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No. of Recommendations: 6
Hey Guys,

Thursday is our 9th annual investment conference. Actually it is our 6th in a row, and before that it was sporadic.

Here is a link to our hand-out. You all who know me over the decades, know I am a bit disheveled in my writing.


https://rbcpa.com/2019-rbs-investment-conference-handout/

As always, and mentioned with earnest. Constructive criticism is welcome.

Still lurking, when posts appear.
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No. of Recommendations: 7
I was going to congratulate you on finally coming round to see the merits of Brookfield (BAM), and wondered how you could have a 20% loss YTD given that the stock has gone practically straight up. But then I saw your allocation, which is -1.7%, so I now understand the entry in your table, where you list Brookfield Asst Mgt (S)... :( Do you feel the share price has gotten ahead of itself, or do you still give credence to the idea that the books are getting cooked?

Big position in energy, 32%. Got to think that will end up working out well. Can't say the same thing about the 10% position in cannabis. The Miracle Gro (SMG) position is half of that, and is basically based on the thesis that there will be a lot more marijuana being grown, as legalization rolls out everywhere? There's already a fair bit being grown, and legalization does not seem to have increased total consumption, at least according to the experience in Colorada and now Canada. Is your SMG position based on the idea that there actually will be increased production, and that this company will be selling the equipment?

Kudos that you have the guts to lay out your whole portfolio like that!

Regards, DT
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No. of Recommendations: 2
like DB, I'm impressed whenever you do this, and whatever comment I have is from a totally different perspective, but here goes: in slide 9, you discuss the typical 'defensive nature' of your portfolios. I think this is terminology is off - what you are typically is uncorrelated, not defensive, regardless of the direction of the portfolio.

When I think of 'defensive' I think of a portfolio full of stalwarts (hopefully appropriately priced) or strong balance sheet companies with counter-cyclical tendencies with hefty dividends with a heavy dose of cash. Either that, or a portfolio which closely mimics the same allocations of those of a chosen index.

Slide 25 clearly illustrates this point - your portfolio is highly concentrated in different industries than, say, the SP500. I would reword this and make the portfolio vs. index comparison if that is something you want to explore (you may not, but most clients don't know the industry components of the indexes they might be compared against, but this is up to you). In the final analysis, 'defensive' can mean to imply it won't go down as much as a chosen index in a drop, and it might go down - esp. with the structure you have. I would be careful here - in the old days, your portfolio was perhaps more traditional - it isn't now in my view.

anyways, 2c - always enjoy your stuff

--
Portfolio composition
Equity sector diversification

Portfolio composition
Equity sector diversification

1-Communication Services
2-Consumer Discretionary
Consumer Staples
Energy
Financials
Health Care
Industrials
Information Technology
Materials
Real Estate
Utilities

1- 10.40%
2- 10.10%
etc.
7.60%
4.50%
12.90%
13.70%
9.40%
21.90%
2.70%
3.20%
3.60%

https://investor.vanguard.com/mutual-funds/profile/VFIAX
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re: BAM

if it matters, you know this, but that OAK acquisition was a VERY high quality asset, with retained AUM and a terrific reputation and a business that can generate tons of FCF. I'm not sure how much it means out of BAM right now, but...I would think that the OAK people would have done appropriate due diligence on BAM before the buyout, but who can say for sure.
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Thanks for reading and commenting DT.

I prefer not to discuss our BAM position from 9/30/19.

In regards to SMG. My notes can be found at this link: https://rbcpa.com/scotts-miracle-gro-rbs-investment-notes/

In essence, I think cannabis will be legalized worldwide. We still have 34% of the states in the USA to go legal. Any production of cannabis, be it indoor or greenhouse, will require infrastructure, and hence SMG should be a beneficiary.

You are obviously fluent in the sector. I think black market is affecting growers and consumption quite a bit. Vaping crisis too. Being illegal both in many states and Federally as well. Only 11 states are recreationally legal, so that leaves 39 to become recreationally legal. Most states will have greenhouse or indoor grows for reasons of weather, and local rules. Greenhouse and indoor certainly produce higher quality strains. Outdoor is starting to be allowed in various areas, and I am guessing that will proliferate world-wide. I think outdoor cannabis is less potent and less smokable, yet with extractions the need for smokable cannabis becomes less. No doubt, premium cannabis is typically grown indoors.



