Zenabis Stock Tanked after Operational Update

Yesterday, Zenabis (ZENA) (ZBISF), a lesser-known recreational and marijuana company in Canada, provided an update of its operational performance for September. The company cultivated 2,089 kg of dried cannabis in September, which is 21.3% higher than the 1,731 kg output forecast in August.

Outperformance at Zenabis Atholville facility

The actual dried cannabis production at the Zenabis Atholville facility also surpassed its revised design capacity by 374 kg. According to the press release, the company has calculated the revised design capacity based on the historical yield of the facility. The company harvested dried cannabis 10 times at the Zenabis Atholville facility in September. The performance ratio in September was 21.8% higher than that based on the revised design capacity.

Since April 2019, the company has managed to harvest actual production significantly higher than the Zenabis Atholville facility’s revised design capacity. The surplus was the highest in August 2019, when it exceeded actual dried cannabis production by 555 kg. The performance ratio was also 40.9% higher than that based on the revised design capacity. Since July, the company has produced 5,323 kg of dried cannabis.

Zenabis stock tanked

Despite the company’s solid operational performance, Zenabis stock fell by 16.18% and closed at 0.57 Canadian dollars yesterday. Investors seem to be concerned about the company’s plans to delay its facility expansion for reducing capital expenditures.

Delayed facility expansion plans

In its press release, Zenabis announced the near-completion of construction at the Zenabis Atholville facility. The company also announced that the first phase of Part 1 of its Zenabis Langley facility is licensed and operational. The construction at Part 2A of the Zenabis Langley facility is almost complete.

On September 27, the company submitted a license amendment application for the existing cultivation license of Zenabis Langley’s Part 2A. Subject to Health Canada approval, Zenabis Langley’s Part 2A facility would have an area of 101,300 square feet. The annual cultivation capacity of dried cannabis at this facility would also grow from 39,400 kg to 96,400 kg.

The company decided to divide Part 2B of the Zenabis Langley facility into Part 2B and Part 2C. The company also plans to submit a cultivation license amendment for Part 2B in November. This would add 14,800 kg of annual licensed cultivation capacity for the company.

As a result, the company plans to delay the submission of the license amendment for Part 2C to February 2020. However, this will also depend on prevailing market conditions and pricing offered at that time.

The company noted that the annual cumulative capacity submitted for licensing at the Zenabis Langley facility would be 64,100 kg by the end of January 2020. The original timeline aimed for the submission of an annual licensed cumulative cultivation capacity of 96,100 kg by the end of November. So, the company plans to defer the license for the annual cultivation of an additional 32,000 kg of dried cannabis at the Zenabis Langley facility to February 2020.

Zenabis’s production capacity

According to its statement, Zenabis aims to have a licensed annual production capacity of 96,400 kg dried cannabis by the end of 2019. However, this would require Health Canada’s approval for the license amendment for the Zenabis Langley – Part 2A facility.

The company also guided for a licensed annual production capacity of 111,200 kg dried cannabis by the early first quarter of 2020. This is subject to approval for a license amendment for the Part 2B facility. By the early second quarter of 2020, the company expects an annual licensed production capacity of 143,200 kg of dried cannabis. This would be subject to the completion of all licensing requirements at the Zenabis Langley facility.

Why is Zenabis delaying its facility expansion plans?

Zenabis plans to reduce cash outflow for capital expenditures. Instead, the company aims to generate incremental cash flows from operations.

The company also expects to overshoot its budget allocated for the Zenabis Langley facility. Instead of completing the entire facility in the remaining amount of $13.7 million, the company now expects the amount to be only sufficient for Part 2B.

The company expects an additional $4 million for Part 2C of the Zenabis Langley facility. So, the company has planned to defer this additional capital expenditure to a time when it can be funded with operational cash flows.

The company also aims to mitigate the ramp-up risk at the Zenabis Langley facility. The company’s packaging equipment at Zenabis Atholville failed to keep pace with cultivation capacity. Instead of the intended 30,000 units per day, the new packaging equipment initially produced only 6,276 units per day.

Even after troubleshooting, the company has increased the average output of the packaging equipment to only 11,643 units per day. The highest output achieved per day has been 22,416 units. This resulted in actual revenues falling significantly short of projections in August and September.

The company is currently ramping up its packaging capacity at Zenabis Stellarton. Thereafter, the company expects surplus packaging capacity by November. The company is now ramping up the Zenabis Langley facility in a staggered fashion, which would enable other functions to keep pace.

How does this affect investor sentiment?

Investors seem to have attributed Zenabis’s delay in facility expansion mainly to budget overages. They seem to be concerned about the company’s ability to generate significant operational cashflows in this challenging environment. Conserving cash is a sensible move, considering the recessionary fears and the increased market uncertainties related to the trade war. However, the market seems to consider this move as the company’s inability to access capital at reasonable rates.

Despite the ongoing marijuana legalization across geographies as well as the Cannabis 2.0 legalization, the overall investor sentiment remains grim. In its pre-earnings announcement on October 10, Hexo (HEXO) had highlighted problems related to the cannabis sector such as pricing pressures, competitive pressures, and slower retail rollout in Canada.

The company also blamed regulatory uncertainty at a pan-Canadian level related to cannabis-derived products for its lower-than-anticipated revenue performance. After the announcement, Hexo stock crashed by 24%. The confirmation of these problems by a prominent cannabis player negatively affected the overall investor sentiment for cannabis stocks.