The OrganiGram share highlights the real risks and benefits of cannabis

<p>For cannabis bullies, OrganiGram (NASDAQ: OGI) looks like a theft. OrganiGram shares are reasonably valued not only by the sector’s standards, but perhaps in relation to the market as a whole. The result, at least on a base, is positive. Sales growth is still impressive and the balance sheet is in decent shape.

Source: Shutterstock

The OGI share looks like one of the better “buy the dip” candidates in a sector that has seen significant sales over the past year. On this site last month, Josh Enomoto called OGI a reasonable cannabis operation. Two weeks earlier, Luke Lango said that the OrganiGram share could be doubled.

With shares returning to $ 2, the case here looks solid. But the cannabis industry in Canada still has questions. So even though I understand the case of OGI as a game in cannabis, I am still wary of the sector as a whole.

The case for OrganiGram bearings

Again, what is interesting about OGI stocks at these levels is that the valuation seems relatively reasonable. Despite the sale of cannabis shares, this is not necessarily true throughout the sector.

OrganiGram ended the first quarter with a business value of approximately $ 435 million (~ $ 41 million in net debt plus a fully diluted market value over $ 390 million). Subsequent twelve-month basis, it is just over 30 times EBITDA (earnings before interest, taxes, depreciation and amortization) and in the interval 6x net sales.

Neither multiple is necessarily cheap by market standards as a whole, but OrganiGram drove impressive revenue growth during its most recent quarter. Net sales more than doubled compared with the previous year and increased by 54% quarter over quarter. The figure completely shattered analytical estimates, which calculated an aq / q decline and about 20% y / y growth.

If, for example, a software warehouse booked that type of growth and that kind of kind, it is very unlikely that it would get the valuation that the OrganiGram share does. Many names in that sector are traded with over 10x revenue and in some cases 100x EBITDA or more.

Simple on a basic basis, it is almost easy to model up and down in OGI shares. And that is not necessarily the case with all pot stocks. Fighting Aurora Cannabis (NYSE: ACB), for example, is still trading at over 7x EV / revenue. It has not yet shown positive EBITDA (nor is it that close yet). Canopy Growth (NYSE: CGC) also has a higher multiple for sale and also remains at least a few blocks from steadily adjusted profitability.

And the OrganiGram share looks like a safer way to test the bottom of cannabis stocks. The balance is in good condition. EBITDA profitability plus lower capital costs should lead to a positive free cash flow in the not too distant future.

But like all other companies in the industry, OrganiGram still faces challenges.

Basic concerns

OrganiGram’s fiscal policy Q1 report in January sent OGI shares up 45%. It also increased the whole sector. In just a few weeks, however, the gains were gone.

We have seen the exact scenario in the industry before. In August, Aphria (NYSE: APHA) showed a surprising EBITDA result. The Aphria share increased by 41%. The sector gathered on the news. In less than two months, APHA was back where it started. It is now down about a third from the end of the day before the blowout report.

Investors still do not trust cannabis stocks. And OrganiGram itself, as reasonable as it seems, shows why. Net debt of $ 41 million (CAD 55 million) seems modest in the context of the sector. But it is still about 3x subsequent EBITDA. That’s a worrying multiple.

In fact, in the Q1 edition, OrganiGram revealed that it had to change covenants on its debt to deal with slower-than-expected growth than Canadian cannabis. These unions “return to their original structure” on August 31.

If the industry’s performance disappoints, OrganiGram will stumble upon these unions again. This does not mean that the company goes bankrupt; Lenders can simply adjust the framework again. They will almost certainly do so, as no one is encouraged to drive the company to a restructuring.

But the debt here alone highlights the continued downside risk in the sector. OrganiGram’s basic features look better than most, but they are still not necessarily good. Free cash flow remains negative and will probably remain so when the company builds stocks in “Cannabis 2.0” products. The company sells shares under an “on the market” facility to raise cash – but it also lowers the share price.

An investor can look at the OGI share and logically argue that a growth share in another industry would probably have a higher valuation, but the argument goes both ways. Debt-ridden companies in challenging sectors rarely receive premium multiples. Like the sector, OrganiGram still has a lot of work to do, and investors can logically have some skepticism on that front.

Will the sector help?

The details of the OrganiGram story are different from Canopy or Aurora or Cronos (NASDAQ: CRON). But stocks share a common problem. None of these names will show a consistent rally until the sector is healthier.

It will take time if that happens at all. OrganiGram itself shows why.

The company is slowing down its production capacity growth due to massive oversupply in Canada. As one analyst noted, Canopy alone can produce more than half of the cannabis needed to supply the Canadian market. It already has over two years of stock.

That is why OrganiGram and others are withdrawing production. Pricing will collapse. OrganiGram’s CEO, Greg Engel, noted in the results for the first quarter that “at least one competitor” took a “significant price drop on its dried flower product”. According to that conversation, competition has already reduced OrganiGram’s market share on Canada’s east coast, where the company had a first advantage.

To be fair, Cannabis 2.0 products come. (OrganiGram delivered its first vape pens late last month.) More stores are opening in the main province of Ontario and elsewhere.

But the supply is so large that even increased demand may not help. OrganiGram already sees significant profit margin effects. Yes, revenues doubled more than the year before during the first quarter. But adjusted EBITDA actually decreased 29% y / y.

The case for caution

Within the industry, the relentless sale of cannabis shares makes sense. This is a market that remains in upheaval – and will remain so.

Fighting companies are already lowering prices to try to turn stocks into cash and gain market share. Bankruptcies are coming. Production assets will be available for pens on the dollar. Sales on the black market are still significant.

Therefore, surprise quarters such as Aphria’s fiscal quarter 4 in August and OrganiGram’s fiscal quarter 1 in January lead to short-term pops fading. A good quarter does not change the feeling towards the industry – or solve the very real challenges with too much supply and too much competition.

Over time, the market will recover. Weaker players will fade. Production costs continue to decrease. Prices should be normalized. But it will take time – years, not months. OrganiGram seems strong enough to withstand the storm. But to stretch the metaphor, investors do not have to jump on the bandwagon yet.

Vince Martin has been covering the financial industry for nearly a decade for and other stores. He has no positions in any of the mentioned securities.