Smarter Team

About the Author Smarter Team

Smarter Analyst was established to fill a gap in financial reporting for sell-side investors, where they can read exclusive reports in real time. Smarter Analyst provides coverage of equities research, unique analyst insights, and outstanding articles from knowledgeable contributors, in addition to the latest stock market news, all hand-picked by our editors.

A Tale of 3 Cannabis Stocks – 2 to Avoid, and 1 to Buy


Public opinion on cannabis is changing quickly, growing ever more lenient. In a short span, less than a lifetime, we’ve seen a series of decriminalization and partial legalization regimes take hold in the US. While the drug remains fully illegal at the Federal level, it is fully legal in 11 states and legalized for medical use in another 15. The result of this patchwork is that Canada, which enacted full legalization nationwide in October 2018, has become the center of North America’s cannabis industry.

Most of the large cannabis companies – the growers and suppliers – are based in Canada. US-based companies face the twin handicap of not being able to operate in the whole country as well as not being able to transport their product across state lines, even when the states involved have legalization regimes. It makes a confusing picture for the financial analysts and stock investors.

That doesn’t mean you can’t get resolution from studying the field. There are advantageous investments in the cannabis industry, but potential investors may have to look a bit harder to find them.

Seaport Global analyst Brett Hundley has taken a deep dive into three cannabis names that have lately been making waves in the sector. The companies include the largest player in the cannabis industry, a mid-sized producer that may or may not be able to live up to its hype, and a small-cap distributor that could be entering its death-throes.

A look at the analyst consensus ratings on these stocks show that Wall Street is watching them with a cautious eye. Yet, Hundley believes that one of the trio presents a buying opportunity. Let’s take a closer look:

Hexo Corporation (HEXO)

Hexo made a big splash in the Canadian cannabis sector. The company quickly grew to be one of the country’s biggest producers, setting up some 2 million square feet of grow facilities in Ontario and Quebec. The company markets several brands and a full line-up of products for the medical and recreational sectors across Canada.

Like MedMen, however, Hexo ran too far and too fast. The company posts regular EPS losses, and in calendar Q3 missed the forecast by 120%. Analysts had expected a 5-cent per share loss – but the net loss per share came in at 11 cents. It was the latest in a long line of bad news for HEXO, news that has pushed the stock value down by 72% since peaking at the end of April.

A closer look at those recent quarterly results sheds more light on what’s wrong with HEXO. Early in October, the company announced that it would be delaying the Q3 report (the company’s fiscal Q4) to the end of the month, and withdrew its 2020 guidance. Shares predictably fell, and industry watchers were understandably nervous. At the end of the month, HEXO reported revenue of C$15.4 million on sales of 4,009 kilograms of cannabis products.

First, the good news. The top line was up 18% sequentially, and a whopping 1000% year-over-year. Sales volume was up 45%. Gross margins, at 45%, were acceptable, and an increase in operating expenses went along with an increase in the size and scope of company operations. But investors just can’t get over that dramatic rise in EPS loss, or the reduction in 2020 guidance. And like MedMen, Hexo has been laying off workers – the company cut 200 positions this past fall.

Hundley very clearly laid out the warning factors in HEXO: “We note that many of the company’s opex improvements weren’t made until late in October, pushing full benefits into later quarters. As well, we are mindful of potential margin pressures from the fact that HEXO may not see 2.0 benefits until its national rollout towards summer of 2020. Quebec recently announced a decision to ban cannabis vapes from its market; this is disappointing for HEXO…” Hundley gives this stock a Hold rating, and declines to set a definite price target.

Wall Street’s view of HEXO is similar to Hundley’s. The stock has a Hold from the analyst consensus, based on 13 ratings, including 8 Holds and 3 Sells, but only 2 Buys. Shares have slipped from over $8 earlier this year to just $2.29 now. The average price target of $3.23 implies an upside of 41%, however – a reminder that the potential for risk and usually includes a potential for reward. (See Hexo’s stock analysis on TipRanks)

Canopy Growth (CGC)

And now we get to the giant of the cannabis industry. With a market cap exceeding $7 billion, Canopy is by far the largest company in this sector. Canopy’s size extends to market share and production capabilities, too – simply put, this company dominates Canada’s legal marijuana markets.

So why isn’t it turning a profit? Canopy received a $4 billion payday in 2H18, when beer giant Constellation Brands bought a 35% stake in the company, and the conventional wisdom then was that Canopy was well-positioned for ‘cannabis 2.0,’ the expansion of Canada’s legal market this December. With new lines of edibles, beverage, and vaping products entering the legal lists, a partnership with a beverage giant and its distribution network seemed like a no-brainer.

