Investing in the cannabis space carries significant risks. The companies in the Canadian marijuana sector are impacted by multiple structural issues that include lower than expected demand, widening losses, a thriving black market, regulatory issues, and high inventory levels, among others. This meant OrganiGram Holdings (TSX:OGI) and several other Canadian pot companies have burnt significant investor wealth.
Marijuana stocks were flying high just before Canada legalized cannabis for recreational use. However, the above-mentioned factors sent pot stocks spiraling downwards in the last 24-months. OGI stock is currently trading 62% below its record high. Despite its recent performance, OGI has been a massive wealth creator for long-term investors. Shares of OrganiGram Holdings have returned a staggering 1,270% since it went public back in January 2012. Let’s see if OGI stock can outpace the broader markets in 2021 and beyond.
British American Tobacco invests in OrganiGram
Last month, British American Tobacco or BAT purchased a 20% stake in OrganiGram. The former is a tobacco giant that aims to establish a “Center for Excellence” at the latter’s Monckton facility in order to develop and expand its suite of cannabis-based products. British American Tobacco is currently testing a CBD-based (cannabidiol) vaping product in the U.K.
BAT’s subsidiary will receive 58.3 million OGI stock priced at US$3 per share valuing the deal at US$176 million. This capital infusion will allow OrganiGram to increase investments in research and development and provide it with an opportunity to enter international markets in the U.S. and Europe.
In its press release, British American Tobacco confirmed that it will currently focus on CBD products where OGI “has a proven track record of consumer-led innovation and developing high quality adult-use recreational and medical cannabis products, which are legally available in Canada.”
Several other marijuana companies have partnered with tobacco or alcohol manufacturing entities. While Cronos Group is backed by Altria, Constellation Brands has a 38.6% stake in Canopy Growth. In late 2020, Aphria also acquired SweetWater Brewing for $300 million.
What’s going right for OGI stock?
OrganiGram aims to increase its market coverage allowing it to improve top-line numbers over time. In the last year, the company introduced 47 new cannabis products and was looking to launch another 14 products in Q1 of 2021. The pot heavyweight might have to continue to burn cash as new products will increase costs. But it will also help OGI to build consumer loyalty and enhance its brand value.
The slow rollout of retail stores in major Canadian provinces impacted demand in the last two years. However, OGI is looking to scale its production due to rising demand for recreational products allowing it to benefit from economies of scale and lower production costs.
In the December quarter, OGI reduced its long-term debt by 48% on a sequential basis and improved its cash position after it raised $69 million via an equity offering.
OrganiGram also offers significant competitive advantages. It is the only major cannabis producer that is located in Canada’s Atlantic region where cannabis use is higher among adults compared to the national average. The company also operates a single cultivation facility in Moncton. This makes it easier for OGI to adjust production output to meet demand. It also has a three-tier production system in its cultivation room in order to maximize licensed area and reduce operating costs.
The bear case for OrganiGram stock
OrganiGram’s total sales were down 23% year over year at $19.3 million in the fiscal first quarter of 2021 ended in November. Its cost of sales rose by 47% while selling costs were up 18%. While these costs can be associated with OGI’s scaling efforts, its top-line decline can be attributed to lower selling prices as well as lower wholesale revenue.
Its gross losses for Q1 stood at $16.7 million compared to $11.2 million in the prior-year period. Its net loss also widened to $34.3 million from $863,000 in this period. The higher losses were driven by write-downs and asset impairments which are a result of overexpansion and oversupply. OrganiGram is currently using just 40% of its cultivation facility and this trend is likely to continue in the near term. OGI’s inventory and asset impairment charges stood at $13 million in Q1.
The Canadian marijuana market is getting crowded and more than 100 licensed producers are competing for a market valued at just $3.2 billion. The lower-priced black market products accounted for around 40% of total recreational sales in 2019 and though this figure should be lower today, we can see why pot producers are grappling with inventory write-downs and tepid demand.
What next for OGI stock?
OrganiGram is valued at a market cap of $1.17 billion. Analysts tracking the stock expect it to increase sales by just 8.1% to $93.8 million in fiscal 2021 and by 38.4% to $130 million in fiscal 2022. Bay Street also expects OGI to narrow its loss per share from $0.79 in fiscal 2020 to $0.04 in fiscal 2022.
We can see OGI stock is trading at a forward price to sales multiple of almost 11 which is steep given its tepid revenue growth, massive losses and rising competition. Analysts tracking OGI stock have a 12-month average target price of $4.14 as of April 7, 2021.