After another new 52-week low, HEXO (HEXO) has become a perplexing stock that should benefit from some of the chaos in the Canadian cannabis sector that isn’t getting any benefit of the doubt. The market is selling most cannabis stocks regardless of valuations and forecasts providing the opportunity to build a solid position in the stock that uplisted to the NYSE in July.
Path Forward
HEXO hasn’t taken the path of massive cannabis cultivation growth like several other competitors in the Canadian market. Possibly the less promotional and aggressive nature of the management team is hurting the short-term stock price.
The company closed the Newstrike merger on May 28. The deal gives HEXO cultivation capacity of 150,000 kg for a company that generated only 9,800 kg of dried cannabis in FQ3. The plan increases quarterly cultivation to 37,500 kg.
In addition, HEXO has a massive supply of hemp lined up. The supply includes 200,000 kg of hemp for CBD in fiscal 2020 that starts next month. On top of this supply, the company has a second supplier providing 60,000 kg of hemp in the current quarters.
This huge supply will provide the company with the hemp needed for the legalization of edibles and concentrates in mid-December in Canada and a plan to enter eight U.S. states in 2020. Even smarter, HEXO is working with Valens for cannabis and hemp extraction of up to 50,000 kg next year.
The extraction agreement allows HEXO to smooth out the operating ramp-up to meet initial demand without having to have all of the facilities internally. Again, the company can focus on building the brand and sales and less on farming.
What To Watch
HEXO has now sold off to $4 following a weak market for cannabis stocks due in part to some management and legal issues in the sector. The market value is now below $1.1 billion for a company forecasting revenues of C$400 million in the upcoming fiscal year or the equivalent of $300 million.
Some question will exist on the revenue impact of the push back on the Cannabis 2.0. HEXO is focusing on gummies and premium vapes on top of the cannabis-infused beverages from the Truss Beverages joint venture with Molson Coors (TAP).
The Truss Beverages joint venture includes a 42.5% investment position from HEXO with Molson Coors owning the other 57.5%. These results won’t be consolidated in the quarterly and annual financials, but the business could become a large part of the investment thesis of the stock.
The near-term focus in the market will shift towards margins. HEXO hit 50% gross margins in the April quarter and Newstrike provides about C$10 million in annual synergies along with higher sales to cover corporate expenses.
Revenues are forecasted to double in the FQ4 quarter ending here at the end of July or somewhere around C$25 million.
Takeaway
The key investor takeaway is that HEXO is trading at the lows as the cannabis sector hits a lull. Investors need to remember that companies like HEXO are going to see revenues nearly double sequentially in each of the next couple of quarters. By next year, the company will look far different with sales forecasted to top C$100 million, up from only C$12 million in the last quarter.
One can’t predict when the pain ends for HEXO or any of the other cannabis stocks, but the stock appears set to outperform over the next year from the $4 levels.
Merrill Lynch analyst Christopher Carey has recently reiterated a Buy rating on HEXO stock with a $10 price target, which implies nearly 150% upside from current levels. (To watch Carey’s track record, click here)
Disclosure: No position.
