Should Long-Term Investors Buy Hexo Stock Ahead of Earnings?

HEXO stock is likely to move higher in the last quarter of 2019

Quebec-based Hexo (NYSE:HEXO) is due to report earnings on Sept 12. In Canada, pot edibles and beverages will become legal on Oct 17, one year from the original legalization of cannabis in the country. Industry watchers are referring to this new era in Canadian pot markets as “Legalization 2.0.” So what does that mean for HEXO stock?

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Around this time last year, Canadian cannabis stocks had started rallying in anticipation of the nationwide adult-use legalization. Therefore, the hype surrounding the launch of pot drinks in Canada is likely to give a bit of fizz to HEXO stock, too.

In 2019, most cannabis stocks have been extremely volatile. And cannabis companies have lost significant value since October 2018. Summer months saw a further correction in marijuana stocks. And the share price of many of these stock, including Hexo, have come down to more attractive levels. Now that the earnings season is upon us, let’s look at what may be next for the HEXO stock price.

What to Expect From Hexo Stock’s Earnings

Hexo produces, markets, and sells cannabis in Canada. It is a leading supplier to Quebec’s retail outlets. The group serves the adult-use market under the HEXO brand, while it serves its medical cannabis clients through the Hydropothecary brand.

In June, HEXO stock reported subdued Q3 fiscal 2019 earnings results. Total net sales came in at CAD $13 million. Over 90% of Hexo’s cannabis sales during Q3 were tied to the adult recreational market.

When Hexo stock reports Q4 earnings, investors are likely to look at the company’s revenue mix. In the last quarter, over 80% of total sales came from dried flower. In recent months, the price of dried flower has been decreasing and consumers are not brand loyal. If this trend continues, investors may decide that HEXO stock is overvalued.

Most pot stocks are burning through loads of cash and losing money as if there is no tomorrow. Cash flows are far from predictable. In Q3, Hexo posted a CAD $2.22 million loss from operations. In the upcoming earnings report, Wall Street will likely pay attention to Hexo stock’s cash flow.

It is important to remember that weed is an agricultural commodity. In late 2018, during the early weeks following legalization, Canadians spent about $40 million on legal weed. However, since then sales haven’t really held up. Instead the figures have come in much less robust than initially anticipated.

In other words, there are possibly too many players in Canada, a relatively small market. Annual Canadian sales are not likely to exceed $4 billion. The black market is still thriving in Canada.

No one knows when (or if) federal legalization will happen in the U.S. And other international sales outside these two countries are not big enough to act as a substantial catalyst for the share price of Hexo as well as other pot stocks.

Could consolidation be a way forward most of these cannabis producers like Hexo stock?

Hexo Stock Has an Important Partnership

New products are not expected to hit shelves till Dec 16 as license holders will have to give Health Canada 60 days notice if they intend to sell them. And Hexo may become one of the first companies to capitalize on this development.

On Aug 1, 2018, Hexo and Colorado-based Molson Coors (NYSE:TAP) announced a joint venture (JV), called Truss. As the company that makes Coors beer, Molson Coors is the third largest brewer globally with a market cap of about $12 billion.

Truss is a stand-alone entity with an independent management team. Molson Coors owns a controlling 57.5% interest in the JV. Hexo owns the remaining 42.5%. The new JV is currently developing a range of non-alcoholic cannabis drinks to be marketed in Canada as of mid-December.

Upcoming Canadian regulations will strictly limit what types of consumables can be produced and marketed. For example, manufacturers cannot legally combine pot and alcohol in products. In labeling, companies cannot use alcohol-related terminology, such as “chardonnay” or “IPA” either.

Hexo management has recently said that the company will “have a very large supply… [and] be able to meet the demand of the marketplace.” Truss is also likely to sell CBD-infused drinks in the U.S. as of 2020.

The upcoming rollout of edibles and drinks is likely to help expand margins of Hexo stock. Prior to the JV announcement in Aug. 2018, Hexo share price was hovering around $3. Therefore, I expect this price level to act as support for HEXO stock in the months to come.

So Should Investors Buy Hexo Stock in September?

I am expecting an up leg in most of the cannabis stocks this fall as investors get ready for Legalization 2.0 in Canada. In fact, most pot stocks have started September on a high note. For example, on Aug 27, Hexo stock saw an intraday-low of $3.71. And yesterday, it hit an intraday-high of $4.75.

Therefore, Hexo shares may initially rally further around the earnings report. And a potential investor could miss out on some profits for not having bought into the HEXO shares prior to the earnings.

If you are considering investing in Hexo, you may want to start building a position between the $4-$4.5 levels, and expect to hold the stock for several years.

$5 level would be likely to act as strong resistance. Only after the stock is able to push through and stay above $5 can Hexo shareholders begin to relax for the longer-term prospects.

If you already own Hexo shares, you may also consider hedging your position with at-the-money (ATM) covered calls. Such a hedge would not only enable you to participate in an up move but also provide some downside protection. HEXO stock price is currently $4.40 and a Oct 18 expiry $4.50 strike call would sell for 40 cents.

However, in the long run, I am of the camp that the rich valuations in this commodity-based consumer market may continue take a hit in the coming months, especially after the hype of Legalization 2.0 ends. In addition, the longer-term technical charts, especially the trend lines and support and resistance levels in most pot stocks, including Hexo, are telling investors to exercise caution.

As of this writing, Tezcan Gecgil holds covered call in TAP stock (Sep 16 expiry).


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