Here is my reason for ownership, which I cut and pasted from the link

SMG is the largest infrastructure company in the cannabis industry. Via their Sunlight Supply acquisition, they developed a modern and cost-efficient supply chain in the cannabis infrastructure industry. This division in known as the Hawthorne Division. Of course, most of SMG’s business is the consumer garden and lawn business. Yet, we are clearly invested in Scotts for the prospect of a very large and profitable supplier to the cannabis industry. We expect cannabis to increase worldwide via the eventual end of cannabis prohibition. Scotts should be an obvious beneficiary if and when the legalization of cannabis occurs.

Scotts certainly has a sizeable debt load, and this is the reason S&P only gives them a ‘BB’ rating. S&P recently upgraded their credit to ‘BB Stable’ from Outlook Negative. ‘BB’ is the Highest Rung of Speculative. My largest concern is with their debt levels, risk of leverage, extended P/E and potential of worsening balance sheet. As of the most recent filing (6/30/19) the company clearly has a potentially concerning balance sheet. The debt to equity ratio is 194.2%. The long-term debt is ~$1.6B.

As far as I can recall, Scotts continues to be the largest company by cannabis related revenues in the world. As more states legalize cannabis recreationally, new licenses will be awarded, and there is absolutely no reason to think that SMG will not be a material beneficiary of such a paradigm. For the first time I can ever recall, the USA is warming up to ending the cannabis prohibition. I expect full decraminilazati0n in the future, as well as legalization of cannabis.

Scotts calls their cannabis infrastructure division “hydroponics.” The term hydroponic includes, all aspects of indoor grows, from supplies, lighting, nutrients, cloning, and virtually every aspect a grower needs. This grower can be industrial size or a home grower. Of course, SMG’s focus will be on the larger commercial organizations. Scotts has defined their use of the word hydroponics, as anything related to the cultivation of cannabis.

We very much like when officers and directors have skin in the game, via share ownership. Officers and directors own over 28% of the company as of October 8, 2019.

When we bought SMG, I thought it was a true “value play.” Because of the price increase, that value has dissipated. Yet, of course, I still think owning SMG is worthwhile. I am not so sure I would buy at these levels, but I think selling would be too premature. When we bought SMG, I often thought of and cited the following quote: "If you wait for the robins, spring will be over." Warren E. Buffett October 19, 2008 (during the financial crisis)

The fundamentals of the valuation seem to be in line, when looking at F2020 forward expected price/earnings ratio of 20.61X, compared to F2020 forward expected return on equity of 29%, and expected forward F2020 return on capital of 12%, as well as the expected forward F2020 dividend pay-out ratio of 49%. I like to see price earnings ratios to be less than return on equity.

Some Fundamental Analysis:

Yield is 2.27% ($2.32). Operating earnings expected at $4.23 (which doesn’t include one-time gains of ~$3.72, which would bring expected GAAP earnings per share to $8.15) which would give a P/E of 22.57X. Dividend pay-out has averaged 55.6% for the last 10 years. The payout ratio was 61% in F2017, and 94% in F2018. Dividend payout ratio expected to be 27% and 49% for F2019 and F2020 respectively. ROE has averaged 27.48% for the last 10 years. ROE was 30.5% in F2017, and 36.0% in F2018. ROE is expected to be 25.10% for F2019 and 29.0% for F2020. ROTC has averaged 13.25% for the last 10 years. ROTC was 12.4% in F2017, and 7.6% in F2018. ROTC is expected to be 13.8% for F2019 and 12.0% for F2020. Average P/E for the last 10 years has been 23.14X. Projected eps for F2020 is $4.95 which equates to a forward P/E of 20.61X. VL gives it ‘B++’ financial strength, and a Safety rating of 3. VL projects a price between $80 - $120 between 2022 – 2024 (9/20/19).

Shares outstanding projected to be 55 at December 31, 2019, and 57 at December 31, 2020.

S&P credit rating is ‘BB’ Highest Rung of Speculative Outlook Negative (8/27/19)

Moody’s credit rating is ‘Ba2’ Upper Rung of Speculative (1/11/10) Outlook Stable (5/24/18)

Fitch credit rating N/A.
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No. of Recommendations: 4
.. that OAK acquisition was a VERY high quality asset, with retained AUM and a terrific reputation and a business that can generate tons of FCF. I'm not sure how much it means out of BAM right now, but...I would think that the OAK people would have done appropriate due diligence on BAM before the buyout,


Good point, Howard Marks' blessing of this acquisition has to be pretty reassuring for anyone who doubts the quality of Brookfield. It won't be a big part of the overall business, though - Brookfield paid $2.4b for 61% of the Oak business, with a plan for acquiring the rest over the next 10 years; by comparison, Brookfield had a market cap of about $46b at the time of the offer. So when Brookfield owns all of Oaktree, it will still represent less than 10% of Brookfield's business.

