Hexo Corp (NYSE:HEXO) has been on a sustained downtrend in the last few months. HEXO stock has declined from $8.28 towards to end of April 2019 to current levels of $3.99.
Of course, Hexo Corp has not been an exception among pot stocks. The entire basket of stocks in the cannabis industry has sharply turned lower in the last few months.
The downside has been triggered by industry level concerns and I don’t see a sharp reversal in industry sentiment coming in the immediate future.
However, there are bound to be pockets of trading and investing opportunities. I believe that Hexo stock is oversold in the near term and fresh exposure to the stock can be considered.
At the same time, I am of the opinion that a big plunge in the industry can be avoided until there are growth triggers beyond the research reports that talk about potential industry growth.
The Industry Concerns
Growing inventory of dried cannabis is a primary concern for the industry as whole as it is likely to put pressure on selling price and margins. According to data from the Canadian Government, the total inventory of dried cannabis has surged from 96,822 kg in October 2018 to 224,037 kg in May 2019. The build-up of dry cannabis inventory has significantly outpaced the growth in sales for the same period. Clearly, this is a worry for producers who are still ramping-up production.
Hexo, among other listed players, is very bullish on the application of cannabis in the medical industry. However, government data again suggests that growth in the medical industry has been relatively muted.
Sale of dried cannabis for medical purpose was 1,941Kg in October 2018 and has declined to 1,698Kg in May 2019. Even the sale of cannabis oil for medical purpose has been steady rather than trending higher. Of course, it would be unreasonable to expect ballistic growth, but that’s how pot stock prices were moving. As reality sinks in, the stocks are adjusting on the downside.
Another concern for the industry is regulatory approvals. According to New Frontier Data, the global market for cannabis is estimated at over $340 billion. While this sounds attractive, the market size can translate into numbers only after respective government approvals. This regulatory hurdle is a headwind and impacts the growth visibility.
The overall point being stocks in the cannabis industry discounted the market potential, but it seems increasing likely that growth will be relatively muted. As valuations adjust on the downside, there will be buying opportunities. Hexo Corp, at current levels, presents one such opportunity.
Positive Triggers For Hexo Stock
There have been positive business developments for Hexo Corp even as industry concerns dominate stock trend.
In June, Hexo Med, which is an affiliate of Hexo, received medical cannabis license in Europe (Greece). This will allow the company to establish a cultivation, processing and manufacturing facility in Greece. It’s a first step towards creating a wider geographical presence.
I would stress on the point that this does not immediately translate into a revenue and EBITDA growth trigger. However, with medical products becoming legal in countries like Germany, UK, Italy and Netherlands, the company can make inroads into several other markets. Tilray (NASDAQ:TLRY) expects the European Union to become the largest medical cannabis market in the world. If this holds true, there is immense growth visibility in the next 5-10 years.
The acquisition of Newstrikes also allows Hexo Corp ramp-up in production capacity. In addition, the combined entity will have distribution agreements in 8 provinces within Canada. Inorganic growth will also support the company’s target to increase revenue to $400 million by 2020.
Another business segment that is worth discussing is the use of cannabis in edibles and beverages. Hexo Corp has formed a joint venture with Molson for non-alcoholic cannabis infused beverage. There are plans to introduce other edibles in the market.
I view this from a margin expansion perspective. Typically, medical products, edibles and beverages will garner higher EBITDA margin. As the market for these products grows, Hexo Corp is likely to witness margin and cash flow growth. Molson serves as a good joint venture partner with the company having an international distribution network in US, UK and Mexico, among others.
Concluding Words on Hexo Stock
Hexo Corp is building a strong foundation with production ramp-up, innovation and focus on high margin products.
I believe that the correction is therefore a good opportunity to accumulate. Since regulatory hurdles can delay entry into potential markets and impact growth, I would still be cautious and consider small exposure than a big plunge.
Disclosure: None.
