For cannabis bulls, OrganiGram (NASDAQ:OGI) looks like a steal. OrganiGram stock is reasonably valued not just by the standards of the sector, but perhaps relative to the market as a whole. Earnings, at least on one basis, are positive. Revenue growth remains impressive, and the balance sheet is in decent shape.
OGI stock looks like one of the better “buy the dip” candidates in a sector that has seen significant selling over the past year. On this site last month, Josh Enomoto called OGI a reasonable cannabis bet. Two weeks earlier, Luke Lango said OrganiGram stock could double.
With shares again retreating toward $2, the case here does look solid. But the cannabis industry in Canada still has questions. So while I understand the case for OGI as a play in cannabis, I remain cautious toward the sector as a whole.
The Case for OrganiGram Stock
Again, what’s interesting about OGI stock at these levels is that valuation seems relatively reasonable. Despite the sell-off in cannabis stocks, that’s not necessarily true across the sector.
OrganiGram closed the first quarter with an enterprise value of roughly $435 million (~$41 million in net debt plus a fully diluted market capitalization over $390 million). On a trailing twelve-month basis, that’s a little over 30x EBITDA (earnings before interest, taxes, depreciation and amortization), and in the range of 6x net revenue.
Neither multiple necessarily is cheap by the standards of the market as a whole, but OrganiGram drove impressive revenue growth in its most recent quarter. Net sales more than doubled year-over-year and rose 54% quarter-over-quarter. The figure absolutely crushed analyst estimates, which projected a q/q decline and roughly 20% y/y growth.
If, say, a software stock posted that kind of growth and that kind of beat, it’s highly unlikely it would receive the valuation OrganiGram stock does. Many names in that sector are trading at over 10x revenue and in some cases, 100x EBITDA or more.
Simply on a fundamental basis, it’s almost easy to model upside in OGI stock. And that’s not necessarily the case with all pot stocks. Struggling Aurora Cannabis (NYSE:ACB), for instance, still trades at over 7x EV/revenue. It’s not yet posting positive EBITDA (nor is it all that close yet). Canopy Growth (NYSE:CGC), too, has a higher multiple to sales and also remains at least a few quarters away from even adjusted profitability.
And so OrganiGram stock looks like a safer way to try and time the bottom in cannabis stocks. The balance sheet is in good shape. EBITDA profitability plus lower capital expenses should drive positive free cash flow in the not-too-distant future.
But like every other company in the sector, OrganiGram still faces challenges.
OrganiGram’s fiscal Q1 report in January sent OGI stock up 45%. It boosted the entire sector as well. Within just a few weeks, however, the gains were gone.
We’ve seen that exact scenario in the sector before. In August, Aphria (NYSE:APHA) posted a surprise EBITDA profit. Aphria stock gained 41%. The sector rallied on the news. In less than two months, APHA was back where it started. It’s now down about one-third from its close the day before its blowout report.
Investors still don’t trust cannabis stocks. And OrganiGram itself, as reasonable as it seems, shows why. Net debt of $41 million (55 million CAD) seems modest in the context of the sector. But it’s still roughly 3x trailing EBITDA. That’s a concerning multiple.
In fact, OrganiGram in the Q1 release disclosed that it had to amend the covenants on its debt to deal with slower-than-expected growth in Canadian cannabis. Those covenants “revert to their original structure” on Aug. 31.
If industry performance disappoints, OrganiGram is going to trip those covenants again. That doesn’t mean the company is going bankrupt; lenders can simply adjust the framework again. They almost certainly will, as no one is incentivized to push the company into a restructuring.
But the debt here alone highlights the continuing downside risk in the sector. OrganiGram’s fundamentals look better than most, but they’re still not necessarily good. Free cash flow remains negative and likely will stay that way as the company builds inventory in “Cannabis 2.0” products. The company is selling stock under an “at the market” facility to raise cash — but that also depresses the stock price.
An investor can look at OGI stock and argue, logically, that a growth stock in a different industry likely would receive a higher valuation, but the argument goes both ways. Indebted companies in challenged sectors rarely get premium multiples. Like the sector, OrganiGram still has a lot of work left to do, and investors logically might have some skepticism on that front.
Will the Sector Help?
The particulars of the OrganiGram story are different from Canopy or Aurora or Cronos (NASDAQ:CRON). But the stocks share a common problem. None of those names are going to show a consistent rally until the sector gets healthier.
That’s going to take time, if it happens at all. OrganiGram itself shows why.
The company is slowing its production capacity growth given massive oversupply in Canada. As one analyst noted, Canopy alone can produce more than half the cannabis needed to supply the Canadian market. It has over two years’ worth of inventory already.
That’s why OrganiGram and others are pulling back on production. Pricing is going to collapse. OrganiGram chief executive officer Greg Engel noted on the Q1 earnings call that “at least one competitor” took a “significant price drop on their dried flower product”. Per that call, competition already has undercut OrganiGram’s market share on the east coast of Canada, where the company had a first-mover advantage.
To be fair, Cannabis 2.0 products are coming. (OrganiGram shipped its first vape pens late last month.) More retail stores will open in the key province of Ontario and elsewhere.
But supply is so large that even increased demand may not help. OrganiGram already is seeing significant profit margin impacts. Yes, revenue more than doubled year-over-year in the first quarter. But Adjusted EBITDA actually declined 29% y/y.
The Case for Caution
In the context of the industry, the relentless selling of cannabis stocks does make sense. This is a market that remains in upheaval — and is going to stay that way.
Struggling companies already are slashing prices to try and turn inventory into cash and gain market share. Bankruptcies are coming. Production assets are going to be available for pennies on the dollar. Black market sales remain significant.
That’s why surprise quarters like Aphria’s fiscal Q4 in August and OrganiGram’s fiscal Q1 in January lead to short-term pops that fade. One good quarter doesn’t change the sentiment toward the industry — or fix the very real challenges of too much supply and too much competition.
Over time, the market will sort itself out. Weaker players will fade. Production costs will continue to come down. Pricing should normalize. But it’s going to take time — years, not months. OrganiGram seems strong enough to make it through the storm. But, to stretch the metaphor, investors don’t need to jump on the ship just yet.
Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.