It is interesting to note that the acquisition allowed Oaktree shareholders to choose between $49 per OAK share or 1.077 shares of Brookfield (BAM), subject to a pro-ration so that overall, 50% of the acquistion was with cash, and 50% with shares. The share option was oversubscribed, suggesting that most OAK shareholders felt that BAM was worth more than $49/1.077= $45.50 (which was the BAM share price at the time of the offer).

If my calculations are correct, that means that on average, only 13% of OAK shareholders wanted cash, and 87% wanted BAM shares. Martian, were you one of these guys, and if so, did you opt for cash or shares? With shares at $53.70 now, that choice is working out for them so far.

https://www.globenewswire.com/news-release/2019/09/30/192247...

dt
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No. of Recommendations: 0
fwiw, I always sell as soon as an announcement comes out, esp. if the acquirer is a company I am not familiar with. that said, I do own OAK preferreds, and I'll admit to slow-walking my evaluation of those now that the merger has taken place...
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glad you prompted that - it is a question for which I need an answer - the preferreds were untouched by the merger, but is the OAK business considered a separate legal entity or do I have now have to worry that the parent's financials now effect these too? My guess is they would be separate, but I needed to confirm. Have a call in...
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I think black market is affecting growers and consumption quite a bit. Vaping crisis too. Being illegal both in many states and Federally as well. Only 11 states are recreationally legal, so that leaves 39 to become recreationally legal. Most states will have greenhouse or indoor grows for reasons of weather, and local rules. Greenhouse and indoor certainly produce higher quality strains. Outdoor is starting to be allowed in various areas, and I am guessing that will proliferate world-wide. I think outdoor cannabis is less potent and less smokable, yet with extractions the need for smokable cannabis becomes less. No doubt, premium cannabis is typically grown indoors.


I am interested in the topic both because I live in Canada and it has been a big hullabaloo, and because it seems like an obvious short. I was at -2% originally, but with all companies down bigly in the last 6 months, I am now at -1.2%. Shorting is a bummer that way, to keep your stake, you have to add new shorts at lower, less attractive prices.

Anyways, my basic thesis is that marijuana is a commodity crop that will command commodity prices, i.e. it will be very competitive and margins will be low. Things will be worse for marijuana, where the high stock prices have encouraged companies to massively build out capacity, far exceeding total demand, so margins may even be negative, as companies try to recuperate some of their sunk infrastructure costs.

Recent problems with fraud (Aphria, and the ironically named CannTrust) don't help. The vaping crisis also doesn't help, although in the long run, I think we will conclude that vaping is much safer than smoking, and while it is too soon to be certain where the problem lies, it seems to involve black market vapes and not the legal industry.

By far the biggest cannabis investment in your portfolio seems to be Scott Miracle Gro, a greenhouse equipment retailer, which should not be as severely affected as the cannabis producers themselves. My worry is that the shares price in big increases in sales which may not materialize. Experience in jurisdictions where legalization has occurred indicate that there is a small uptick in consumption which is already quite high (about 1 million kg consumed in Canada per year, for instance), but mostly at the expense of the black market, with very little overall increase in consumption or (of course) production. At the moment, Canada's legal cannabis retailers have taken about 40% of the market, unable to produce more than about 400,000 kg per year, but they all have plans to increase capacity, with their total projected capacity close to 2 million kg.

I agree with your hypothesis that legalization not only makes sense from a societal point of view but is almost inevitable, politically. It is unlikely that foreign suppliers will be allowed into this market (they certainly aren't in Canada), so Canadian producers' dreams of supplying the world market are a pipe dream, but there will be opportunities for local producers in each country. Unfortunately, they are likely to be stuck with the same commodity problems that I have discussed for Canadian producers.

So where do equipment providers like SMG come in? For one thing, to the extent that they have benefitted from the rapid build-out, they may already be at their peak, at least in Canada. On the other hand, in the USA, that peak may be something they can hope for, and I agree that most of it will be grown indoors, SMG's market.

But if I am right in saying that overall production or consumption will not change much with legalization, you have to wonder where all these new sales are going to come from, for a company like SMG. There is already a huge illegal market is producing marijuana, along with some local production for medical use or in states that have legalized already. Some of it comes from overseas (Mexico, etc.), but to avoid the hassle and risk of getting illegal substances across the border, most of it is grown in greenhouses already, and these producers may already be customers of companies like SMG. Maybe I'm wrong? Maybe it is too dangerous to buy hydroponic equipment over the counter, since that would make it pretty easy for the DEA to catch wind of their operations?

dt
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"the ironically named CannTrust I believe I started the renaming of Can't Trust"

"Scott Miracle Gro, a greenhouse equipment retailer"

Their sweet spot is really indoor grows, which is vastly different than greenhouse.


