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OGI

Wall Street Has This Pot Stock All Wrong

No matter how you slice the data, marijuana is expected to be one of the fastest-growing industries over the next decade. Global weed sales have already tripled between 2014 and 2018 and are expected to grow fourfold between 2018 and 2024. The sky really does seem to be the limit for an industry with plenty of demand, but also a lot of black-market activity.

Canada legalized recreational marijuana sales in 2018 and two-thirds of all U.S. states allow medical marijuana prescriptions, so the stage is set for cannabis stocks to thrive -- and Wall Street knows it.

Although consensus estimates for sales and profitability have varied wildly, which we'd expect from an industry with no legal precedent, Wall Street has been pretty consistent with its bullishness. This is to say that many of the brand-name pot stocks -- e.g., Canopy Growth and Aurora Cannabis -- are rated as the equivalent of a buy.

However, one pot stock last week wasn't initiated with the green flag waving.

A cannabis leaf lying atop a neat stack of one hundred dollar bills.

Image source: Getty Images.

OrganiGram Holdings stuck in neutral?

Last Thursday, covering analyst Rupesh Parikh at Oppenheimer initiated coverage on Atlantic-based grower OrganiGram Holdings (NASDAQ: OGI) with a perform rating (this is the equivalent of a hold). Oppenheimer didn't assign a price target, which simply implies that the company is expected to perform in line with the S&P 500 over the next 12 to 18 months.

In a released research note detailing the rating, Parikh points out that OrganiGram has executed well and has even generated positive earnings before interest, taxes, depreciation, and amortization (EBITDA). "Early success in the Canadian market coupled with above-peer financial delivery gives us confidence in the company's ability to further ramp-up from here," said Parikh.

But Oppenheimer's covering analyst also noted that OrganiGram was liable to face numerous near-term headwinds. Parikh and his team are particularly worried about the upcoming launch of vape products in Canada by mid-December, considering the negative recent health findings associated with vaping.

As of Monday, Sept. 9, more than 450 cases of vaping-related lung illnesses have been reported in the United States, with some reports suggesting that tetrahydrocannabinol (THC) being used in electronic vaping devices may be the culprit. Though this is pure hearsay at the moment, it has people -- and investors -- talking. 

An up-close view of a flowering cannabis plant growing indoors.

Image source: Getty Images.

Wall Street has this outperformer all wrong

However, the thing to remember about Wall Street analysts is that they're just as fallible as retail investors. Despite numerous near-term "headwinds," this is a pot stock that Oppenheimer has all wrong. If there's a major cannabis grower worthy of a buy rating, it's OrganiGram Holdings.

The way I see it, there are three factors that allow OrganiGram to stand out.

First, OrganiGram offers geographic advantages. It's the only major marijuana grower located in Canada's eastern provinces, with its sole growing facility in Moncton, New Brunswick. Though eastern Canada is home to lesser-populated provinces, surveys have shown them to be regions with higher cannabis-use rates. OrganiGram should have little trouble establishing its brands in these high-use-rate provinces while also leaning on the fact that it's one of only four pot growers to have supply deals in place with all of Canada's provinces.

Secondly, this is one of the most efficient weed growers throughout Canada. Despite the lone facility in Moncton, OrganiGram aims to produce 113,000 kilos of peak annual output utilizing less than 500,000 square feet of cultivation space. By implementing a three-tiered grower system, the company should be able to yield about 230 grams per square foot, which appears to be well above the 75 grams per square foot to 125 grams per square foot that most of its competition will yield. These impressive yields should equate to below-average production costs and higher margins.

Third and finally, as alluded to by Parikh, OrganiGram is light-years ahead of its peers on an operating basis. In the company's fiscal third-quarter report, released in July, OrganiGram generated 24.75 million Canadian dollars in net sales and a gross margin of CA$12.28 million. If we were to exclude all (and I do mean all) one-time benefits and fair-value adjustments, and simply subtract the company's operating expenses of CA$11.11 million, OrganiGram would have been operationally profitable in the third quarter. Very few other cannabis growers can say they're operationally profitable right now.

A cannabis leaf laid within the outline of the Canadian flag's red maple leaf, with rolled joints and a cannabis bud to the left of the flag.

Image source: Getty Images.

The biggest issue Oppenheimer may have overlooked

While I feel that OrganiGram is one the few growers that should have a buy rating on Wall Street, there's one reason the company and entire industry could struggle. And it's not something that Parikh goes into detail about in his firm's coverage note.

The biggest factor working against cannabis stocks right now is that the industry needs time to mature, as evidenced by early-stage supply problems. Since recreational pot sales launched on Oct. 17, it's been virtually impossible for supply to keep up with demand. Licensing backlogs at Health Canada, coupled with cannabis store licensing delays in select provinces and compliant-packaging shortages, have all played a role in reducing near-term expectations for the marijuana industry.

Although the launch of high-margin derivative products is expected to be a major driver for the pot industry in December, it's unlikely that the solutions being implemented to fix supply issues prevalent throughout the country will be resolved by then. This means derivative products, including vapes, beverages, and edibles, could face many of the same headache-causing supply concerns that dried flower experienced when it was legalized for sale in October 2018.

This is the one viable reason to tone down near-term expectations for OrganiGram. But aside from this, OrganiGram looks superior in many ways to its peers, thus making it worthy of a buy rating.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends OrganiGram Holdings. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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