OrganiGram: undervalued and with new brands in the works

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OrganiGram Holdings Inc. (NASDAQ:OGI) is expected to generate revenue and free cash flow growth. Management has announced that new products will be announced in the remainder of 2022. Also, with cash in hand, I would expect more M&A activity to improve revenues and bring economies of scale. Even taking into account the risks of further regulatory pressures around the cannabis industry and inflationary pressures, I believe the current stock is significantly undervalued.

OrganiGram: product development and mergers and acquisitions

Founded in 2013, OrganiGram is a supplier of medical cannabis as well as a seller of cannabis to adult recreational consumers. Right now, the company seems to be more valuable for its expertise in creating new brands than for its medical cannabis.

Source: company website

Source: company website

I believe that looking at the impressive recent growth from the company’s recreational wholesale business, the revenue is enough to be interested in OrganiGram. In the nine months ended May 31, 2022, adult recreational revenue grew nearly 98% and net revenue reached nearly C$100 million.

Source: Quarterly Presentation (expressed in thousands of Canadian dollars)

Source: Quarterly Presentation (expressed in thousands of Canadian dollars)

Note that management acquires a large number of competitors, which explains the growth in revenues. The company acquired its intangible assets, biological assets and inventories. Here are some examples of previous acquisitions.

On December 21, 2021, the Company acquired 100% of the shares and voting rights of unlisted Laurentian for CAD 36,000, being CAD 10,000 in cash consideration. Source: Quarterly presentation

Source: Quarterly presentation

Source: Quarterly presentation

On April 6, 2021, the company acquired 100% of the shares and voting rights of the unlisted EIC. Source: Quarterly presentation

Source: Quarterly presentation

Source: Quarterly presentation

I quite like the fact that OrganiGram has significant expertise in the M&A markets. Future transactions will likely help the company maintain revenue growth.

Analysts’ expectations are rather beneficial

I looked at the numbers reported by other financial analysts. They expect OrganiGram to be able to trade at nearly 9x 2024 EBITDA and 1.34x 2024 revenue. Keep in mind that 2024 sales and EBITDA are expected to increase significantly .

Source: Marketscreener.com

Source: Marketscreener.com

According to analysts, net sales growth in 2022 would reach 80%, 33% in 2023 and 28% in 2024. It should also be noted that the EBITDA margin should increase from around 1% in 2022 to more than 15% in 2024. As a result, free cash flow would finally be positive for the first time in 2024 after many years of negative results. In my view, if the results are in line with market analysts’ expectations, the stock price will likely head north.

Source: Marketscreener.com

Source: Marketscreener.com

Balance sheet

As of May 31, 2022, management reported cash worth CAD 127 million, property, plant and equipment worth CAD 250.4 million and total assets worth CAD 583 million. With an asset/liability ratio above 7x, I think the balance sheet is in very good shape.

Source: Quarterly Presentation (expressed in thousands of Canadian dollars)

Source: Quarterly Presentation (expressed in thousands of Canadian dollars)

In terms of total liabilities, OrganiGram reports derivative liabilities worth CAD 8.2 million and a current portion of long-term debt of CAD 0.08 million. I think more investors might be interested in OrganiGram once they learn about the company’s negative net debt.

Source: Quarterly Presentation (expressed in thousands of Canadian dollars)

Source: Quarterly Presentation (expressed in thousands of Canadian dollars)

More products, new vaping industry initiatives and partnerships could push the stock up to $1.77 per share

In the best-case scenario, OrganiGram’s new strains will succeed in differentiating themselves from those of competitors. For example, I assumed that Edison Kush Cakes and Edison Frozen Lemons, launching in 2022, will likely receive consumer demand. As a result, sales growth will most likely be skewed north.

Completion of these initiatives should increase sales for Edison, which have a higher ASP than value brands and therefore attract higher margins. In March 2022, the company released two new strains – Edison Kush Cakes and Edison Frozen Lemons. To meet growing demand for strain differentiation in the value segment, in the third quarter of fiscal 2022, the company introduced the Pink Cookies strain to its Big Bag O’ Buds line. This high THC strain differentiates Big Bag O’ Buds in the value segment and brings the number of SKUs on the market to five. Source: OrganiGram Holdings Inc. – MDA

Additionally, if the company’s vape strategy is also successful and new initiatives become a catalyst for revenue generation, the P&L may improve. In this regard, note that the management is preparing new products for the rest of 2022.

