Cannabis Bulls Should Consider HEXO Stock … Eventually

This year has been the best of times and the worst of times for Hexo (NYSE:HEXO). The HEXO stock price is up 31% so far this year after a huge rally in the first four months of 2019. From late April highs, however, Hexo Corp stock has dropped some 48%.

Cannabis Bulls Should Consider HEXO Stock ... Eventually

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And it’s still dropping, with a 5% decline for Wednesday’s close. With that, HEXO’s chart looks like a classic falling knife. Additionally, fundamental concerns exist as well.

Indeed, it looks like Hexo Corp stock simply ran too far. As I wrote in May, HEXO stock was the ‘it’ stock in cannabis at the start of the year. The story hadn’t received the same coverage as larger plays like Canopy Growth (NYSE:CGC) or Tilray (NASDAQ:TLRY). For savvy investors who saw those stocks as overvalued — or traders who saw them as too crowded — HEXO was an attractive alternative.

The story at this point is much more widely known. And the problem for HEXO now is that the story isn’t quite good enough, at least from a near-term standpoint.

That could change — and at some point likely will. But in the meantime, with an ugly chart and sector sentiment muted at best, there’s no reason for investors to try and time the bottom just yet.

Did Hexo Corp Stock Run Too Far?

There are several factors that have contributed to the decline in HEXO stock over the last three months. The first seems to be that the equity simply ran too far. At late April highs, shares had risen 140% from its year-end 2018 close.

A rally of some kind admittedly made sense. HEXO was left out of the fun in cannabis stocks in 2018, gaining just 5%. Investors liked the company’s plan to acquire Newstrike Brands, in what David Moadel has called a “game-changing expansion.”

The company’s focus on edibles — it plans to become the “premier branded ‘ingredients for food’ cannabis company,” as Hexo somewhat clumsily termed it — limits exposure to concern about oversupply and pricing pressure in flower.

Still, after those 140% gains, HEXO stock quickly approached the nosebleed valuations of CGC and Cronos (NASDAQ:CRON). These are the companies that had billions of dollars in backing from Constellation Brands (NYSE:STZ,NYSE:STZ.B) and Altria (NYSE:MO), respectively.

That certainly seemed like a stretch. In other words, HEXO went from being under the radar to taking center stage on Wall Street. Once that shift played out, demand for Hexo Corp stock seemed to dry up.

Cannabis Names Plunge

Of course, the other issue is that pot stocks have struggled of late. CGC is down by roughly one-third since the beginning of May. CRON has dropped 40% since early March. TLRY, Aurora Cannabis (NYSE:ACB), and Aphria have similar profiles.

With the Canadian market’s slower-than-expected progress in part due to a regulatory backlog, growth expectations have come down. There’s still a very real question as to what recreational market will open next (and, no, it’s not going to be the U.S.). At least some investors in the sector are worried about valuations in the context of what appears to be a softer outlook for the industry.

After all, this quite clearly isn’t a case of investors backing away from risk (as was the case in the fourth quarter of last year). Indeed, dozens of growth stocks elsewhere in the market, notably in tech, are at all-time highs. Plus, they continue to post big gains.

Expectations for the sector — and for the Hexo stock price — simply ran too far. And Hexo didn’t help its cause by posting disappointing earnings in June. This included a sequential decline in sales (on lower pricing, no less). All told, the big pullback here makes some sense.

Don’t Write Off HEXO Stock Just Yet

With the ugly chart, I’m not recommending investors jump into HEXO yet. The stock is cheaper but not cheap. It’s always dangerous to try and time the bottom. That’s a lesson many investors in Hexo Corp stock already have learned.

That said, a cheaper price does help. The Newstrike deal still makes sense. Hexo is entering the medical market in Greece. It still has opportunities in edibles. And with a market cap now around $1 billion (pro forma for Newstrike; it’s still not clear exactly how many shares will be outstanding after the merger, which closed this month), HEXO could become an acquisition target itself down the line if it rights its ship.

Indeed, it’s possible, though it may take some time, that HEXO falls off investors’ radar again. At that point, it might be time for cannabis bulls to take advantage of the selloff.

As of this writing, Vince Martin has no positions in any securities mentioned.

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