? June 2019 Green Rush: Cannabis Market Will Grow by 9 Times by 2030 Amid Widening Legalization Contents Cannabis stocks have delivered impressive investor returns in 2019, with many of the publicly traded 2 Key Takeaways companies soundly outperforming the broader market. Optimism has preceded actual performance as 4 Cannabis Playbook: We See Multiple Ways to Play Trends the industry has yet to generate positive free cash flow. However, unlike other emergent industries that 12 The U.S. Will Be the Largest and Fastest- have enjoyed fleeting popularity with fickle investors, the cannabis industry should realize a steep Growing Cannabis Market in the World 38 National Legalization Has Unlocked demand growth trajectory that could appeal to investors with a long-term investment horizon. The five Massive Growth for Canada industry leaders we now cover are far from burning out, with some offering attractive upside potential 50 Global Medical Cannabis Market Will as early overhead investments are harvested over time. See Huge Demand Growth but Increasing Competition 60 Cannabis Primer: How It Grows and Is Prohibition has kept cannabis largely in the hands of criminal enterprises. However, legalization is Consumed Has Implications for the gaining momentum. In the United States, 11 states and Washington, D.C., have legalized recreational Industry's Future 72 Appendix: Company Models cannabis, and 35 states have legalized medical cannabis or products that are low in tetrahydrocannabinol, or THC, and high in cannabidiol, or CBD. We expect federal legalization to take place in the U.S. by 2023. Canada legalized recreational cannabis in October 2018. Internationally, more Important Disclosure The conduct of Morningstar's analysts is governed and more countries have recognized the benefits of medical cannabis and are expanding access. With by Code of Ethics/Code of Conduct Policy, Personal cannabis' popularity already growing organically due to expanded use cases, widening legalization will Security Trading Policy (or an equivalent of), and Investment Research Policy. For information further catalyze demand. regarding conflicts of interest, please visit: https://shareholders.morningstar.com Our research indicates that legal cannabis sales will grow nearly 9 times their current size by 2030. U.S. recreational, U.S. medicinal, Canada, and the global medicinal export market have penetrated just 8%, 21%, 11%, and 19% of their estimated markets, respectively. This large, underserved market will provide massive top-line growth and fixed cost leverage for cannabis companies, supporting a "green rush" through at least the next decade. Canopy Growth and Curaleaf are our top picks. Canopy provides investors attractive exposure across all markets, as well as a consumer goods-focused strategy. Curaleaf provides pure-play exposure to the U.S. market, where we see massive growth for both its recreational and medical end markets. Page 2 of 84 Basic Materials Observer | 27 June 2019 | See Important Disclosures at the end of this report. Key Takeaways × Cannabis companies are poised to see sales grow by nearly 9 times through 2030 amid widening legalization and increasing consumer participation. × Current U.S. recreational and medicinal cannabis sales have penetrated just 8% and 21% of their estimated markets, respectively. With a significant runway for growth, recreational cannabis sales will Lead Analysts: grow at a 25% compound annual growth rate and medicinal cannabis sales will grow at a 15% CAGR. Kristoffer Inton Director × In the U.S., 23 states have legalized medical cannabis, 12 states have legalized low-THC/high-CBD hemp +1 312 384-4897 or cannabis derivatives, and 11 states and Washington, D.C., have passed both recreational and medical [email protected] cannabis. Through 2030, we expect seven more states to expand recreational cannabis and two states that have already legalized to expand commercial operations amid implementation. Rachel Elfman Associate Equity Analyst × Current Canadian recreational and medicinal cannabis sales have penetrated just 12% of the estimated +1 312 244-7698 market. We expect Canadian cannabis sales will grow at a 20% CAGR. [email protected] × We size the current global medicinal cannabis market (excluding the U.S. and Canada) at $3.7 billion, 1 2 Contributing Analyst: while other published estimates range from $3.5 billion to $11 billion. We forecast total market Seth Goldstein, CFA potential of nearly $43 billion by 2030. However, due to increasing global competition, Canadian Equity Analyst +1 312 384-5506 cultivation would only see an estimated market of $20 billion. [email protected] × The six cannabis and cannabis-related companies we cover provide exposure to different geographic footprints and long-term strategies. × Canopy Growth: Canadian producer with a focus on cannabis-infused recreational products and the option to expand into the U.S. through an acquisition of Acreage Holdings. × Aurora Cannabis: Canadian producer focused on low-cost production; currently lacks a strategic partner and offers no exposure to the U.S. market. × Tilray: Canadian producer with limited exposure to the U.S. through a CBD partnership and strategic investment from Anheuser-Busch InBev. × Cronos: Canadian producer with a strategic investment from Altria, focused on significantly expanding its production capacity. × Curaleaf: U.S.