OrganiGram Holdings (OGI) has a strong position in the Canadian recreational pot market, recently receiving a supply deal with Quebec, making it only one of several companies that are allowed to supply all Canadian provinces at this time.
While the company has the supply deals in place, the fact it generates over 90 percent of sales from recreational cannabis, is a significant concern over the long term.
In the short term it is a positive for OrganiGram, allowing it to generate a lot of revenue, especially in a market where supply can’t keep up with demand, partially because of poorly operated government operations.
From the start of legalization in Canada, it was apparent that the smaller competitors would enjoy a more-than-level playing field because of the focus on recreational pot, and the time it would take to work through the inevitable snafus that were inevitable.
For that reason, OrganiGram should do very well in that environment. It doesn’t hurt that it is one of the market leaders in productivity as well, with its only facility on the production side expected to produce about 113,000 kilograms annually when its completed.
Based upon roughly 490,000 square feet of growing space, it means the company will produce approximately 230 grams per square foot; over twice as much as the projected industry average.
Long-term outlook suspect
Within its current business model, a lot is going right for OrganiGram, but further out it faces a huge problem and challenge because of its heavy reliance on adult-use pot as its main revenue stream. What happens when the market is saturated and recreational pot demand in Canada levels off? OrganiGram is faced with a no-growth outlook.
The challenge is even though OrganiGram could begin to transition to medical cannabis as a larger part of its product mix, the reality is that it takes time to gain entry into those markets, let alone learn them.
At the end of March 2019, management said it had 16,157 registered patients. That’s far below what most of its peers have.
There is also the issue of recreational cannabis being very low margin. Even with strong growth rates per square foot, there is only so much it can do before hitting a ceiling in this market.
It’ll without a doubt provide some higher-margin consumable products that will generate more revenue and earnings, but it’s still extremely limited in the long haul by its domestic focus on recreational pot.
As the adult market in Canada matures, where is growth going to come from?
Conclusion
It’s understandable why OrganiGram decided to take this route, as it provides a meaningful revenue stream at a time it has lowered costs, allowing it to generate positive cash flow.
That means the bulk of its inventory is being designated for recreational cannabis.
Organigram is set up well for the Canadian recreational market in the near term, but it has a lot of problems it must solve once it is forced to move beyond that to other markets in order to generate growth.
Most management teams on the production side of cannabis have stated that serving the recreational cannabis market isn’t sustainable. I agree with that. My view is it’s a temporary revenue stream that will assist companies in transitioning to segments of the cannabis market that have long-term growth potential.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
Disclosure: The author has no positions in OrganiGram stock.
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