"At the moment, Canada's legal cannabis retailers have taken about 40% of the market, unable to produce more than about 400,000 kg per year, but they all have plans to increase capacity, with their total projected capacity close to 2 million kg."

I concur. Of course SMG should be the obvious beneficiary of expansion. You can't run an indoor grow or greenhouse, without the infrastructure. SMG is clearly the 800 lb. gorilla in that infrastructure. This includes, but not limited to,fans, filters, lighting, tables, cloning, propagation, venting, and tents.

"It is unlikely that foreign suppliers will be allowed into this market (they certainly aren't in Canada)"

I could be incorrect, but I don't agree. Tulsi Gabbard (who in a #metoo Ken Fisher moment, thinks she is awfully pretty) has been part of The More Act – A bill to de-schedule cannabis on a nationwide basis. Bring in social justice via expungements and a national sales tax to products manufactured or imported into the U.S. Ultimately, here in the States, I think the cannabis industry will be like the alcohol industry). I would imagine Canada too, as many companies already have licenses abroad (at least they allege to), such as Canopy and Aphria, to name two.

"But if I am right in saying that overall production or consumption will not change much with legalization"

Eliminate the black market, and consumption doesn't have to change. Legal entities will gain market share from illegal entities.

I don't concur that consumption won't change. I think it will. Especially in USA and world wide.

"Some of it comes from overseas (Mexico, etc.)"

Mexico is expected to legalize like Canada shortly. Perhaps this year. One of their thoughts is legalization will stop the Cartel.
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HBM (at least for this week?).

Thank you. I always appreciate your writings, thoughts and comments!

Thanks for reading and commenting.

All is printed, so I will consider changing in the future. I really have to think about it.

All good stuff, and hearing both of your replies is very helpful and appreciated.

OT: Here is a picture of me, my wife of almost 358 months, and my oldest son, at his former job in OR. He now works at a cannabis company in Denver CO, as a financial data analyst (same as his job in OR). https://photos.app.goo.gl/FCBGKCBvERnqifvn6
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Their sweet spot is really indoor grows, which is vastly different than greenhouse.

Ok, my terminology is off. Isn't a lot of the equipment the same, though?


Eliminate the black market, and consumption doesn't have to change. Legal entities will gain market share from illegal entities.

Right, but my point is, aren't those illegal entities already buying the equipment to (illegally) grow indoors and in greenhouses?


I don't concur that consumption won't change. I think it will. Especially in USA and world wide.

You may be right, it seems consumption did go up a bit in Colorado, for instance. On the other hand, it doesn't seem to have made much difference in Canada. Legal production is up from about 20% (mostly medical marijuana) to maybe 40%, with the addition of legal recreational consumption, but overall, consumption seems stable - about 16% of adult Canadians having used once in H1 2019, up from 14% the year prior, but most of that increase was very occasional, probably a lot of it being the novelty factor with a few percent of previous non-users experimenting with something that was scarier when it was illegal. Of course, reported sales of cannabis companies are way up, because that's the legal part of the market, but the total doesn't seem to have changed very much.

In Colorado, it's a bit more complicated: percentage of adults using it has gone from 10% to 16%, but most of that increase was actually before legal adult sales started in 2014. From legalization (December 2012), the increase is more like 13% to 16%. Washington State seems about the same, but I can't find anything concrete about actual kg of production, nor for Oregon - what's your experience there?

d
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DTB -

Excellent points.

Probably similar equipment indoors and greenhouse. I'm really not certain. I never get to granular into any of my investments. Which will hit on some of your other questions in the post above.

Yes, the illegal producers are using SMG or some type of cannabis infrastructure.

" Of course, reported sales of cannabis companies are way up, because that's the legal part of the market, but the total doesn't seem to have changed very much."

I think we are on the same page here. Most, if not all of the producers and cannabis companies we own have exponential revenue growth. This doesn't make it a good investment at all, as most of the companies I own, are expected to do $100M to $400M annually starting in F2020/2021. Aphria revenues are expected to be $700M CAD in F2020, but much of that is from distribution and not cannabis production. Again, lots of revenue growth even with black market.

Also, commoditization is rearing its head in Canada and Colorado. It already hit big time in OR several years ago. In the picture I presented we were holding in total about 6 pounds of cannabis. In 2016ish, that would have sold for up to $30K USD in OR. I stopped following OR about 9 months ago, but at that time the same product would sell for about $3,500 (maybe even less).

