One year ago, the future was bright for Canada's marijuana industry. Recreational weed sales commenced on Oct. 17, 2018, and all expectations were that sales would roar out of the gate. But as we've witnessed, Canadian pot stocks haven't come close to roaring. In fact, it's been more like a whimper.
A number of issues have caused the Canadian weed industry to struggle. A backlog of licensing applications with Health Canada, for example, has kept legal weed off the market. Likewise, the slow rollout of retail dispensaries in select provinces has coerced many Canadians to purchase black market marijuana. The result of these struggles is that most Canadian pot stocks are still losing a lot of money.
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Canadian cannabis stock profits (so far) should come with an asterisk
Now, I know what you might be thinking: "Wrong! Aphria (APHA +0.00%) and Cronos Group (CRON +3.08%) are both profitable."
While technically correct, the only way Canadian cannabis stocks have been able to produce a profit in recent quarters has been with a number of one-time benefits.
For example, Aphria's first-quarter operating results featured net income of 16.4 million Canadian dollars on CA$126.1 million in sales. Sounds great, right? But thing is, the company benefited from a fair-value adjustment on biological assets of CA$18.9 million tied to its cannabis operations. Although fair-value adjustments are par for the course with International Financial Reporting Standards (IFRS) accounting, the door on IFRS accounting can easily swing both ways. If all one-time benefits and costs were removed, Aphria is still not generating an operating profit.
The same goes for Cronos Group, which has blown Wall Street's profit projections out of the water in back-to-back quarters. It's not Cronos Group's cannabis operations that led to the company recording nearly CA$251 million in comprehensive income in the second quarter. Rather, it's Cronos' revaluation of derivative liabilities (i.e., warrants given to Altria Group) that have accounted for these huge swings. On an operating basis, Cronos Group is decisively losing money.
So, which Canadian pot stock is going to break this money-losing streak and be the first to push toward a no-nonsense, recurring operating profit (i.e., one that doesn't involve one-time benefits or fair-value adjustments)? If my arm were twisted, I'd choose OrganiGram Holdings (OGI +0.70%).
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Here's why OrganiGram will be the first Canadian pot stock to generate a recurring (and real) profit
New Brunswick-based OrganiGram is unique for a number of reasons. Among major growers, it's the only company located in the Atlantic region of Canada. This can be particularly helpful in serving these eastern provinces. Although Nova Scotia, Prince Edward Island, New Brunswick, and Newfoundland and Labrador are lesser-populated provinces, cannabis usage rates tend to be higher among adults in these Atlantic provinces than the national average.
OrganiGram is also different in that it's working with just one major grow facility in Moncton. Rather than having to spend money developing and maintaining multiple grow sites, OrganiGram has focused its efforts on building up its only growing and processing capacity at Moncton.
Speaking of which, OrganiGram's cultivation efficiency is particularly interesting. Because of its proprietary three-tiered growing system, the company should produce 113,000 kilos annually, at its peak, in less than 500,000 square feet of space. Conservatively, this means OrganiGram will yield about 230 grams per square foot, which looks to be about double what most of its peers will be averaging on a yield-per-square-foot basis.
What's more, OrganiGram's third-quarter operating results show that it's well on its way to leading its peers into recurring profitability. During the fiscal third quarter, OrganiGram produced CA$24.75 million in net revenue and a gross profit of CA$12.28 million, before fair-value adjustments. This compares to CA$11.11 million in operating expenses. In other words, OrganiGram was profitable on an operating basis in Q3 2019 by CA$1.17 million, but was ultimately dragged down by a CA$12.46 million fair-value adjustment that worked against its gross margin. Remember, the fair-value adjustment door swings both ways, which is why I'm placing a big asterisk next to Aphria's profit.
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As the icing on the cake, OrganiGram stands ready to take advantage of cannabis legalization 2.0. This past week saw marijuana derivatives become legal in Canada. By derivatives, I'm talking about edibles, vapes, infused beverages, topicals, and concentrates. Even though derivatives aren't going to make it into dispensaries until mid-December for sale, these are considerably higher-margin products. OrganiGram planned for this by purchasing fully automated equipment to produce 4 million kilos of infused chocolate per year. The company also developed a nano-emulsification technology for beverages and is one of four companies chosen to be PAX Labs' partner for the Era vaping device.
Long story short, OrganiGram has clear competitive advantages, solid production efficiency, margin expansion opportunities in the very near term, and a means to keep its costs down. It has a very good chance of being the first Canadian pot stock to deliver no-nonsense, recurring profits.
