When MKM analyst Bill Kirk initiated coverage of Aurora Cannabis (ACB) with a “sell” rating yesterday, the company’s low cash reserves ($238 million) relative to debt levels ($486 million) were high on the analyst’s list of concerns.
Fortunately, this is not a problem that HEXO Corp (HEXO) has. Blessed with a balance sheet replete with cash ($129 million) and little debt ($23 million) to offset it, HEXO is one Canadian cannabis company where a lack of cash is not an immediate concern. Perhaps even more importantly, though, Kirk likes HEXO’s business model and the prospect for the company to quickly make the tradition to a sustainable business of providing cannabis for the THC edibles market.
As a result, Kirk initiates coverage on HEXO with a “buy” rating and C$12.00 price target, predicting about 130% gain for the Canadian marijuana stock in the next 12 months.
HEXO, as Kirk explains, “has the best chance of creating a defensible brand” of marijuana ingredients that its consumer products partners such as Molson Coors (with which HEXO operates a joint venture) can incorporate into their products. In addition to just beer, Kirk sees HEXO providing a key ingredient in other beverages, cosmetics, and food. In furtherance of this strategy, HEXO has trademarked the phrase “Powered by HEXO” to advertise its importance in its partners’ products.
By making its cooperation in the creation of a product both clear and desirable to consumers (think how important seeing “Intel Inside” used to be to your choice of buying a laptop), Kirk argues that HEXO will avoid becoming just another “commoditized” marijuana producer. It could even be invited by future partners to team up, and thereby gain “early access to some exciting [marijuana product] categories.”
This could soon become important if, as expected, Canada legalizes the sale of “cannabis edibles” in December — an event that Kirk describes as “Day One” of a new era for the marijuana industry. As he explains, HEXO is one half of a “two-horse field” angling to dominate the market for marijuana edibles. Giant Canopy Growth, partnered with Constellation Brands, is obviously the “horse” getting most of the attention today. But HEXO, partnered with Molson Coors, is the other half of the equation. The first company to get to market once edibles are permissible in Canada, argues Kirk, will have the best chance of building a “defensible moat” in the business.
This will become even more important as marijuana production capacity ramps up over time. “Compared to Canopy, Aurora, and Tilray,” you see, “HEXO has less growing” capacity — but that’s okay because simply cranking out “grams for the sake of grams” will become a losing proposition as supplies surge and marijuana prices fall. What’s most important is figuring out a way to get the most money out of the marijuana you sell — and in Kirk’s estimation, HEXO’s emphasis on building a brand, and making its product attractive to consumer goods partners, is the best way to do that.
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