Again, consumption can stay the same, we need black market to be eliminated. That will probably be accomplished via regulations, enforcement, and of course, commoditization. If you look at my company notes, you will see that eventual commoditization is certainly a theme and expectation of ours.

"In Colorado, it's a bit more complicated: percentage of adults using it has gone from 10% to 16%, but most of that increase was actually before legal adult sales started in 2014. From legalization (December 2012), the increase is more like 13% to 16%. Washington State seems about the same, but I can't find anything concrete about actual kg of production, nor for Oregon - what's your experience there?"


Way to granular for me. I don't model that close at all. Not sure about OR, but I suspect similar to what you wrote. I'm not sure about Canada, but OR, CO, WA and CA, have always been stoner states, with lots of black market growers.
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In the picture I presented we were holding in total about 6 pounds of cannabis. In 2016ish, that would have sold for up to $30K USD in OR. I stopped following OR about 9 months ago, but at that time the same product would sell for about $3,500 (maybe even less).


Wow, that's a big drop. There is some seasonality, and there are good years for production and bad years, I guess because a significant amount really is grown outside. I found this, for example:

Here’s what McKee is seeing in wholesale prices per pound in the Oregon market as compared to last summer:

Indoor-grown flower: $1,800-$2,4000 (up from $1,000-$1,500 last year).
B-buds, or midgrade flower: $500-$600 (up from $300-$350).
Trim: $250 (up from $100).


https://mjbizdaily.com/marijuana-wholesale-prices-on-the-ris...

$3,500 a pound would be about $7.70 a gram, or $10 Cdn, so presuming you are talking about street prices (not wholesale), that would be about the same as the Canadian price. That is the estimate from Statistics Canada, which has been following these things since legalization a year ago. They also estimate that in 2017, prior to legalization, domestic (Canadian) production was about 880 tonnes, a little less than my estimate of 1 million kg.

https://www150.statcan.gc.ca/n1/pub/13-607-x/2016001/1284-en...



Again, consumption can stay the same, we need black market to be eliminated. That will probably be accomplished via regulations, enforcement, and of course, commoditization. If you look at my company notes, you will see that eventual commoditization is certainly a theme and expectation of ours.

... Not sure about OR, but I suspect similar to what you wrote. I'm not sure about Canada, but OR, CO, WA and CA, have always been stoner states, with lots of black market growers.


I think consumption is probably fairly similar in Canada and the US. I have seen estimates of about 10 million tons production in the US, which is about 10 times the Canadian level for 10x the population. Of course, some parts of both countries are more interested than others - BC being the province with a reputation for weed, maybe similar to the northwestern US states.

There's an interesting comparison with tobacco: the US produces about 10 million tons of marijuana (dry leaf), and about 250 million tons of tobacco, 25 times as much. But the wholesale price of tobacco is about $2 a pound, and the wholesale price of marijuana is about $500, i.e. 250 times as much. So marijuana farming actually generates more revenue than tobacco. I suspect that, just like for tobacco, there won't be much money to be had from farming it - the money will be had in taxing it and, maybe, in selling products marked up as brands. That will be hard to do in places like Canada, where the government does not allow advertising. So if and when the US does legalize marijuana, a lot of the economics will depend on what the government decides to allow. And if it is possible to develop brands, it is a bit hard to predict whose brand will be popular - for the moment, I don't think most marijuana purchasers are familiar with any brand. I think you may disagree about this last point, and it may vary from place to place, but it would be hard to argue that marijuana brands have anything like the name recognition that tobacco and alcohol products have.

dt
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No. of Recommendations: 9
OT: Here is a picture of me, my wife of almost 358 months , and my oldest son, at his former job in OR.

BGM, although I appreciate the precision in which you date your relationship with your wife - almost 358 months - I think you can safely round it up 360 months, i.e. 30 years ;)

***

As always, it's fascinating when an investing colleague opens up the kimono for all to see. I want to avoid any ridiculously picky criticism ("why is that one hanging a little lower than the other one?").

I do agree with HBM/greenmartian that as your portfolio shifted away to a degree from dividend paying financials and utilities to include Gazprom and cannabis stocks, perhaps it shouldn't be characterized as "defensive."

Still, I recognize that another term like "non-correlated" which may be an accurate description is probably not helpful to the average client. I like something like a "mix of defensive, growth, deep value, and cannabis stocks."

What I appreciate the most about your approach is your willingness to embrace unconventional positions in the pursuit of outsized returns. I don't think there is a single other investor in the entire world with a portfolio mix like yours. This is a straight-out compliment.

In the end we all need to create a good return per unit of risk over long periods of time, say, almost 358 months.

ET
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Thanks for all your comments. I really appreciate you taking the time to comment and to have looked at my presentation.