But Constellation’s $4 billion stake in CGC also came with control of the Board of Directors – and a desire to see the stake pay off. Constellation had no patience for steady EPS losses, and after two consecutive quarters of increasing losses, Canopy CEO and founder Bruce Linton found himself out of a job.

Since then, the company has had to deal with upper management churn as well as the known headwinds of Canada’s cannabis market: oversupply, regulatory bottlenecks, too-low retail prices. In the November quarterly report, for Q2 fiscal 2020, CGC reported yet another loss, this time of 82 cents per share. Revenues were up year-over-year, but missed the analyst forecasts.

In a piece of good news, Canopy will head into the New Year with some stability at the top. David Klein will take the CEO spot effective January 14. Klein is currently CFO of – you guessed it – Constellation Brands, so it appears that the beverage giant will be exerting greater control over Canopy in 2020.

Hundley, in his note on Canopy, points out that the appointment of Klein to the top spot should come as no surprise. Constellation dwarfs Canopy, and even though it only holds a one-third stake in the smaller company, this was no ‘merger of equals.’ Hundley expects that Klein will move quickly to reverse CGC’s losses, as Constellation wants to see a return on its $4 billion investment. Hundley writes, “We expect that Klein will move quickly to pursue profitability within Canopy, with an overriding focus on this metric. Canopy has burned $800MM in cumulative funds over the past two quarters, driving a cumulative adjusted EBITDA loss of almost $250MM. Our model assumes deep cuts to SG&A during FY2021, and we feel better about execution of such an occurrence, with Klein at the helm. We also anticipate substantial cuts to capital expenditures and business investment…”

As with HEXO above, Hundley declined to put a price target on Canopy and rates the stock a Hold. He wants to see what the new management will do, and how the company will execute as the cannabis beverage market begins to open.

Like Hundley, Wall Street is cautious on Canopy. Even though the consensus rating on the stock is a Moderate Buy, it’s based on a mix of 6 Buy ratings and 10 Holds. Adding to the warning flashers is the average price target, which at $20.60 suggests a 2% downside from the $20.38 current share price. Canopy brings plenty of advantages to the table, but the cannabis industry is still full of pitfalls. (See Canopy’s stock analysis on TipRanks)

MedMen Enterprises (MMNFF)

The weakest of our cannabis plays today is MedMen. Based in California, the most populous state in the Union and the country’s largest single legalized-cannabis market, MedMen has been in business since 2010. The company operates 32 dispensaries across six states: California, Nevada, Arizona, Illinois, New York, and Florida. MedMen produces much of its own product, in growing facilities that total well over 90,000 square feet.

Despite offering a wide range of cannabis products – edibles, vaporizers, concentrates, topicals, pre-rolled joints – for both the adult use and medical markets, MedMen has had difficulty gaining traction. For its Q1 2020, the company reported some good news – a 105% year-over-year revenue gain to $44 million, and gross margins of 52% – but the basic fact of a $22.2 million net loss overwhelmed that. Investors have limited patience for companies that bleed money, and MMNFF shares have been declining steadily throughout calendar year 2019.

MedMen may be able to survive the growing pains of a new industry in the process of both formation and legalization, but can it do so while downsizing? Last month, the company released plans to improve market share and cut expenses – but what cannabis industry watchers noticed most was that the plan also includes extensive layoffs. Over 190 employees are being cut in the name of efficiency and capital allocation, but behind the management spin is the simple fact the company expanded too fast and now is bigger than it can afford to be. The picture does not inspire confidence.

In his yesterday’s research note on MedMen, Hundley personifies the Wall Street view of this stock. He gives it a Buy rating, noting that the company has a strong brand presence and that management is willing to make hard decision, but his comments show the underlying caution: “It is clear that the company will need to cut its cost base further, while also generating a healthy amount of asset sale proceeds, if it wants to remain as a going concern… we believe that institutional investors have now mostly lost faith in the long-standing leadership of this business.” It’s not exactly a ringing endorsement.

Hundley’s $4 price target, implying a massive 925% upside, also is not a signal of earth-shaking potential here. Rather, it indicates that MedMen has fallen so far – the stock is down 86% this year – that at this point, there is really nowhere for it to go but up. (To watch Hundley’s track record, click here)

Check out these 5 ‘Strong Buy’ stocks that top Wall Street analysts recommend

Stay Ahead of Everyone Else

Get The Latest Stock News Alerts