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Vic Neufeld CEO, left, Cole Cacciavillani, centre, and John Cervini co-chairs of Aphria, stand in front of some of their Medical Marihuana plants at the company's greenhouse in Leamington, Ontario, May 26, 2014.

The Globe and Mail

Investors in marijuana stocks enjoyed phenomenal returns last year. While the parabolic rallies for many of these stocks have paused in recent months, further longer-term gains may be far from over. This may be the calm before another explosive move higher for these stocks.

Last year, speculative traders in this space helped drive stock prices higher. Absent news from the government, many of these traders may have moved into other areas with price momentum, such as the so-called "Trump"-driven stocks.

However, this spring, the federal government is expected to table legislation to legalize recreational marijuana.

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Favourable news for the marijuana industry may be a driver to reinvigorate these stocks, and more importantly, may, over time, expand the shareholder base to a greater number of longer-term investors with a high risk tolerance who see the growth potential for companies in this space in the years ahead.

However, there are risks for shareholders to consider, one being time. While the path for the legalization of recreational marijuana appears to be moving forward, it is still a long road ahead. For shareholders, patience may be required while many of these investments transition from speculative stocks to growth stocks.

For interested investors, several companies in the space stand out. One such company is Aphria Inc., given its cost leadership and attractive growth profile. I sat down with Vic Neufeld, the chief executive officer of Aphria, in December. My questions ranged from those of my own, to those submitted by readers to me.

Potential catalyst

Mr. Neufeld says the expected draft legislation will bring "a lot of clarity" to the rules of recreational marijuana and investors will be in a better position to assess industry players. "Who's got the commitment, the passion, the capital, the money in the bank, who's got capacity to grow?"

The answers to these questions, he says, may lead a potential investor back to Aphria.

Growth potential

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Mr. Neufeld's near-term vision for Aphria revolves around the company's core operation in Leamington, Ont.

On Jan. 16, the company announced that its board approved a $137-million capital project, the company's "Part 4" expansion plan at its Leamington facility. This project is a massive plan expected to propel Aphria's annual harvest capacity up to 70,000 kilograms. To put this in perspective, today, the company has approximately 2,800 kilograms of annual harvest capacity.

The company has also purchased another 200-acre farm about six kilometres north of its main operation. Mr. Neufeld says he wanted to make sure Aphria has land in place for future growth saying, "You don't have the land, you can't build. You can't build, you can't build a business model."

Low cost producer

A key competitive advantage for the company is its low-cost structure due to its greenhouses, "Greenhouse is the only way to go forward to command a good share of the market price because at the end of the day the low-cost producer is going to dictate the market price."

He noted that, "Almost every other licensed producer is indoor. What does that mean? They have more lights, intensity of lights, they're more intense, they use them longer during the course of 365 days, they have to air condition in the summer. We have less lights, lower intensity, we use them less, and we don't air condition…We use so much less power…That's a huge cost differentiator."

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Today, Aphria has a cash cost of approximately $1.30 per gram, and when you add depreciation and packaging to the cash cost, it rises to roughly $1.80 per gram. He is targeting even lower costs down the road with expected efficiencies realized from the company's expansion projects. For instance, the Part III expansion is anticipated to reduce costs to approximately $1.50 per gram from $1.80, and he says with pride, "it's even better after Part IV".

Lowering costs is a main objective for management, "We are still learning little trade secrets on how to tweak our growing techniques to improve yield, less yield loss, better potency, better bud, thicker bud, bigger bud."

He added, "There are many other benefits of being in Leamington. We use biological controls in terms of our pests. The incubation lab that grows them is like a mile and a half down from our campus, right in Leamington. ... We buy massive tanks of individual fertilizers… It is very simple to us because we've grown it for decades."

Top three priorities

In terms of Mr. Neufeld's objectives, capacity growth and increased efficiencies from the Leamington facility top the list. No. 2 would be "clinic platform growth." The purchase of cannabis clinics would enable the company to service more medical cannabis patients, accelerating Aphria's growth model.

The third key objective is for Aphria to build a product presence in Canada's drug stores.

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If Health Canada allows pharmacies to be a distribution point for medical marijuana, Aphria is in a good position given Mr. Neufeld's professional background. For more than 20 years, he was the CEO at vitamin and natural health manufacturer Jamieson Laboratories. This position enabled him to establish strong relationships with pharmacies. "We are in deep, deep dialogue with a major banner to service their medical needs," he said.

Professional expertise

If Health Canada allows pharmacies to be a distribution point for medical marijuana, Aphria is in a good position given Vic Neufeld's professional background.

For over 20 years, he was the chief executive officer at the vitamin and natural health manufacturer, Jamieson Laboratories. This position enabled him to establish strong relationships with pharmacies. He indicated, "We are in deep, deep dialogue with a major banner to service their medical needs."

With a plethora of new marijuana companies sprouting into the market, Aphria's experienced management team is a key differentiator.

Vic recalls his team at Jamieson, "We grew up as a family. When I started I had four executives, when we sold, I had 14, so in other words, I straddled myself with more intelligent people than me, and a lot of them." While this may be a humble statement from a former accounting professional and accomplished CEO, he has maintained this philosophy of surrounding oneself with a team of strong individuals. Co-founders Cole Cacciavillani and John Cervini are both farmers by trade with decades of experience. In addition, last October, Arlene Dickinson, an accomplished business executive well-known for her stint on the popular television show, "Dragon's Den", joined Aphria's board of directors in 2016, contributing her marketing expertise to the company.

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Industry consolidation

Merger and acquisition activity may heat up. For instance, last month, Canopy Growth Corporation (CGC-T) announced plans to acquire Mettrum Health Corp. (MT-X). Once recreational marijuana legislation becomes clear, larger players may enter the space.

"There are five spaces that are so logical as potential friendly suiters to come into Canada and look at licensed producers." He listed them as Tobacco, Alcohol, Energy Drink, Agriculture, and Pharma.

"Every one of these spaces has a lot of 900-pound gorillas" noting companies such as Philip Morris, Bacardi, Red Bull, Monster Energy, Monsanto, Bayer, Scotts Pharma as, "all logical suiters".

"They'll all be friendly. They need management so these will not be hostile."

Aphria's low-cost production profile, sizeable harvest capacity, and land available for future growth may put the company in the spotlight for potential takeover consideration.

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In terms of any exit strategy plans, he notes that while he was a Jamieson Laboratories, he, "Built a company with 7 per cent market share to 27 per cent… I like to build. What we've done at Aphria from square one, started with nothing, absolutely nothing except a lot of our own money... What we've been able to do in two, two and a half years,… we've just done a lot of things right. I don't want the journey to stop."

His growth objectives for the company are not dependent on receiving a takeout offer. "There are no land mines either ahead of us. The government is going to do what they are going to do and we are very capable and flexible to change whatever strategy we have to change ... We are not building our livelihood around waiting for the day when recreational comes."

Graduation to the TSX

He anticipates the stock may graduate to the Toronto Stock Exchange from the TSX Venture Exchange this month.

Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.

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