Just a few hours from now, Canadian cannabis company Hexo Corp (HEXO) will report its fiscal Q3 2019 earnings, but not everyone’s willing to wait to hear the bad news. For example, Seaport analyst Brett Hundley went ahead and cut its price target on Hexo stock — by nearly half.
That’s right. In a note reiterating his “buy” rating on Hexo, Hundley cut his price target from $13 to just $8. On the plus side, at least he’s saying eight US dollars, and not their cheaper Canadian variant. But even so, Hexo’s new target cuts close to the $6.64 a share that Hexo costs today. (To watch Hundley’s track record, click here)
So what is it about Hexo that has Hundley souring on the stock?
Overemphasis on cannabis
Hexo’s products include dried cannabis flower, cannabis oil, and cannabis powder. But while this emphasis on cannabis may seem natural in a Canadian cannabis company, Hundley worries that Hexo may have made a bad bet in ignoring the virtues of hemp. In the analyst’s view, major consumer packaged goods companies (“Big CPG”) and pharmaceutical companies (“Big Pharma”) “have increasingly turned their attention away from marijuana towards hemp and biosynthesis.”
Pivoting to address this quirk in its potential partners, Hexo recently established a US subsidiary (HEXO USA) that will focus on developing “a presence in hemp-derived” cannabidiol, and has named a US-based chief financial officer to boot. Hundley hopes that these moves may help Hexo to win additional partnerships with Big CPG and Big Pharma firms, and the analyst says he still holds Hexo in “high regard,” and remains “positive on HEXO’s strategic plan to become a value-added ingredients supplier to the CPG and pharma sets.”
Nevertheless, Hundley is “disappointed in the company’s [in]ability to attract additional strategic partners to its hub and spoke model” to date — and as a result, believes his previous hopes for the company’s sales and earnings may turn out to be “too aggressive with assumptions around production, gross margin, and SG&A expense.”
(Canadian) dollars and cents
Putting numbers to his fears, Hundley roughly tripled his estimate of the amount of money Hexo will lose this year, to an earnings before interest, taxes, depreciation, and amortization (EBITDA) loss of C$33.5 million. Then, looking ahead to fiscal 2020, the analyst began cutting estimates. Next fiscal year, Hundley sees sales coming in 11% lighter than previously projected — C$406 million. He cut his EBITDA projection for Hexo’s FY2020 even more deeply, from more than C$133 million previously, to barely C$33 million today.
Proceeding down the timeline, Hundley then reduced his estimate for fiscal 2021 sales by 5%, to C$611 million, and said FY2021 EBITDA should be C$128 million — 36% less than the C $201 million previously posited. (Mercifully, 2021 seems to be about as far out as Hundley is forecasting).
So where does all this leave investors? According to Hundley’s estimates, Hexo now sells for about 27 times current year sales — which seems like a pretty steep price to pay. Granted, even after the estimate cuts, Hexo’s current market capitalization is only about 4.6 times the sales the analyst expects Hexo to rake in next year.
Then again, the more those sales estimates fall, the more expensive Hexo stock looks.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.