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Tue, October 20 at 4:00PM ET

Why It’s Not Time to Buy Hexo Stock Yet

Hexo needs more consumers if its growth strategy is going to pay off

Hexo (NYSE:HEXO) may be a relatively unknown name for many American investors. HEXO stock just moved up to the New York Stock Exchange from a lower-tier listing last month. Unfortunately, investors haven’t given Hexo a warm welcome.

Why It's Not Time to Buy Hexo Stock Yet
Source: Shutterstock

While moving to the NYSE boosts Hexo’s credibility, as our Josh Enomoto pointed out, it hasn’t fixed the company’s other problems. Overall, HEXO stock has fallen about 40% since its spring peak, and is down more than 10% since moving up to a major stock exchange.

Honestly, that’s not a terrible performance, given the slump that pot stocks are in right now. But Hexo has some specific hangups that should make investors think twice before buying.

Hexo Management Seems Overly Optimistic

In Hexo’s latest earnings release, the company stated that it is on track to ramp up to C$400 million ($302 million) in revenues next year. This seems rather ambitious, as the company reported just C$16 million in gross revenues this quarter, suggesting annual sales are running around C$60-C$70 million. It’s a huge jump to try to grow revenues something like six or seven fold in just one year.

The last quarterly results were not especially positive either. If you’re a HEXO stock bull, it’s tempting to look at production and see a favorable trend. Hexo’s production soared from 4,938 to 9,804 dried kilos between the quarter endings Jan. 31 and the quarter which ended in April.

However, despite doubling production, sales barely budged. Hexo’s recreational sales grew from 2,537 kilos to 2,759 kilos, a roughly 10% move. Meanwhile, medicinal kilos sold dropped from an already low 152 kilos down to 145. Notably, the price per gram for recreational marijuana dropped sharply. It fell from C$5.83 to C$5.29 over the latest quarter. As a result, the company managed little revenue growth.

Canadian Marijuana Simply Isn’t a Fast-Growing Market

In my recent article discussing Canopy Growth (NYSE:CGC), I offered a detailed look at the latest marijuana supply and sales data from the Canadian government. It’s not a pretty picture.

Since marijuana was legalized last fall, the amount of finished and in-progress inventories has more than doubled. Meanwhile, monthly sales volumes are only up by roughly half. Suppliers are flooding the market, but demand just isn’t there.

Companies like Hexo seem determined to increase their growth capacity as much as possible, regardless of whether the end market can absorb all the marijuana or not. This, unfortunately, has led to mounting losses across the industry. And Hexo may have another issue as it tries to figure out a way to increase demand.

Hexo Overly Aggressive Advertising?

Recently, well-known short selling research firm Friendly Bear took aim at Hexo. Friendly Bear suggested in their report that an anonymous source had tipped them off to the fact that Hexo advertises aggressively on Snapchat (NYSE:SNAP). Friendly Bear said that Hexo may be pushing the envelope in terms of what is permitted. That’s because Canada has extensive restrictions on marijuana advertising and strictly forbids anything aimed at minors.

The company responded, saying that it hasn’t been investigated by any regulators. It further notes that it hasn’t advertised on Snap’s platform in Quebec. Additionally, outside of Quebec, it relies on Snap’s age verification system to ensure that it doesn’t advertise to children. Friendly Bear, however, suggested that Snap’s age verification system is unreliable and thus Hexo could end up in hot water.

It’s a story worth watching if you own HEXO stock. So far, the stock has largely shrugged off the negative report. But if Health Canada or another agency gets involved, that could change in a hurry. If you doubt that, just look at what happened to CannTrust (NYSE:CTST) with its scandal recently. The marijuana industry remains new and is still figuring out its operational framework. At this point, management teams need to be extra careful to make sure they comply with all the regulatory structures in place.

HEXO Stock Verdict

It’s tempting to want to rush into all these marijuana stocks down here. The sector has certainly gotten battered in recent months. At some point, all these stocks will rip higher, and HEXO stock will take part in the rally. But it could have significantly farther to fall before things turn.

As far as Hexo goes in particular, there are specific reasons for caution. Let’s see how the advertising situation plays out, for example. More broadly, the questions around advertising speak to the demand shortfall. Hexo, and the other producers, are making way more marijuana. But demand simply hasn’t been there.

Look at Hexo’s last quarter; they produced nearly twice as much product, but sales barely budged. That might explain why Hexo’s former Chief Brand Officer, Adam Miron, just left the company. One thing’s for certain, Hexo needs to figure out to get a lot more sales and quickly. Otherwise they will miss next year’s expectations, and investors will sell the stock down even farther.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media,

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