Strategy with OGRMF is to be buying and not selling?

Strategy with OGRMF is to be buying and not selling?

Anyone who is disappointed with the Organigram (OTCQB: OTCQB:OGRMF) results for the three months ended May 31, 2017, probably drives their car looking only in the rear view mirror. From my perspective, the results were very positive and investors should be looking ahead with optimism. Investing looking back is just as dangerous as driving that way. In my opinion, the advisable strategy with OGRMF is to be buying and not selling.

The quarterly report covers the months of March, April and May, 2017. This was a time still greatly influenced by the aftermath of the myclobutanil related product recalls centered on Mettrum and OGRMF. Health Canada had already added new terms and conditions their licenses requiring ‘expanded’ testing regimes.

So all LPs were impacted but especially OGRMF and Mettrum. Many of the expenses incurred by OGRMF in the most recent quarter related to regulations imposed specifically on them and on all LPs by HC recently. I can get to nearly $5 million of total costs related to the original recall and the subsequent changes imposed on all LPs in OGRMF’s first three quarters. These are non-recurring expenses, that is, destruction of product that did not meet new standards, the systems put in place to test for unauthorized pesticides and the consequent negative impact on sales due to lack of product.

One additional thought. It appears many provinces will not meet the deadline for legalized adult marijuana on or before July 1, 2018. That may be disappointing news for the Canadian adult cannabis industry but it plays right into the hands of the Licensed Producers. It is starting to look as if the legislation will be approved by the federally self-imposed deadline.

If this happens, there is bound to be some backlash. In Vancouver, for example, there are 10 dispensaries that have paid a $30,000 licensing fee ($1,000 for compassion clubs) and are officially sanctioned by the city to operate dispensaries even though such outlets are still illegal. There are another 38 shops not subject to enforcement because they have promised to apply for a license. To no one’s surprise officials are finding many of these are not actively trying to get licensed. There are 57 others that, in an ironic sense, are more honest and are simply operating without promising to comply with the city rules. In total, Vancouver has issued approximately 1,600 tickets to illegal operators. Bylaw officers issue new tickets once a week to illegal dispensaries. Prior to December 2016, the tickets carried a fine of $250 that was raised to $1,000 after that date. What is noteworthy is a $1,000 ticket per week is $52,000 in fines per year compared to a $30,000 licensing fee excluding the costs of making an application.

In addition, the city has issued 27 injunctions trying to close unlicensed dispensaries. The city reports 13 new shops have opened since the city began its licensing regulations. So if B.C. is not ready to go, there will be a problem for dispensaries that will have to continue to operate illegally, municipalities that have issued licenses and collected very high licensing fees, the municipally licensed dispensaries that will still be operating illegally and the B.C. provincial government in particular that has just changed as a result of an election. Policing activities on illegal dispensaries will likely be stepped up once legalization is approved. Any province that isn’t ready will encounter similar problems.

But one province is taking a progressive approach to cannabis legalization. New Brunswick (NB) sees the upcoming legal adult cannabis industry as an economic driver for their province and is taking steps to be ready by the federally mandated target date. New Brunswick and other provinces in the region face economic challenges that cannabis can help resolve. The Liberal provincial government of NB’s Premier Brian Gallant believes cannabis will create badly needed revenues and jobs. NB Health Minister Victor Boudreau said, “Your government is working to ensure a successful approach to the legalization of recreational cannabis by prioritizing public health and safety concerns while maximizing the economic opportunities presented by this emerging sector.” He went on to say, “We want to keep cannabis out of the hands of youth and its proceeds out of the hands of criminals.” And, I might add, redirect those proceeds to legal growers and local government coffers.

OGRMF stands to benefit from its positioning in the province of New Brunswick. At the time, I only knew the province was looking for ways to boost its economy and OGRMF stood to benefit from lower electric power costs, lower cost labor and government programs to stimulate employment. (see the original Seeking Alpha report here) So although I don’t agree with the idea of a Crown Corporation to regulate and sell cannabis, if that happens in New Brunswick it doesn’t take a rocket scientist to imagine where that Crown Corporation will buy most of its cannabis supply. OGRMF is the only Licensed Producer based in New Brunswick. Buying mainly from locals to sell mainly to locals will maximize employment, government revenue, and provincial economic benefit. This could also produce an unexpected boon for OGRMF.

The Canadian Licensed Producers have been treading water for the past few months as shown in this chart. This is a proprietary chart published weekly in my free newsletter Let’s Toke Business. The Licensed Producers peaked in November 2016 with the index at 3112.27. Since then the group is off 14.8% as measured by the index. Still the index is up 50.7% over the past year.

There are several reasons for the consolidation in prices including an exceptionally strong rally in LP stocks prior to the peak, heavy equity financing by the group taking advantage of high prices, an increase in the number of LPs going public, a major product recall late in 2016 and subsequent new testing protocols introduced by Health Canada. However, the Licensed Producer group has outperformed the average cannabis stock as measured by the Let’s Toke Business Marijuana Composite Index. The following is the LP Index relative to the Composite Index.

The pattern for OGRMF is very similar to the LP group: a strong rally prior to a November 2016 peak and an extended period of consolidation since.

We believe in the months ahead OGRMF will report accelerated sales and a return to positive EBITDA and cash flow. In addition, it appears medical marijuana users like their product so the number of patients should also continue to grow strongly.

Financial Position: at May 31, 2017, the Company had current assets of $56,273,210 of which $48,457,327 was in the form of cash and short term investments. Current liabilities stood at just $4,026,188 leaving a working capital position of $52,247,022. The balance sheet was very liquid. Long term debt was only $3,199,776 of which $1,765,641 was to Farm Credit Canada. At the same time, there were 102.56 million shares outstanding. At the recent closing price of $2.23 per share, the market cap was $228.7 million.

Summary and Conclusion:

OGRMF is a long established Canadian Licensed Producer. The first nine months of the current fiscal year was a difficult period for the Company because of the miclobutanil-related product recalls and changes to the testing protocols that were handed down by Health Canada. However, the aftermath of these difficulties are essentially behind them and I expect the company will quickly return to rapid sales growth, positive EBITDA and cash flow.

In the past six months, OGRMF has taken important steps to bolster management and the number of employees in anticipation of rapid growth moving ahead. In addition, the company has continued to move ahead with its planned 10,000 kilogram expansion scheduled for completion by the fourth calendar quarter of 2017.

As expected from the outset that being in New Brunswick would be an advantage for OGRMF because power costs are lower, employee costs are also lower than in areas such as Ontario and British Columbia and government programs are in place to stimulate employment. On the verge of legalization, however, there is another benefit. NB has announced marijuana sales will be regulated by a Crown Corporation. It seems likely that a Government that wants a cannabis kick-start for its economy will be motivated to buy locally and sell locally to maximize economic impact.

Ted Ohashi