With HEXO Corp. (NYSE:HEXO) firmly below the key $1 billion market capitalization, investors are at a loss on what to do next. Although HEXO stock is holding the $4 support line, its earnings report, expected in late October, might prove to be a turning point.
Ahead of the report, MKM Partners initiated coverage on a few cannabis companies last Friday, Sept. 20. It gave HEXO stock a buy rating, which sent the stock up that day. Howver, to get an idea on what to expect from HEXO’s upcoming report, investors should look at the Q3 2019 report posted in June.
Investors are Tired of Waiting
Hexo reported revenue growth of 944%, albeit at $9.76 million. Analysts expected $1 million but at this level, the absolute figures should not matter much. Hexo’s vision of becoming a top-three global cannabis company is a secondary point. Cannabis stocks are simply out of favor.
Since peaking in May, stocks like Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB) are in a sustained downtrend. Investors have grown tired of waiting for profits to come. But that is the nature of a nascent industry that needs the big players to spend heavily on operating expenses. And while these companies continue to grow revenue at a blistering pace, the profits never seem to come.
Why is Hexo stock different from all other cannabis companies, if at all?
Hexo outlined three pillars that will deliver on its goal in becoming a top-three global cannabis firm, specifically, according to management’s conference call comments: operational stability; product innovation; and, brand leadership. It invested in a strong team of scientists, chemists, and those with industry experience working at Kellogg’s (NYSE:K) or Coca Cola (NYSE:KO). With 25 PhDs on staff, the R&D department is developing innovative products. To leverage its expertise, Hexo is partnered with Fortune 500 companies.
The company secured around 200,000 kilograms of hemp supply for CBD and non-THC cannabinoid extraction for the fiscal 2020 year. It has a secondary supply agreement that adds 60,000 kilograms of hemp. The risk here is similar to that faced by other cannabis firms: it is waiting for the second stage of legalization in October in Canada — the production and sale of edible cannabis, cannabis extracts and cannabis topicals. Its strategy also relies on cannabis legalization in eight U.S. states in 2020.
New Lows for HEXO Stock Possible
At a recent price of $3.94, HEXO stock is down 53% from 52-week highs but is still up 30% from yearly lows. The increased selling pressure could send the stock to new lows. This may frustrate existing shareholders. Still, those willing to average down or to start on a speculative position could get a big reward. Cannabis legalization in the U.S., Canada, and in other countries will lead to revenue growth.
Hexo has the title of being the first cannabis company to join the Food and Consumer Products of Canada, a leading national trade group. The company’s added 374 new workers and raised its total headcount to 822 employees at the end of last quarter. It has 1,100 employees in total.
CAD $400 Million Revenue Target
Hexo has an ambitious CAD $400 million ($301.5 million) revenue target. It faces two risks in getting there. First, regulatory risks would delay the advancements of its products. More likely, regulatory delays will push out the company meeting its revenue target. Execution is the second risk. If its Belleville operations are ready in the fall as planned, Hexo will be mitigating that risk.
In Quebec, Hexo targets 30% share. But Hexo has a preferred supplier status in the region, a strong reputation, and a product its customers like.
In the near-term, the company set a goal of a 40% gross margin. Longer-term, the company may achieve 50%. But to get there, it needs to be a top-four global cannabis company.
Your Takeaway on HEXO Stock
Investors have a number of financial models available to forecast the stock’s fair value. But until Hexo starts generating consistently growing revenue each quarter, the estimate is a guess with a wide margin for error. Investors should instead wait for legalization and regulatory clarity first. This will remove some of the risks that may still not yet be priced in HEXO stock.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.
