Organigram Shares Slump as Production Ramps Up

Whether you are already an active investor in marijuana-based industries or just taking notes from the sidelines, chances are you don’t need me to tell you that the business is becoming fast and furious.

For starters, there just aren’t many publicly-traded companies available in which to invest. Those that do exist are small, undercapitalized, and strapped down by a currently tenuous legal environment. Any one of the latter can cause a stock to be more volatile than your average S&P 500 company; the combination of all three form a fiercely volatile cocktail.

Viewed through this important lens, Canadian medical marijuana distributor Organigram becomes an interesting case study as a stand-alone pure play into the industry. Organigram is a wholly-owned subsidiary of Organigram Holdings, which “went public” in a reverse takeover earlier this year. Shares trade both over-the-counter and on the Toronto Venture Exchange (TSX: OGI), and the company is solely focused on growing, testing, packaging, and distributing 100% organically-grown medical marijuana for approved patients.

Organigram has a market cap just north of $61 million CAD, or roughly $55 million U.S. dollars. In the brief period since the reverse takeover, Organigram shares have lost nearly 50% of their value, despite the company’s massive ramp up in production. Organigram is in the middle of adding an additional 3000kg to its annual production, a 500% increase from current levels that should be available for distribution to customers by early next year.


Organigram’s Basic Value Proposition

On first glance, investors should be rewarding Organigram’s big push to increase its sales, but as any veteran investor can tell you, it is nearly impossible to “fight the tape,” and the tape for marijuana-based stocks has been running deep in the red all year. Notable performance indices like the 420 Marijuana Indexwhich seek to capture the broad performance of the legal marijuana industry as a whole, have been cut in half in just the past six months, despite the rise in equity markets here in the U.S.

Organigram seeks to differentiate itself from other licensed Canadian producers like Tweed and Bedrocan by touting a purely organic grow process, which it hopes will produce the “highest quality, organic, condition-specific marijuana grown in Canada.” To be fair, we have seen many other Canadian producers sing a similar tune, so it will be up to the market to determine if any one company’s product offering is superior enough to justify a customer changing up their supplier.

In the meantime, Organigram has some very optimistic financial projections for the next few years. Per an Organigram company investor presentation:



A Primer on the Toronto Venture Exchange

The Toronto Venture Exchange is like the younger, more immature brother of the well-respected and liquid Toronto Stock Exchange. Companies that seek to list and trade on the Venture Exchange are by their very nature smaller, have less revenues and less operating experience. That said, there are basic listing requirements for the Venture Exchange which serve as essential tools for any investor seeking a legitimate equity investment. Financial results and balance sheet data have to be signed off on by an auditor, and the company must meet minimum thresholds for assets and the number of outstanding shares available.

This cutout of the relative cost to list on the Toronto Stock Exchange vs. the TSX provides a good look-in to the general class of company that would seek out either listing:


A Primer on the Canadian Market – Size and Potential

In April of this year, Health Canada oversaw the implementation of the Marihuana for Medical Purposes Regulations (MMPR), which took over for an earlier 15-year program called the MMAR which allowed patients with a doctor’s recommendation to consume, purchase, and/or grow their own medical marijuana.

Health Canada’s stated goal with the MMPR is to increase the level of regulation and safety in pharmaceutical-grade cannabis production, while also reducing the massive “gray” market for marijuana by allowing market forces to be the biggest determinant of product prices.

Currently there are 13 licensed producers under the MMPR, with hundreds of other applications yet to be processed. Most of these applications will be denied, as approved cannabis producers must meet stringent requirements for record keeping, security and quality control. But most of the companies who have clearance (or will soon have it) to mass produce will indeed do just that; tens of thousands of pounds of new supply could hit the Canadian market by this time next year.

All else being equal, this should lead to a downward pressure on the average price per gram of marijuana available to MMPR consumers. Combined with the fact that the MMPR is designed to be easier for individuals to enroll into, lower prices and a more streamlined delivery process should bring a lot of gray market Canadian marijuana users into the legal market. But as a consequence, companies like Organigram will see constant pressure on their margins and subsequently their net income.

Health Canada estimates that there are 50,000 medical marijuana patients nationwide, but up to 500,000 people who consume the product inside the nation’s borders. Other state-sponsored estimates run much higher, stating that there may be over 2 million people in Canada who consume marijuana for either medical or recreational purposes.


Investor Takeaways

If the current usage base in Canada is closer to the 2 million figure, then the prospects for producers like Organigram could be quite bright. But we remain very cautious on putting a timeline to anything other than the natural transition from MMAR to MMPR patient enrollment, as Canada will have to make a strong legislative push for legalization before that larger customer base can be truly tapped.

All else being equal, if Organigram were to reach their financial projections, would shares be worth more than they are now? Most certainly. But even for the best companies in the world, projections more than two years out are are thought of more as soft clay than as concrete. Throw in the fact that this company has almost no operating history and it is moving through a regulatory environment as murky as legal marijuana, and we can understand the broad reluctance of investors to bid up shares of anyone in the space.

A particularly dubious aspect is the company’s operating (pre-tax) margin forecasts, which call for margin expansion from 30% all the way to 50% by 2018. This would violate just about every basic rule of economics; a steady, industry-wide decline over time is the much more likely outcome. Investors should remain focused on macro trends – the sea changes in the political, banking, and regulatory landscape that will determine the size of the potential end market going forward. The bigger the pie, the bigger the slice that Organigram can go after.

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