When a stock declines by a considerable percentage over a short period of time, some investors may see value. The value proposition is, in some investors’ eyes, only enhanced by a low price tag. However, those traits are often more hallmarks of value traps than characteristics of legitimate value.
Such is the plight of Hexo (NYSE:HEXO) stock. While the shares traded somewhat sideways in August, losing just 1.23% compared to 11.12% for the ETFMG Alternative Harvest ETF (NYSEARCA:MJ), Hexo stock is still off 36% in the third quarter and labors 52.14% below its 52-week high. Even with all that, the cannabis company still isn’t a value play. Not yet anyway.
What makes Hexo stock risky over the near-term, particularly for those perceiving value here, is that there’s actually a lot to like with this name. Hexo has enviable partnerships and a compelling business model that, for the most part, executes well on. However, the broader cannabis investment space is largely out of favor with investors at the moment — a significant headwind for Hexo stock.
In other words, Hexo may not be the cause of the disease (it’s not), but it’s not the cure, either. Broader weakness in the cannabis space only adds to Hexo’s “falling knife” status.
Some Rays of Light
One longer-ranging factor in favor of Hexo stock is that the company, unlike so many of its cannabis rivals, isn’t carrying goodwill on its balance sheet. Analysts and investors usually tolerate goodwill until it becomes a problem.
Goodwill isn’t a tangible asset. It’s considered intangible related to a purchase of something intangible in which the buyer likely overpaid, betting that the acquired business would eventually deliver growth that made overpaying for it a good deal. The problem with this strategy is that it doesn’t always work out and it leads to companies taking charges or impairments on that good will.
That’s when Wall Street gets frustrated. The scenario isn’t unusual, but it’s usually something that if investors tolerate, they do so with larger, profitable companies with strong balance sheets, descriptors that are hard to come by in the cannabis arena. Hexo remains among the denizens of money-losing marijuana firms and while that’s not a positive, it is good news that the company isn’t carrying mountains of goodwill.
Another area of strength for the company, and one that could be a long-term driver for Hexo stock, is its logistical superiority. The company has an array of strategically situated distribution hubs that can cement forays into important markets while keeping costs to a minimum. It’s possible that competitors will encroach on this model and adopt it for themselves, but Hexo has mostly mastered it ahead of its rivals.
Additionally, Hexo is growing revenue at an impressive rate and the recent Newstrike acquisition gives the company important scale. The rub is that with rising revenue and solid scale come increasing analyst and investor demands for profitability.
Bottom Line on Hexo Stock: Wait It Out
In the current environment, Hexo stock is being hit with a triple whammy: cannabis, growth and small-cap stocks being out of favor and yes, Hexo is a small-cap growth name. Add to that, Hexo stock trades for 41.15x forward earnings, compared to about 21x on the S&P SmallCap 600 Growth Index (INDEXSP:SP600G). That gets us back to Hexo stock not being cheap by any stretch.
The other issue for Hexo stock is that it closed around $4 at the end of August, but the average analyst price target is $7.20, meaning that forecast needs to be revised lower or that stock needs to start moving higher. It’s likely the former happens before the latter.
For risk-tolerant investors who just can’t resist the allure of Hexo stock, let it stay around $4 for a few weeks before jumping.
Todd Shriber does not own any of the aforementioned securities.