It was a successful event. We had 65 attendees. The survey comments were the best we ever had. People seemed to enjoy and learn from the evening.

Here is an unprofessional smart phone video of the event which I produce every year.

https://www.youtube.com/watch?v=pJwxhZIkG4w&t=4849s

I think my cannabis discussion started around 1:12.

Constructive discussion, even criticism is welcome.

Now, off to a hard earned vacation in Paris, Amalfi Coast, and Rome, with my wife of 359 months (11/26/89) and to see my daughter, who lives and works in Rome.
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If you haven't been to the Borghese Gallery in Rome yet, DO NOT MISS IT!
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If you haven't been to the Borghese Gallery in Rome yet, DO NOT MISS IT!

This was my 3rd time in Rome. Thank you for the wonderful recommendation. What an excellent museum! I also did The Vatican, but only focused on the Sistine Chapel, since I read a bunch of Michelangelo books since my last visit. 2 hours at the Chapel was wonderful! I love that he came back 30+ years later to paint The Last Judgement. The perspective and mood is totally different. Breathtaking. Lots of wine, biked the Appian Way, Pizza in Naples, excellent beer bar in Trastevere, where are VRBO is located. La Salumeria one of our favorite lunch places. Stayed in Sorrento, and visited Capri, took the chairlift, more wine. Also visited Positano. Ran the Tiber of course.

We also stayed in Paris (landed in Paris, flying to EWR from Rome $307 round trip United), which was also wonderful. Saw the Louvre, and Musée d'Orsay. I was touched by the holocaust memorial, as I had no idea (ignorance), that Paris was so affected. One of my favorite things in Paris was joining my international running group, The Hash House Harriers, for a hash with the Paris hash, with my daughter Just Carly. Hashing is a wonderful way to see neighborhoods. https://en.wikipedia.org/wiki/Hash_House_Harriers

So, a wonderful trip, and thanks again for providing one of the highlights!
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I'm glad you enjoyed it, has my favorite sculpture ever, a Bernini, as well as an amazing St. Jerome by Caravaggio.

https://www.romeing.it/bernini-galleria-borghese-rome/

ratto di Proserpina, I think he was like 24 when he did it. Insane.
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Also, commoditization is rearing its head in Canada and Colorado. It already hit big time in OR several years ago.


Have a look at Tilray’s Q3 today, avg price/g down 48% to $3.25. Other Canadian cannabis companies have reported big drops, but this is the worst I’ve seen. Still could go lower, I think. Compare with commodities like fine herbs (basil, say) which are much lower.

dt
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more on the question of supply and demand (oversupply)

The challenges in the Canadian market are ongoing, with a limited number of retail locations and a supply/demand imbalance,” Tilray president and chief executive officer Brendan Kennedy said on the call.

Those concerns have dampened investor enthusiasm for cannabis stocks, most recently driving down shares of Organigram (OGI.TO)(OGI) after that company lowered its guidance late Monday due to a lack of stores in Ontario amid rising supply.
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I will read the articles next week sometime. Not surprised at all. We were in Denver last April. We saw cannabis being sold in dispensaries for about $100 out the door, including taxes. Outdoor grown, but supposedly pretty good. That comes out to $3.53 per gram, all in with taxes.

I think typical prices now are about $10.60 per gram for a premium ounce in CO. MA, an ounce out the door with tax will cost $420 (at least that is what a friend told me).

Companies will adjust. Again, I don't get too granular, but the ability to grow good cannabis is underestimated in my opinion. I think there will be a turning point, where some premium cannabis will generate better pricing. Craft like.

BTW, I was in a craft beer bar in Rome, and found a wonderful 2008 beer, De Dolle Oerbier Special Reserva. IIRC, I paid $35 Euro's for what I think was 12OZ bottle. So, there are those who pay up for a nice vintage. I typically don't do that, but will certainly spend $20 on a nice 4 pack. I think this could relate to cannabis as well.

OT: My wife finds it odd that I coupon shop, am typically quite frugal, but will spend without frugality on a nice beer.
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Companies will adjust. Again, I don't get too granular, but the ability to grow good cannabis is underestimated in my opinion. I think there will be a turning point, where some premium cannabis will generate better pricing. Craft like.

BTW, I was in a craft beer bar in Rome, and found a wonderful 2008 beer, De Dolle Oerbier Special Reserva. IIRC, I paid $35 Euro's for what I think was 12OZ bottle. So, there are those who pay up for a nice vintage.



