OrganiGram: undervalued and with new brands in the pipeline

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OrganiGram Holdings Inc. (NASDAQ:OGI) is expected to provide revenue generation and free cash flow growth. Management announced that new products will be announced in the remainder of 2022. Also, with cash on hand, I would expect increased M&A activity to improve income and generate economies of scale. Even considering the risks of increased regulatory pressure around the cannabis industry and inflationary pressures, I think current stocks are significantly undervalued.

OrganiGram: Product Development and Mergers & Acquisitions

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

Source: Company website

Source: Company website

I think looking at the impressive recent growth from the company’s recreational wholesale, the income is enough to get interested in OrganiGram. In the nine months ended May 31, 2022, adult-use recreational revenue increased by nearly 98% and net revenue reached nearly CAD$100 million.

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

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

Let’s keep in mind that management is acquiring a significant number of competitors, which explains the growth in revenue. The company acquired its intangibles, biological assets and inventory. The following are some examples of previous acquisitions.

On December 21, 2021, the Company acquired 100% of the shares and voting rights of non-listed Laurentian for CAD36,000, consisting of CAD10,000 in cash. 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 appreciate the fact that OrganiGram has a significant amount of experience in the M&A markets. Future transactions will likely help the company maintain revenue growth.

Analyst expectations are quite beneficial

I took a look at the figures reported by other financial analysts. They expect OrganiGram to trade at about 9x 2024 EBITDA and 1.34x 2024 Revenue. Please note that sales in 2024 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 is also worth noting that the EBITDA margin will probably 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 opinion, if the results are as expected by market analysts, the share price is likely to trend lower.

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Source: Marketscreener.com

Source: Marketscreener.com

Balance sheet

As of May 31, 2022, the administration reported C$127 million in cash, C$250.4 million in property, plant and equipment and C$583 million in total assets. With an asset/liability ratio of over 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)

With respect to the total amount of liabilities, OrganiGram reports derivative liabilities of CAD 8.2 million and a current portion of long-term debt of CAD 0.08 million. I think more investors may be interested in OrganiGram once they find out 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 initiatives in the vaping industry and partnerships could push the shares up to $1.77 per share

In my best case scenario, OrganiGram’s new strains will successfully differentiate themselves from the competition. For example, I assumed that Edison Kush Cakes and Edison Frozen Lemons, released in 2022, will likely receive consumer demand. As a result, sales growth will most likely trend north.

Completion of these initiatives is expected to boost Edison’s sales, which have a higher ASP than value brands and therefore attract higher margins. In March 2022, the company released two new varieties: Edison Kush Cakes and Edison Frozen Lemons. To address the 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 sets Big Bag O’ Buds apart in the value segment and brings the SKUs on the market to five. Font: OrganiGram Holdings Inc. – MDA

Furthermore, if the company’s vaping strategy is also successful and new initiatives become a catalyst for revenue generation, profit and loss may improve. In this regard, let’s keep in mind that the management is preparing new products for the rest of 2022.

OrganiGram has renewed its focus on building share within the vape category through unique formulations, premium hardware, and high-quality consumables. For the remainder of fiscal 2022, the Company intends to introduce numerous innovative offerings in the vape segment, all geared towards increasing our share of this category. Source: OrganiGram Holdings Inc. – MDA

In my opinion, management may also receive significant demand for shares if further partner deals are announced. In this sense, let us highlight the investment with a subsidiary of BAT, a consumer goods company, established in 1902. In my opinion, the knowledge accumulated in the consumer industry and research on cannabis could enhance the generation of new products:

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

OrganiGram and BAT have agreed to jointly develop cannabis vapor products, oral cannabis products, and any other products, intellectual property, or technology that the parties mutually agree to develop. Font: OrganiGram and BAT form collaboration for product development

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

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If we also assume moderate 2030 EV/EBITDA of 10x, the exit valuation would be $812 million. We would be talking about free cash flow close to $7 million in 2024 and $22 million in 2030. The amount of future free cash flow discounted at 6.7% would be close to $468 million. Finally, if we include a net debt close to -$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 earnings growth could lead to a fair price of $0.65 per share

Taking very pessimistic assumptions into account, I’d say regulators could significantly hurt OrganiGram’s profit and loss. 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 required to sell cannabis, revenue growth may be lower than expected. Under these conditions, OrganiGram may see a decrease in its fair price.

OrganiGram’s finances may also be affected by increases in the price of equipment, labor and raw materials needed to grow cannabis. In this sense, the recent rise in inflation may push wages and electricity prices higher than expected. If OrganiGram is unable to increase the price of its products, inflation would affect the company’s EBITDA margins. In addition, a disruption or decrease in the supply of raw materials can also stop production, which would most likely lower revenue growth.

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Finally, in my opinion, in the future, management will probably not report the same level of sales growth reported in the past. Construction of new facilities may not be as fast as in the past. With this in mind, if sales growth declines faster than expected, some investors may decide to sell their shares, which would increase the company’s cost of capital. As a result, I’d say OrganiGram’s stock price would go down.

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

Using an exit multiple of 7.8x, I got an exit valuation of around $225 million, implying an enterprise value of around $113 million. The equity valuation would be equal to $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 plenty of cash on hand, in my opinion, company acquisitions and new product development are likely to serve as revenue catalysts. Taking into account other analysts’ expectations, moderate EBITDA margin and FCF margin, future free cash flow would imply a valuation of around $1.7 per share. I also see risks from increased regulation, inflation and supply chain disruptions. However, the downside risk in the share price looks small.

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