This was supposed to be the year that marijuana stocks matured and took the next step toward profitability. Canada had just become the first industrialized country in the modern era to green-light recreational cannabis in October 2018, and derivative pot sales were forecast to begin no later than October 2019. We also saw plenty of legalization momentum at the state level in the United States.
Yet with a little over one week to go before we ring in the New Year, we see that most pot stocks have been throttled in 2019.
The thing is, these declines have some investors wondering whether or not now is the time to pick up shares of cannabis stocks on the cheap. One pot stock at the center of the debate is New Brunswick-based OrganiGram Holdings (OGI -1.49%), which has shed 34% this year. But before deciding on whether or not OrganiGram is worth buying now, let's review the buy and avoid theses behind this popular Canadian grower.
The buy thesis
Arguably one of the top reasons to consider buying OrganiGram is the fact that it's the only major grower located in an eastern Atlantic province. By "major grower" I mean a cultivator with peak capacity of at least 100,000 kilos of cannabis per year. Although these eastern provinces aren't nearly as populated as Ontario or British Columbia, cannabis-use rates are significantly higher than the national average, putting OrganiGram in great shape to become a market share leader in these provinces. It's also worth noting that OrganiGram is one of just four pot growers to have worked out supply deals with every Canadian province.
OrganiGram is also one of the most efficient growers on the planet. According to the company's management team, it should be able to produce 113,000 kilos at full capacity despite working with less than 500,000 square feet of cultivating space. By utilizing a three-tiered growing system at its Moncton facility in New Brunswick, OrganiGram should yield about 230 grams per square foot (psf). For context, most of its peers will probably yield 75 to 125 grams psf at peak production.
This is also a company with a prime focus on the high-margin derivative market. OrganiGram has invested $15 million Canadian into a line of fully automated equipment capable of producing 4 million kilos of infused chocolates per year, and has developed a nano-emulsification technology that can be added to beverages to speed up the process by which cannabinoids take effect. It'll be introduced first as a powder next year, but the company is actively looking for a beverage partner with which to incorporate this technology.
Lastly, consider that OrganiGram is the only Canadian cannabis grower to generate a genuine operating profit thus far. During the third quarter, OrganiGram delivered CA$24.75 million in net sales and an operating profit of CA$1.17 million after cost of goods sold and recurring operating expenses were subtracted. Note, this operating profit does not include the impact of fair-value adjustments or one-time benefits. This demonstrates how far ahead of its peers OrganiGram has been in the early stages.
The avoid thesis
While this probably sounds like a slam-dunk buy, there's another side to this stock that needs to be examined.
For one, there have been persistent supply issues in Canada since day one of legalization, and these issues aren't expected to ease anytime soon. Regulatory agency Health Canada has struggled to approve licensing applications, while Ontario, the country's most populous province, had a mere two dozen open dispensaries on the one-year anniversary of adult-use sales commencing in October 2018. Although Ontario plans to issue additional licenses and Health Canada is working through its backlog, these supply problems will not resolve overnight. This means both dried flower and high-margin derivatives will be adversely impacted for some time to come.
Building on this point, OrganiGram is liable to face operating losses for the foreseeable future as supply problems and a thriving black market weigh on its top-and-bottom lines. For instance, even though OrganiGram's third-quarter report produced the first no-nonsense operating profit among growers, the company's sequential fourth-quarter report was abysmal. Net sales wound up falling by about a third to CA$16.3 million, with cost of goods soaring. Given that earnings matter now with pot stocks, it could be a while before OrganiGram has a shot at recurring profitability.
Additionally, OrganiGram recently announced that it would be idling the last phase of construction at its Moncton facility, which would put the company on track for 89,000 kilos of run-rate output as opposed to the 113,000 kilos the facility is designed to produce at peak capacity. While this move is being done to align production with a challenging supply environment, this cutback in output could adversely impact the company's production efficiency and increase its per-gram growing costs.
Now that we've taken a closer look at both sides of the aisle, we can get back to the initial question at hand: With OrganiGram down 34% in 2019, is now the time to buy?
After careful debate, I do believe OrganiGram makes for an attractive buy, albeit with its fair share of near-term risks and volatility.
As noted, investors are going to have to be patient from a profitability perspective as Ontario rolls out new retail locations and derivatives slowly begin hitting dispensary stores. It could also be argued that OrganiGram may struggle on a guilt-by-association basis given the poor balance sheets, steep losses, or even fraudulent activity associated with its peers.
But beyond these near-term concerns there's simply too much to like to ignore. We're talking about a company that's among the most efficient in the industry, with a key focus on high-margin products and a keen eye on costs. You'll also note from the company's SEDAR filings in Canada that it's generally done a good job of not diluting its shareholders into oblivion. If there is a marijuana grower in Canada that is going to be the first to generate recurring operating profits from their cannabis operations, my money would be on OrganiGram. That makes it a clear leader in the industry and an intriguing pot stock to consider buying.