-only producer with exposure to both the medical and recreational markets through cultivation, processing, and dispensary operations. × Scotts Miracle-Gro: Cultivation equipment supplier that serves the U.S., Canadian, and international markets and provides cannabis exposure without "touching the plant." × At current share prices, we think Canopy Growth, Aurora Cannabis, and Curaleaf offer investors attractive risk-adjusted upside. 1 Source: Coherent Market Insights, as cited by MarketWatch. https://www.marketwatch.com/press-release/global-medical-cannabis-market-to- surpass-us-201765-million-by-2025-2019-01-11 2 Source: Medical Cannabis Market, ResearchAndMarket.com, as cited by GlobeNewswire. https://www.globenewswire.com/news- release/2018/11/01/1641481/0/en/Global-Medical-Cannabis-Market-2018-2023-Market-Value-is-Expected-to-Reach-Approx-US-37-Billion.html Page 3 of 84 Basic Materials Observer | 27 June 2019 | See Important Disclosures at the end of this report. Exhibit 1 Increasing Participation and Widening Legalization Will Drive Massive Demand Growth for Cannabis in the U.S., Canadian, and International Markets Millions of constant $ 1a U.S. Recreational and Medical Markets Are 8% and 15% Penetrated, Respectively 1b Legalization Remains Widely Different Across the U.S., Current 2030 Market Medical cannabis legal All cannabis illegal Low-THC / High-CBD legal Recreational and medical cannabis legal $80,000 $60,000 $40,000 $20,000 $0 U.S. recreational U.S. medicinal 1c …but Recreational Participation Has Room to Grow… 1d …and Medical Access Continues to Expand Marijuana - today Marijuana - 2030E Alcohol - today Tobacco - today Medical Cannabis Legal Low-THC / High-CBD Legal 100% 60% 80% 50% 40% 60% 30% 40% 20% 20% 10% 0% 0% 18-25 year olds 26+ year olds 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 1990s 1e The Canadian Market Will Grow by 9 Times by 2030 1f The Global Medicinal Market Will Grow by 11 Times, but the Opportunity Is Better for Cultivation Outside Canada and the U.S. Canada Total Canada Recreational Canada Medical Global medicinal market (ex-US and Canada) $16,000 $50,000 $14,000 $12,000 $40,000 $10,000 $30,000 $8,000 $6,000 $20,000 $4,000 $10,000 $2,000 $0 $0 Current 2030 Current 2030 Market 2030 Market (excl. Self-Supply) 1g We See Attractive Valuations that Allow Investors to Play the Green Rush Across a Number of Markets and Themes USD USD End-Market Exposure Run-rate Fair Value Current Morningstar U.S. Intl. Production Strategic Strategic Market Cap Name / Ticker Estimate Price Rating Recreational Medical Canada Medical Footprint (sq ft) Partner Focus (bil) Canopy Growth CGC $54.00 $39.77 ÙÙÙÙ 5,940,000 Constellation Brands Consumer goods $14.0 Aurora Cannabis ACB $9.50 $7.46 ÙÙÙÙ 5,158,700 None Low-cost production $7.8 Tilray TLRY $40.00 $46.81 ÙÙÙ Not disclosed AB InBev Consumer, medical $4.7 Cronos CRON $11.00 $15.79 ÙÙ 1,270,500 Altria Expand production $5.2 Curaleaf CURLF $10.50 $7.11 ÙÙÙÙ 890,800 None Verticalized; U.S. $3.3 Scotts Miracle-Gro SMG $88.00 $98.01 ÙÙÙ Not relevant None Equipment, inputs $5.4 Sources: 2018 Marijuana Business Factbook, National Conference of State Legislatures. http://www.ncsl.org/research/health/state-medical-marijuana-laws.aspx#3 (accessed April 2019), Substance Abuse and Mental Health Services Administration, Centers for Disease Control, State of the Legal Marijuana Market by Arcview Market Research and BDS Analytics (as cited by Digital Journal), Coherent Market Insights (as cited by MarketWatch), ResearchAndMarket.com (as cited by GlobeNewswire), and Morningstar. Page 4 of 84 Basic Materials Observer | 27 June 2019 | See Important Disclosures at the end of this report. Cannabis Playbook: We See Multiple Ways to Play Trends Investors Have Multiple Options to Play Cannabis Whether it's investing in widening international medical cannabis legalization or U.S. federal legalization, we see options for investors seeking exposure to different trends. In this section, we discuss which companies in our coverage universe that we see as best ways to play different cannabis trends. We then discuss each company under our coverage in depth. In Exhibit 2, we've compared the five cannabis companies and one cannabis equipment company we cover. At present, we see Canopy Growth, Aurora Cannabis, and Curaleaf as undervalued. Each company offers different exposure to cannabis trends. Exhibit 2 We See Attractive Valuations that Allow Investors to Play the Green Rush Across a Number of Markets and Themes USD USD End-Market Exposure Run-rate Fair Value Current Morningstar U.S. Intl.