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Cannabis Stock Hexo: The Cheapest Way to Invest in a Giant Market for Marijuana?

Canada has become the epicenter for a global marijuana market — but like the center of any circle, right now it looks like little more than a dot.

Despite aggressive predictions of explosive demand for cannabis upon Canadian legalization, the first three months of legal weed sales in Canada were underwhelming in the extreme — just $115 million sold, according to Canadian authorities, implying an annualized sales rate of perhaps $500 million or less. But just how big a marijuana plant might spring from this first small seed?

Undeterred by Canada’s initial, weak sales, Desjardins analyst John Chu makes some aggressive predictions of its own about how the marijuana market might evolve as it spreads its canopy out beyond Canadian borders. Globally, the analyst envisions a base scenario of perhaps $230 billion to $270 billion in annual sales. Recreational marijuana sales, in Desjardin’s view, could account for $110 billion to $150 billion of this market. Medical marijuana sales would add perhaps $90 billion, and the balance of the market would comprise sales of “edibles, beverages, cosmetics, health and wellness products, pet care.”

What’s more, as the drug becomes more and more accepted, and perhaps reaches adoption rates similar to global tobacco use for example (30% of the world’s population) or even alcohol use (50%), Chu argues there’s a case to be made for the marijuana market to grow to $350 billion or even $500 billion in annual sales.

That’s a pretty sizeable crop to grow from the small seed planted in Ottawa last year.

Now… what’s the cheapest way to invest in it?

Surveying three key cannabis players through the lens of its internally developed, 24-point analysis of each company’s strengths and weaknesses, and scoring each company 0 to 5 points in each category analyzed, Chu thinks there’s a case to be made for investing in Gatineau, Quebec-based Hexo Corp (HEXO)

Hexo may not be the strongest player in the Canadian cannabis market. Actually, larger Aurora Cannabis (ACB) and Canopy Growth (CGC) both score much better than Hexo in most categories examined). Still, Chu finds Hexo performing well in recreational pot (5 points out of 5 possible), in management quality (4 out of 5), winning awards (4 points), product innovation (5), securing provincial supply agreements (4) and doing so in volume (5), and in innovation (5).

Chu also likes the company’s joint venture agreement with Molson Coors to create a “portfolio of cannabis-infused beverages” for sale, and notes that this deal, along with the company’s having secured “the single largest supply deal with any province (Québec),” have catapulted Hexo into the “elite ranks” of Canadian cannabis companies.

Objectively speaking, of course, Chu has to give Hexo a subpar score of 55 points out of 120 possible. But we haven’t yet addressed the real selling point in Hexo’s favor: Price.

Valuations on most Canadian cannabis companies within Chu’s field of coverage, the analyst notes, “are pretty crazy right now,” with investors paying an average of 39 times fiscal year 2020 estimated earnings before interest, taxes, depreciation, and amortization (EBITDA) in order to ride the marijuana wave. In that context, and despite Desjardin’s quality concerns, Hexo’s valuation of just “21x FY20 EV/EBITDA” looks like a relative bargain — about half the going rate for marijuana stocks.

This, in the end, is why Hexo earns Chu’s endorsement of a “buy” rating and a C$14 price target.

To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.


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