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Organigram (OGI) Growth Experiment Hits Earnings – Long-Term Narrative Remains Solid

support@smarteranalyst.com (Ben Mahaney)

For investors looking for positive earnings sooner rather than later, OrganiGram Holdings (OGI) has been one of the favorites of the cannabis sector. While it under performed in its last earnings report, for the most part, it is a correctable situation that has already been resolved.

CEO Greg Engel said the drop in plant yield in the reporting period was temporary, and "not only have our yields returned to historical levels, but we have seen a meaningful increase in average cannabinoid levels in harvests to date in Q4."

That said, OrganiGram shareholders will have to temper their short-term expectations concerning derivative sales, as Health Canada has pushed back the date of first delivers to mid-December 2018; originally initial sales was expected to come in mid-October. It will also be rolled out on a staggered basis, meaning it'll take some time to sell derivative products to the point of making a positive impact on the results of the company.

For that reason investors will probably have to wait until the earnings report from the first calendar quarter of 2020 before seeing an impact from derivative products on the performance of OrganiGram.

Its failed experiment

Even though a number of companies failed in similar experiments, OrganiGram, for some reason, thought replicating it within their facilities may work. They were wrong.

What the company attempted was called 'cloning,' which in the cannabis industry refers to cutting small parts of an existing plant and using it to produce plants instead of using seed. This is fairly common with some fruits, vegetables and herbs, outside of the sector.

The difference here and within the cannabis sector, was the company took pieces of plants at an earlier stage of growth than normal.

The company did use a smaller sample to try it out first, but when attempting to scale with more strains, the experiment failed.

Consequently, growing costs soared almost 50 percent more in cash, having a negative impact on earnings, which in the last few quarters had been positive.

All-in costs related to cultivation jumped from from C$0.65 and C$0.95 per gram in the prior quarter, to C$0.95 and C$1.29 per gram in the earnings period, according to MarketWatch.

The time lost in the grow room impacted by the experiment was from "four to six weeks," said Engel.

As for product mix, it sold 5,090 liters of cannabis oil and 3,926 kilograms of dried flower in the fiscal third quarter.

Outlook for fiscal 2020

Engal said the company expects to generate a record harvest in the first half of fiscal 2020 for its dried flower grown in its indoor facilities. It also sees positive growth catalysts coming from derivative products associated with edibles and vape pens.

One thing investors in Canadian-based companies need to understand in order to manage short-term expectations, is Health Canada has pushed back the date derivative products in the country will be sold and distributed to mid-December. Initially it was set to launch in mid-October. It also said product approvals will be staggered, meaning it's going to take some time for all derivatives to be legally sold.

I'm looking at the first calendar quarter as being the first one that will have any significant impact on the performance of OrganiGram, or any other cannabis company based in Canada.

As for its existing business, its performance should align with guidance and expectations. Concerning additional revenue and earnings from derivatives, that's now further out.

For investors not taking that into account, the company could appear to underperform over the next couple of quarters, when it's in fact something that is outside of its direct control.

Conclusion

Organigram is getting close to finishing its Phase 4 production expansion, which when complete and fully operational, will boost its capacity to an annual run-rate of 113,000 kilograms. That should be completed by the end of 2019.

Once it's ready to go, and the company is able to ramp up sales of higher-margin derivatives edibles and vapes, the company has a very visible path to growing revenue, margins and earnings going forward. It just needs to not get too cute with its experiments at such large levels.

Finally, I also like its discipline on taking its time to enter international markets like the U.S., which I think some Canadian companies have prematurely entered, with the risk of legalization of recreational pot far from a surety, and scaling across the country still a significant challenge in other segments of the market.

In the end, other than that temporary experiment blip and some issues in Ontario, the company appears to be on a upward growth trajectory that should reward shareholders nicely over time.

To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.

 

Read more: Organigram (OGI) Reported a Strong Quarter, But Don’t Buy the Stock Just Yet

 

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