Yes, this might be true. However, I think there has been an implicit assumption that there might be $1 or 2 of profit per gram as an average profit margin for the whole industry, so $1-2 billion for the Canadian industry (at its present size, assuming the legal market eventually takes the whole market). That might make the whole industry worth $10-$40 billion. In Canada, at the peak, the Canadian pot producers were worth about $60 billion, which is counting a lot of chickens before they were hatched - they are all losing a lot of money, and they only have about 30% of the total market.

By my count, the total market cap of the biggest 9 Canadian producers is just under $18 billion, which seems more reasonable, but not if pot eventually goes to, say, $1 or $2 a gram, with maybe 20% margins on that. Using $2/g prices and a 20% margin, and 1 billion grams sold, $400 million a year is not much profit to be shared around by companies worth $20 billion (50x future earnings). And that is if they ever get to 20% after tax margins, which I very much doubt.

You raise the question of premium products, and to the extent that some company is able to persuade customers that it is worth paying a lot more for a higher quality product, that might add a fair bit of profit to that $400m figure. Beer is maybe a good comparison - the big volume producers, like Budweiser and Coors and Anheuser Busch surely do make a little more on premium products, but I doubt it's a large part of their total profit. The 2008 De Dolle Oerbier Special Reserva you were prepared to pay $35 for is probably very low volume, and I am guessing that the company that makes it is not rolling in money.

It is also not easy to guess who will be able to charge higher prices for premium products. It may depend on the kind of regulations that are set up in countries that have legalized. I am proud of Canada's legalization, and think it is very good policy, but it is accompanied by very strict limits to advertizing, marketing, and even labeling. So the kinds of strategies that might allow companies to establish premium brands would be difficult in Canada and I think you can not assume that differentiation will be easy in the US, either, assuming legalization eventually comes (which I do). Perhaps the West coast USA experience is different.

Regards, dt
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We were in Denver last April. We saw cannabis being sold in dispensaries for about $100 out the door, including taxes. Outdoor grown, but supposedly pretty good. That comes out to $3.53 per gram, all in with taxes.


Ok, here's a question I can't answer, but maybe you and your son who also has some inside knowledge of the industry can help me with: Why is it so expensive to grow marijuana?

I referenced an article a few days ago that said prices should come down to $1 a gram, and I thought there were some good arguments there. But even that price is very high compared to other legal products, like herbs used for cooking.

I thought of comparing something like basil, for instance. If anything, basil is a plant that is more fragile than marijuana, as anyone who has grown both at home knows. It is a high value product, often grown in greenhouses, and like marijuana, most of it is dried. You can buy it retail on Amazno for about $6 for a 3 oz. bottle, or $2/ounce, or 50 times cheaper than the cheap marijuana in your Denver dispensary. Perhaps that's not a good comparison: basil leaves are mostly what is used, and for marijuana, the high value part is the flowers.

So take some flower like calendula, which tastes a bit like saffron. You can buy a pound for $32, so it's also about $2 an ounce, still 50 times less than marijuana. Saffron itself is notoriously expensive (something referred to as 'red gold'). You can buy a pound for as little as $500 (a little over $1 a gram), but saffron doesn't just come from flowers, it comes from the 2-3 tiny stigmata on the crocus stativus flower, which is apparently very difficult to grow and to harvest. It takes about 150 of these crocus flowers (450 stigmata) to get one gram, and the tiny stigmata have to be harvested by hand. Marijuana should be relatively easy to grow and harvest, and yet it still costs almost as much as saffron or more.

I can understand that there are higher costs when you're making an illegal product, like the threat of raids, the need maybe for protection money, the higher markup because of the risk, etc. But once marijuana is legal, as we both expect, what is to prevent marijuana wholesale prices coming down by another order of magnitude? Any ideas?

dtb
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Presumably the gov't will artificially restrict supply? No idea.
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The government is likely to want to restrict supply, because as usual, the government feels it knows what is good for people, and wants them to use as little marijuana as possible. However, the usual way of doing this, like for tobacco, is to add a tax onto the price, not to restrict supply. Either method would increase the price and decrease accessibility, but the government would just as soon see that money go into its pockets, rather than into the producers' pockets.

But for the moment, job #1 is to take market share from the black market, and that limits what the government can do, in terms of taxes (or supply restriction). For instance, at the moment, the black market cost of marijuana is about $5 a gram in Canada, and what you can get in the legal stores is about $8-10, which has made it difficult, so far (one year into legalization), for the legal producers to take more than about a 20% share of the market (as of August).

To compete with black market cannabis, legal producers will probably have to have prices that are similar, meaning the retail price has to go down close to $5, which probably means only about $3/g in revenue for the producers, way below where they are now. But in the long run, the legal industry is in the process of hugely increasing production capacity, and legal competition alone might be enough to get the price down well below $5, and maybe as low as $1.

dt
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DT, very cool discussion. As I mentioned previously, I really don't get that granular in my research.