OrganiGram has once again focused on building market share in the vape category through unique formulations, premium hardware, and high quality inputs. For the remainder of fiscal 2022, the Company intends to introduce many innovative offerings in the vape segment, all focused on building our share in this category. Source: OrganiGram Holdings Inc. – MDA

In my opinion, the management could also receive a large inventory demand if more agreements are announced with partners. In this regard, let us highlight the investment with a subsidiary of BAT, a consumer goods company, established in 1902. In my opinion, the know-how accumulated in the consumer industry and research on cannabis could improve the new generation of products:

On March 11, 2021, the Company announced a strategic investment of $221 million from a wholly owned subsidiary of BAT. Source: Organizational chart

OrganiGram and BAT have agreed to jointly develop cannabis vapor products, oral cannabis products and any other product, intellectual property or technology that the parties mutually agree to develop. Source: OrganiGram and BAT Form Product Development Collaboration

In this scenario, I have assumed a decline in sales growth from 33% in 2023 to around 11% in 2030. I believe that the higher the turnover, the more difficult it will be for OrganiGram to maintain high levels of sales growth. I also assumed an EBITDA margin around 12% and 16%, which is not far from what other analysts expect. In the end, my FCF/CA ratio would be around 5% or 4%.

If we also assume a moderate 2030 EV/EBITDA of 10x, the exit valuation would be $812m. We would be talking about free cash flow close to $7 million in 2024 and $22 million in 2030. The sum of future free cash flow discounted at 6.7% would be close to $468 million. Finally, if we include the net debt of nearly -$118.6 million, the equity value would be $556 million and the fair price would be $1.77 per share. Note that I also expect an IRR close to 11.2%.

My DCF model

My DCF model

Regulatory changes, inflation and a significant decline in revenue growth could lead to a fair price of $0.65 per share

Given the very bearish assumptions, I would argue that regulators could significantly hurt OrganiGram’s P&L. If governments decide to regulate the transportation, marketing, storage, sale and manufacture of cannabis, the company’s free cash flow may not increase.

Additionally, if regulators decide to increase the level of disclosure needed to sell cannabis, revenue growth could be weaker than expected. Under these conditions, OrganiGram could see its fair price drop.

OrganiGram’s finances may also suffer as the price of equipment, labor and raw materials needed to grow cannabis increases. In this respect, the recent increase in inflation could push wages and electricity prices higher than expected. If OrganiGram cannot raise the price of its products, inflation will affect the company’s EBITDA margins. In addition, an interruption or decrease in the supply of raw materials can also halt production, which would most likely reduce revenue growth.

Finally, in my opinion, going forward, management is unlikely to report the same level of sales growth as in the past. Construction of new facilities may not be as rapid as in the past. With this in mind, if sales growth declines faster than expected, some investors might decide to sell their shares, which would increase the company’s cost of equity. As a result, I would say OrganiGram’s stock price would decline.

In my worst-case scenario, I assumed that sales growth would likely decline faster than in the previous case. I assumed a sales growth of 10% in 2024 and close to -10% in 2030. The EBITDA margin could also decline from around 15% in 2024 to almost 12.5% ​​in 2030. Finally, with an FCF/CA margin of approximately 3.5% from 2027 to 2030, FCF would be approximately $7.5 million from 2027 to 2030.

Considering an exit multiple of 7.8x, I got an exit valuation close to $225 million, which implied an enterprise value of around $113 million. The equity valuation would be $200 million and the fair value would be $0.65 per share.

My DCF model

My DCF model

Conclusion

OrganiGram’s revenue growth is very impressive. With a lot of cash in hand, in my view, company acquisitions and new product development will likely serve as revenue catalysts. Given other analysts’ expectations of a moderate EBITDA margin and FCF margin, future free cash flow would imply a valuation of nearly $1.7 per share. I also see risks from further regulation, inflation and supply chain disruptions. However, the downside risk to the stock price seems low.

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