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3 Cannabis Companies Cutting Production – How Their 2020 Prospects Look

The Green Organic Dutchman, OrganiGram Holdings, and HEXO have been among the more compelling plays for cannabis companies based in Canada, until the temporary limitations inherent in the Canadian market have put immense pressure on the three companies, driving now their growth propects for some time.

It has gotten so bad that all three companies, along with many of their peers, have announced they're reducing production until the market can absorb more supply.

The primary issue isn't demand, but the slow roll out of cannabis retail stores in Ontario and Quebec. That has allowed black market cannabis producers to thrive, which has also put downward pressure on prices because of the lower cost basis enjoyed by illegal pot producers.

In this article we'll look at how this ongoing challenge will impact the performance of these companies going forward.

OrganiGram Holdings (OGI

For some time OrganiGram had generated a lot of positive buzz with investors because of its unique growing system that allows it to produce cannabis at very low costs in comparison to the majority of its competitors.

It was assumed that OrganiGram was going to probably become the first consistent generator of positive earnings of the pot producers. After its last earnings report, that's obviously off the table at this time.

It's also going to produce less cannabis in the near term than projected. In November 2019 it announced it was going to produce 89,000 kilograms of cannabis annually, rather than the previously announced 113,000 when operating at full capacity.

As mentioned, the ongoing positive catalyst is its unique three-tiered system that allows it to product a yield of approximately 230 grams per square foot.

Another positive for now is it's the only key Canadian producer located in the Atlantic province located in eastern Canada. Not only could it potentially dominate those markets, but it could lower distribution costs if it focuses on markets closer to home. Organigram is one of the few companies licensed to sell pot in all Canadian provinces.

After a sold third-quarter earnings report where the company generated a solid profit, it followed up with a dismal fourth quarter, where net revenue plunged by close to 33 percent, falling to C$16.3 million.

With no relief on the growth side in regard to retail outlets in the near term, there's no visible catalyst to suggest a turnaround anytime soon.

What do analysts say about the cannabis producer? TipRanks, a company that tracks and measures the performance of analysts, showcases OGI as a Moderate Buy. Based on 7 analysts tracked in the last 3 months, 5 rate the pot stock a "buy," while 2 say "hold." Meanwhile, the 12-month average price target stands at $6.19, marking over 160% upside from where the stock is currently trading. (See OrganiGram stock analysis on TipRanks)

HEXO Corp. (HEXO)

HEXO was another high-flying Canadian company that was considered to be among the market leaders in the nation, but that has rapidly crumbled, as it too has announced cutting back on production capacity in 2020.

HEXO management had projected production capacity of up to 150,000 kilograms annually, but is now looking at a range of 90,000 to 100,000 kilograms per year.

In its first fiscal quarter results, the company reported net revenue falling to C$14.5 million, down from the C$15.4 million generated in the previous quarter. Even worse was its loss from operations of a huge C$58.5 million.

Of these three companies, HEXO is the most concerning for me because of its exposure to Quebec, which is probably the most challenging province to operate in because of its outlook toward increasing retail outlets and increasing the age of pot usage to 21-years-old.

It has stated that it isn't going to aggressively push for rapid expansion of dispensaries. Combined with a higher legal age, it's going to probably struggle more than its peers to gain traction over the next twelve months.

Ultimately, the word on the Street points to a sidelined majority on HEXO. In the last three months, the Canadian cannabis maker has landed 2 ‘buy’ ratings vs. 8 ‘hold’ and 5 "sell" ratings. That said, the consensus average price target points to $2.85, or nearly 75% upside potential for the stock. This suggests that by consensus expectations, for now, the bulls still win on HEXO. (See HEXO stock analysis on TipRanks)

The Green Organic Dutchman (TGODF)

Of these three companies, The Green Organic Dutchman will cut output far more than its two other competitors.

The company gave updates in October 2019 that it was going to cut back on its production at Valleyfield facility. Fully operational, the facility could produce up to 130,000 kilograms annually. Instead, in 2020 it'll only generate about 10,000 kilograms a year at Valleyfield. With output from its Ancaster campus expected to reach about 12,000 kilograms in 2020, that means the company will only produce at the top end, about 22,000 kilograms a year, far off management's assertion the company has the capacity and capability to produce about 219,000 kilograms a year.

The company is aligning itself with market realities, and instead is looking to cut back on costs this year to the point of possibly generating a profit.

Even so, with the company only producing about a tenth of its potential, it's going to struggle to attract investors that believe in its viability in 2020. That could change if it does manage to turn a profit this year.

Judging from the consensus breakdown, it has been relatively quiet when it comes to analyst activity. Over the last three months, only 3 analysts have reviewed the marijuana stock; two of which are sidelined and one is bullish, making the consensus a Moderate Buy. On top of this, the $0.63 average price target puts the upside potential at 17%. (See TGOD’s price targets and analyst ratings on TipRanks)

Conclusion

There are a lot of headwinds as 2020 starts up for the Canadian cannabis sector, and it's going to take time to work through them. The major metric to watch in my view for not only the three companies mentioned here, but for all Canadian companies, is how quickly Ontario retail outlets become operational.

A distant second will be the level of success companies will have in the derivative markets, which we won't have a clear understanding of until after the earnings reports for the current quarter.

The major problem is the lack of ability to scale, and the robust black market that has survived largely intact because of the lack of competition in the key markets of Canada. That has put downward pressure on prices and margins, and ultimately, earnings results.

While all of this sounds dismal, the reality is nothing has really changed in the long-term for the Canadian cannabis market. The demand is still there, and once hundreds of more retail stores are operational, it's going to have a big impact on the performance of these three companies.

Again, I see HEXO as having the most challenges because of its location in Quebec. But even that could be overcome in time once many more cannabis sales outlets are available to sell in.

The Canadian cannabis market is going to remain volatile for awhile, but investors that take positions in some of these companies while they're selling at these levels, with patience, should be rewarded with strong returns over the next few years.

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