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No. of Recommendations: 4
Follow-up:

Stock was $8-$10 in early 2018, fell to about $5 when fraud allegations were first made by QCT/Hindenburg research groups, and we debated the pros and cons of holding this stock, I was short at about $6, BGM was long with an average cost of about $4.

We haven't had much in the way of news about what seemed pretty stinky to me, which tends to support the bullish view holding that the Latin American asset flip by previous management was a one-off and not significant to the business.

On the other hand, the rest of my short thesis seems to be playing out: the Canadian market for cannabis is still about 1 million kg of dry flower equivalent, and all the major Canadian brands have continued to rapidly build out capacity. Producer prices (https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=361005...) have continued to drop, down from $5.10 (CAD) in 2015 to $4.58 in 2018. I think they can go much lower. Aphria's revenues have rocketed up as one would expect, because of legalization, and were $13m, $22m, $74m and $129m in the last 4 quarters, but most of this comes from distribution partnerships in continental Europe; $29m came from selling 5574 kg of cannabis in Canada. Annualized, that would be about 22,000 kg, still tiny compared to their projected capacity of 255,000 kg which they expect to produce when current projects are complete, or about 1/4 Canadian demand (mostly recreational).

The 1 million kg estimate seems about right, with Stats Canada projecting about $5b in sales at consumer prices of about $8/g, suggesting just under 1 million kg. Another recent report from an American research firm, Brightfield, suggests the total market in Canada (medical + rec) will be about $8b in 2021, which is also close to 1 million kg. This is slightly less than the Colorado experience, where a state with a population of 4 million generates $1b in sales. (Canada has a population of 37m).

Ballparking the value of Aphria, (current market cap of $1.5b CAD), if they can maintain about 1/4 of the Canadian market under full capacity, and they get $5/g, that would mean $5k per kg, times 250,000 kg, so $1.25b in revenue. The whole question becomes, what kind of margins might they get? Current financial reports are not much help, since they are spending so much building out infrastructure and developing new products (comestibles become legal in Canada this Fall.) My bear thesis is that there will be fierce competition for market share, with capacity far exceeding demand, and margins will be close to zero for the basic product. Any hope for profit has to be on the basis of branding, but I still feel that all the Canadian marijuana brands are pretty much unknown to most people. Ask your Canadian friends if they can name one, for instance.

An additional piece of bad news for the whole industry is that vaping is taking a big hit, with the current crisis over 8 deaths in the USA and up to 500 cases of pulmonary illness. It is not clear whether this is a real problem, or something related to one of the vehicles for the active drug (vegetable glycerin, propylene glycol). Or perhaps the whole thing is being blown out of proportion (there are about 15 million vapers in the USA). On the other hand, maybe it is just the tip of the iceberg, since the product is fairly new and effects may build up over the years of use.

Anyways, it has been a bit of a roller coaster so far: $10/share in early 2018, down to $5 last Fall, back up to $10 this spring, and now back down to $5.70 as I type. I maintain a small short position, along with shorts in 3 other Canadian producers opened in the last 6 months. So far, I am comfortably in the black, and expect them all to drop by at least a half again, where I will probably close them. Aphria would be the last one I would close, as there is the additional possibility that further evidence of fraud eventually surfaces.

Regards, DTB
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