Raymond James analyst Rahul Sarugaser says the downward pricing pressure on cannabis in Canada will favour the lowest-cost producers, and that includes Organigram Holdingss (Organigram Holdings Stock Quote, Chart, News TSX:OGI), which in a client update on Thursday Sarugaser continues to rate as “Outperform.”

Sarugaser points to the latest data from Statistics Canada on pricing for legal cannabis over the second quarter of 2019, which shows a 3.9-per-cent quarter-over-quarter drop from $10.65 per gram to $10.23 per gram. The price for illicit weed Stats Can says has dropped 5.9 per cent from $5.94/g to $5.59/g, which is almost half the cost of legal cannabis. By the Stats Can numbers, Sarugaser estimates that more than 80 per cent of Canadian cannabis users are still buying their product from the black market.

Organigram positioned well for a price war…

All of which is to say that pricing pressure on legal weed is likely to persist, says Sarugaser.

“For us, it means that all licensed producers are seeing their margins compressed, and this problem is most acute among high-cost LPs,” writes Sarugaser. “Two of the five largest LPs, Canopy Growth and Tilray continue to produce cannabis at around $4 per gram. Given that they have to tack on $1.00/g in excise taxes and then sell to the provinces at an average price of $6.00/g, simple math illustrates that they are producing only ~$1.00/g or ~20 per cent in gross margin. As prices come down, we see this small margin getting further compressed. Even Aurora Cannabis and Aphria, the lowest-cost producers in the big five, are manufacturing at approximately $1.50/g to $2.00/g, yielding a ~50 per cent margin.”

The analyst says that the advantage will therefor go to the lowest-cost producers, which puts Organigram in good stead, he says, with its all-in costs of about $1.00 per gram (OGI registered $0.85/g in its Q2 and $1.29/g in its Q3). The only producer with better numbers is Village Farms at $0.65 per gram, Sarugaser says.

For evidence, the analyst points to the Ontario Cannabis Store’s website which, of the 126 dry flower products available, has OGI’s Trailblazer as by far the cheapest product at $5.59 per gram, with the second-cheapest coming in at $7.50 per gram.

Low cost producers better able to survive price pressure…

“While the cannabis sector continues to experience head winds—the HMMJ index is down more than 50 per cent over the last six months—low-cost producers like OGI, driven by excellent manufacturing processes, in our opinion, are best positioned to weather the storm and emerge as the long-term winners in the space,” he said.

The analyst thinks OGI will generate fiscal 2019 revenue and EBITDA of $97 million and $36 million, respectively, and fiscal 2020 revenue and EBITDA of $219 million and $87 million, respectively.

Moncton-based Organigram, which produces cannabis for both Canada’s medical and adult-use markets, has seen its share price decline with the rest of the sector over the past four or five months. Since hitting a high of $11.30 per share on May 21, OGI is down 67 per cent. Year-to-date, the stock is down 24 per cent.