OrganiGram shares are up 350% in 2020 as it joined Tilray and Sundial as some of the most popular cannabis stocks this year.
We believe the rally was stoked largely by short-term speculative investor interests but the pace of gains has led to stretched valuation.
We think investors should consider taking profits given a pullback is highly likely; we recommend rotating into U.S. MSO stocks for better value and maintaining exposure to future upsides.
OrganiGram (OGI) joined other Canadian cannabis stocks to stage an astonishing rally in 2021, sending its shares up 350% since the year began. The company reported weak quarterly results last month and we continue to believe that the stock should trade at a discount to other mid-tier Canadian LPs. Consistent with our recent analysis, we believe OGI shares are trading at unsustainable levels and a pullback is likely imminent. Investors should consider taking profits and understand the heightened risks during volatile periods like this. We believe a logical place to rotate your gains from OGI into would be U.S. MSOs that have largely missed out on the current rally. For a list of these U.S. names please refer to our "2021 Cannabis Sector Outlook". (All amounts in C$).
Reefer Madness
OGI joined a few other cannabis stocks in the latest installment of the Reefer Madness. Its shares jumped 350% since 2021 began including a 120% rally in the last week alone. There are two other Canadian cannabis stocks that also experienced a similar outburst of trading: Tilray (TLRY) gained 673% and Sundial (NASDAQ:SNDL) climbed 520% this year so far.
The reason why Canadian cannabis stocks have produced the biggest winners this year so far is likely due to their significant underperformance in the last few years and high short interests. Internet users have also been discussing these few cannabis stocks fervently which likely contributed to the rally underway. We think OGI is certainly trading at inflated levels at this point especially considering the weak Q1 results it recently published on January 12, 2021.
OGI reported Q1 F2021 results that showed net revenue declining 23% YoY due to significantly lower wholesale revenue. Recreational sales jumped 30% YoY but wholesale revenue collapsed to near zero as the oversupply crisis in Canada continues. Gross margin came in at negative 20% due to lower selling prices and inventory charges, reflecting ongoing product assortment and cultivation challenges.
OGI has been experiencing operational issues as it shelved capacity and changed cultivation methods to improve efficiency and tweak production to match consumer demands. OGI reduced its workforce during the pandemic which backfired and led to production bottlenecks and missed revenue opportunities in the last two quarters.
During Q1 OGI introduced its first-ever value product line called SHRED targeting price-conscious customers in response to a shift in market demand. HEXO (HEXO) was the first Canadian LP to introduce affordable product lines in order to compete with the black market and grab market share from other LPs. OGI is clearly late to the game but it is hoping SHRED could help reverse the negative top-line trend after several disappointing quarters.
OGI also narrowed its cash burn to near break-even in Q1 which is an improvement from previous quarters. Notably, the company has cut back on capex significantly as it tries to rein in spending and come to grips with the reality of an oversupplied Canadian market. OGI has also improved its balance sheet with $79M of cash and $60M of term loan outstanding.
The company raised $69M in November 2020 by issuing 37 million shares at $1.85 per share which looks like a steal at today's prices. Given the significant reduction in operating cash burn and capex, we think OGI has sufficient liquidity for the near-term; the company is likely considering additional equity raises to capitalize on its current red hot share price.
Fundamentals
We think OGI shares, along with Tilray and Sundial, reflect the current ongoing irrational exuberance in the cannabis sector. According to a website that tracks user activities on a popular online forum, cannabis stocks are currently the most popular ahead of GameStop (NYSE:GME), Tesla (NASDAQ:TSLA), and AMC. While OGI is only 13th on the list, its shares have likely benefited immensely from interests and buying activities from retail investors.
We have been covering the cannabis sector since 2017 and the sector trades on sentiment and momentum. Therefore, it is not news that cannabis stocks are popular again among investors especially given the Democratic win in the U.S. election and visible progress on the federal legalization front. However, it is also easy to forget that money has been made and lost in the cannabis sector through the past cycles, and only those that cashed out before the sentiment ended up making money.
OGI has a market cap of $1.8B and trades at 23x EV/Sales which is in-line with other mid-sized Canadian LPs including Aurora Cannabis (ACB), HEXO, and Village Farms (VFF). While OGI's valuation seems in-line with peers, we think the stock should trade at a discount given its recent execution woes. Also, OGI has practically no international presence which is another disadvantage compared to Aurora.
HEXO benefits from its Truss beverage partnership with Molson Coors. Based on our continued coverage, OGI has historically been a conservative Canadian LP focused on its home market, thereby trading at a modest multiple compared to the rest of the market.
Another interesting point to make is that U.S. MSOs are looking very cheap at current levels compared to Canadian LPs. Most MSOs trade at 10-15x EV/Sales such as Trulieve (OTCQX:TCNNF) at 10x and Green Thumb (OTCQX:GTBIF) at 12x. This is why we think smart investors could consider putting some of the profits from OGI into these well-run U.S. MSOs.
Conclusion
In summary, we think OGI shares are overvalued on a relative basis given weaker fundamentals and lack of additional growth areas compared to other Canadian LPs. OGI shares traded above $10/share during the 2019 bull market but dropped to below $2/share in the 2020 downturn. The stock has risen 4-5x since bottoming out in 2020 but its recent gains have far outpaced most cannabis stocks, especially the U.S.
MSOs which have far better fundamentals and financials. OGI recently reported its Q1 F2021 results which showed that revenue declined 23% YoY and gross margin turned negative due to lower selling prices and inventory charges - none of which is encouraging. The company still has a long way to go before a successful turnaround.
We believe the current rally in OGI and some Canadian cannabis stocks are largely fueled by renewed interests in cannabis given positive U.S. legalization progress and short squeezes. The rally will likely subdue in the future, just like it did every time in previous cycles, but investors should have a strategy to capitalize on this opportunity and realize your gains.
The cycles in cannabis will repeat themselves so it is important to take profits while you can. The biggest near-term fundamental driver of the industry is the potential U.S. federal legalization of cannabis. However, despite recent comments made by members of the Senate and rising popularity among Americans, it remains too difficult to predict exact timing. Therefore, it is highly likely that the current rally will run out of steam before federal legalization is done.
Therefore, there will be other buying opportunities for all, and investors need to be patient and not chase stocks like OGI at current levels which is very dangerous. For existing investors sitting on large profits, they could consider taking some gains and rotate into more attractively valued U.S. cannabis stocks.
