47% 389% 100% 87% 25% 37% 43% 41%

2019E 2020E 2019E 2021E Company 2017E 2018E 2019E 2018E2020E 2020E 2020E 2021E2021E2019E2021E 2019E2018E 2021E 2018E 2020E

Note: THCX, WEED, FIRE, and MJN estimates are Beacon Securities’. Estimates for other companies are consensus.

Source: Company reports, Thomson Reuters, Beacon Securities estimates.

Exhibit 9. NEW And OLD Estimates

NEW OLD

FY2018E FY2019E FY2020E FY2018E FY2019E FY2020

kg sold 1,375 4,925 13,425 1,375 4,925 13,000

Revenue (MM) $11.5 $40.6 $110.8 $11.1 $39.4 $104.0

EBITDA (MM) -$4.3 $9.7 $39.9 -$4.2 $6.6 $24.8

EPS (f.d.) -$0.14 $0.11 $0.59 -$0.10 $0.04 $0.35

Source: Beacon Securities.


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

Disclosure Requirements

Does Beacon, or its affiliates or analysts collectively, beneficially own 1% or more of any class of the issuer's equity securities? Yes No

Does the analyst who prepared this research report have a position, either long or short, in any of the issuer’s securities? Yes No

Does Beacon Securities beneficially own more than 1% of equity securities of the issuer? Yes No

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?

Yes No

Has Beacon Securities performed investment banking services in the past 12 months and received compensation for investment banking services for

this issuer in the past 12 months? Yes No

Was the analyst who prepared this research report compensated from revenues generated solely by the Beacon Securities Investment Banking

Department? Yes No

Does any director, officer, or employee of Beacon Securities serve as a director, officer, or in any advisory capacity to the issuer? Yes No

Are there any material conflicts of interest with Beacon Securities or the analyst who prepared the report and the issuer? Yes No

Is Beacon Securities a market maker in the equity of the issuer? Yes No

Has the analyst visited the head office of the issuer and viewed its operations in a limited context? Yes No

Did the issuer pay for or reimburse the analyst for the travel expenses? Yes No

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 November 30, 2017 #Stocks Distribution

BUY 72 77.4% Buy Total 12-month return expected to be > 15%

Speculative Buy 12 12.9% Speculative Buy Potential 12-month return is high (>15%) but given elevated risk, investment could result in a material loss

Hold 8 8.6% Hold Total 12-month return is expected to be between 0% and 15%

Sell 0 0.0% Sell Total 12-month return is expected to be negative

Under Review 1 1.1%

Tender 0 0.0% Tender Clients are advised to tender their shares to a takeover bid or similar offer

Total 93 100.0%

Dissemination

Beacon Securities distributes its research products simultaneously, via email, to its authorized client base. All research is then available on

www.beaconsecurities.ca via login and password.

Analyst Certification

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.

http://www.beaconsecurities.ca/

Documents

BUY $4.00 Company Update · of the company’s recent $69MM financing, in this report we provide an update on key points of our investment thesis. Hydropothecary generated revenue