I asked your question and comments to several people, and prefaced it with this, "The person who wrote the original question lives in Canada. I think he/she is fairly fluent in cannabis investing, and has been short for at least a year now. Certainly no great shakes, but I think worth sharing."

This is a response to your question I asked several cannabis investors, and/or industry insiders.

Response from industry insider:

"If I was going to tell you in short, it will be like beer and alcohol. There will be mass produced low quality product available for under $1 per gram, and there will be craft type stuff and up. The branded product is what will hold the value. Not the actual input (cannabis) itself, if it isn't attached to a brand. Think Absolute versus Svedka, or Everclear versus branded single malt whiskey. It's all alcohol, but it's brand and quality that dictates the price. Once supply and demand have time to mature, in all markets after legalization. I think prices will stay higher without interstate commerce, in states like Michigan, that have less access to greenhouse and outdoor production, and need to rely on indoor grow."

I responded, and will possibly hear back the following, "I guess and argument would be that cannabis could be grown outdoors in a state like Florida, and shipped anywhere, as they do tobacco. Of course that would require laws changing, and legalization, but isn't that possible, and even probable, allowing interstate and international commerce? Similar to our current rules of alcohol and tobacco, and anything else? If that is the case, what do you think would happen to pricing of cannabis?"

This was this industry insider's final response to my question: "As long as supply met demand, which I think it easily would after a short transition period, I think prices would commoditize and the value would be in the branded product. No reason for prices to be high, except for quality, marketing, and/or taxes."

Several cannabis investors responded:

"Often, maybe always, the value of something is worth whatever people will pay for it. If basil went for $5-12 a gram then people would just stop buying basil except maybe on very special occasions like a wedding anniversary. Also, the price cannot be so low that it makes the business not profitable."

"Can you get high from Saffron? If so...I'd buy it for that price. Even a lot higher. Trying to understand your comparison."

"That seems like a ridiculous comparison since cannabis has so many medicinal uses and benefits compared to seasoning herbs. I wonder if this person has even used cannabis. The only thing valid in the comparison is that they are both plants. Can't imagine cannabis ever selling at a commodity price like bulk oregano or basil."

"If you're a CPG company u want cannabis as cheap as u can get it because it will increase your margin. Look at cannabis as a ingredient when it comes to CPGs. When it comes to CPGs that make claims, look at cannabis, or cannabinoids, as you would vitamins. When you combine cannabinoids A and B together you create a outcome that will help u sleep for example. Doesn't matter how cheap cannabis becomes when its used as a ingredient."


I think much of above is food for thought.
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Most of those comments make sense to me. I think most cannabis will be like Budweiser beer, cheap, good enough, very low margins, and all the value is in the brand. There will be a few high end brands that will emerge and will be able to sell marijuana at much higher prices.

In that case, most growers are going to be in big trouble, just like barley and hops makers. They will be subject to cut-throat competition, and there will be no major money to be made. This might be a problem for your Miracle Gro position, if growing ends up being unprofitable.

Then there will be a few high end brands that do fine, despite low prices, like Sam Adams beer maybe, or even smaller craft brewers, or Absolut vodka. Guessing who these will be will be very hard to do - I see no particular reason why this should be Aphria, Aurora, Canopy, Cronos, Hexo, Tilray, etc. etc. I think they are all more likely to be Budweisers than Adams or Absoluts, but who knows?

As your investor says, low input prices, while bad for the grower, are good for the company that is transforming the product - Absolut is not complaining about low wheat prices in Sweden.

My point in comparing other flowers like saffron to cannabis was not to suggest you could get high on saffron or that it was worth just as much. The point is, the cost of these things, once they're legalized, is basically a function of how costly it is to produce them. If you can sell saffron for $1 a gram and it is way harder to grow and harvest than marijuana, then I would presume that competition is going to force marijuana farmers to sell their marijuana crops at prices much lower than $1 a gram.

The value of saffron vs marijuana is not the issue, it is the cost of production. There are lots of things I would pay a lot more for, like wheat flour for instance, because I like making bread and I don't really care whether flour costs $1 a kilo or $3 a kilo. But since lots of companies offer to sell it to me for $1 a kilo (because they have to compete against each other), $1 it is. Marijuana is probably going to be the same thing: lots of people would pay $10 a gram ($280 an ounce) if they had to, but if they can get it for $1, for a product of reasonable quality, that's usually all they will pay, no matter what its value for them is.


dtb
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