Ever since it reported quarterly results on June 13, HEXO (NYSE:HEXO) stock continued its downtrend. At a recent price of $4.23, the stock is getting close to falling below the symbolic $1 billion CAD ($750 million) market capitalization. Growing bearishness around cannabis stocks and the uncertainties around the company’s growth prospects are hurting HEXO stock. Then, last month, its key brand executive stepped down from the position. What will it take to get investors interested in the company again?
On July 18, Hexo’s co-founder and chief brand officer, Adam Miron, stepped down from his position. He will retain his seat on the Hexo Board of directors. Miron may have decided to leave the company because of regulator Health Canada slowing the pace of growth in the industry. Excessive regulations and slow decision-making took away the growth momentum for Hexo and the cannabis market in the last year. Sebastien St-Louis, Hexo’s co-founder, said just about what you’d expect: “I respect his decision to take on new challenges and focus on his true passion: building.”
The Hexo stock price is down more than 40% in the past three months, versus the near-25% decline in the cash-heavy exchange-traded fund AdvisorShares Pure Cannabis ETF (NYSEArca:YOLO). Hexo is the fifth-largest equities holding in the marijuana fund’s 28 constituents, at 4.72% of the portfolio. YOLO has a ~17% cash position.
New C’s in the C-suite
In its Q3 2019, Hexo added a new COO, Donald Courtney, who has notable experience at Pepsi Bottling Group, Mars, and as head of MedReleaf. Michael Monahan joined the company as its new CFO. His chief responsibility is driving Hexo’s global strategy. By expanding outside of the U.S., the company will have less geographic risks and a bigger addressable market. As more countries legalize cannabis, Hexo’s addressable market will expand. These additional executive members will lead the 25 PhDs that the company has on staff.
Last quarter, Hexo secured around 200,000 kilograms of hemp supply for CBD and non-THC cannabinoid extraction for fiscal 2020. It has a secondary supply agreement of around 60,000 kilograms of hemp that will be supplied in the next two quarters. Hexo is gearing up for upcoming demand in edibles and concentrates, pending legalization in October in Canada. It signed a multi-year extraction agreement with Valens. This will add 30,000 kilograms of output in the first year and 50,000 kilograms of cannabis and hemp biomass in the second year. Collectively, Hexo has a near-term target of having 150,000 kilograms of supply.
Greenhouse Helps Double Output
To date, Hexo sold over 7.5 million grams of adult-use medical cannabis to Canadians. In the last quarter, sales increased 9% to 2,700 adult-use grams and grams equivalent. As its distribution across the Great White North expands, expect sales from this segment growing.
Hexo produced ~9.8 tons of dried gram equivalent (9,800 kilograms). Output increased 98% sequentially after yields increased from its 250,000-square-foot B6 greenhouse. It also benefited from the first harvest at its 1-million-square-foot B9 greenhouse.
Looking ahead, the company is prepared for the legalization of edibles and concentrates in October 2019. But the big risk here is any Canadian regulatory delays. This would push Hexo’s phase two adult-use output into December. To mitigate these risks, the company is developing CBD gummies, a premium vape line, and cannabis-infused beverages in partnership with Truss, its joint venture with Molson Coors Canada that was announced in October 2018.
A drop in gross margins is a major risk for Hexo shareholders. Though the company reported a gross margin of 49% on net revenue, it expects price pressures ahead, as CEO St. Louis said on the recent conference call. “We do expect over the next 24 months as there is significant pricing compression that the flower might gradually gross margins towards the 40% level,” he told participants.
Despite the pricing compression, Hexo expects its introduction of more advanced products will push the gross margin back toward 50%.
Hexo Stock Valuation and Your Takeaway
Hexo will report quarterly results on Sept. 12 after the market closes. Two analysts who cover Hexo stock have a 125% upside target price (per TipRanks). Realistically, number-crunching a fair value on Hexo at this time is difficult (per finbox.io).
Forecasting its revenue is difficult without knowing when the Canadian government will finalize the regulations. Hexo forecast FY2020 revenue of over $400 million CAD, which is multiples bigger than its $15.9 million CAD ($63.9 million CAD annualized) reported in the third quarter.
Investors are taking a wait and see approach. As stocks like Tilray (NASDAQ:TLRY) or CannTrust (NASDAQ:CTST) fall, investors want more proof that revenue growth is sustainable and profits are achievable. HEXO stock investors need the market warming up to cannabis stocks again. It must also meet its revenue projections to win back investors.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.