Hexo Stock Is Cheap on a Forward Basis—but Success Is Not Guaranteed

The "smokeless" pot stock trades at low forward EV/Sales valuation

Hexo (NYSE:HEXO) stock has traded sideways since my last analysis on Aug. 30. Shares currently trade at the $4 price level. The Hexo stock price is down more than 50% from its 52-week high of $8.40/share set in May.

As Canadians Get Ready for Edibles, is Hexo Stock Ready to Bounce?
Source: Shutterstock

Like other names in the “cannabisphere,” investor expectations have been blunted by short-term results. Long-term, the legal marijuana space could become a major industry. But, for now, the emerging companies in the industry are experiencing growing pains.

As the United States market has yet to fully open up, investors are betting on future, not present performance. Unlike its peers, HEXO may have an edge. Their focus on “smokeless” cannabis products—especially infused beverages, could be the path to profitability.

Hexo is not the cheapest pot stock out there, but could be a solid play if shares continue to fall.

HEXO Stock on Track with Truss

The company is on track to launch infused beverage Truss with partner Molson Coors (NYSE:TAP) in December, when infused beverages and edibles become legal across Canada. The rollout of these higher-margin cannabis products has been a key catalyst for pot stocks.

Hexo’s larger pot peers, such as Aurora Cannabis (NYSE:ACB) and Canopy Growth (NYSE:CGC), are also banking on branded products as a game-changer. Straight-up marijuana sales are a commodity business. Branded products provide a clear path to profitability.

The launch of Truss is make-or-break for the company. But with their Molson Coors partnership, they have hedged their bets. Set up as a joint venture, Hexo owns 42.5%. While this limits upside, it does provide a way for Hexo to access outside capital and expertise without significant dilution. Unlike Canopy Growth, which has slowly ceded control to partner Constellation Brands (NYSE:STZ), Molson Coors owns very few (11.5 million) of Hexo’s outstanding warrants (50.9 million). To put this in perspective, there are about 257 million shares outstanding.

The partnership with Molson Coors is just the beginning. The company is focused on finding additional Fortune 500 partners to rollout infused products. Potential partners include big names in cosmetics, pharmaceuticals, food products, and vaping. This diversification is another solid catalyst. Grand View Research estimates the CBD skincare market alone could grow to $1.7 billion by 2025.

But is this potential upside baked into the Hexo stock price? At first glance, that seems to be the case. However, taking into account forward revenue, the stock looks like more of a bargain.

Cheap on a Forward EV/Sales Basis

HEXO trades at a trailing 12-month (TTM) enterprise value/sales (EV/Sales) ratio of 35.2. Using this metric, Hexo now trades at a premium to peers such as Aurora and Canopy. Aurora’s TTM EV/Sales ratio is 26.5. Canopy’s is 25.4. The stock is expensive relative to Aphria (NYSE:APHA). Aphria’s trailing EV/Sales ratio is a mere 7.3. However, Hexo remains much cheaper than Cronos (NASDAQ:CRON), which trades at an EV/Sales of 114.6.

I have used trailing EV/Sales in past analysis. But using forward sales may provide greater insight into pot stock valuations. For HEXO, analyst consensus estimates sales of $259.2 million for the FY ending July 2020. At the current enterprise value ($908.9 million), that means shares trade at a forward EV/Sales of 3.5.

Let’s compare that to its peers. Based on analyst consensus, Aurora trades at a forward EV/Sales of 11. Using the same formula, Canopy’s forward EV/Sales ratio is 16.2. Cronos’s forward EV/Sales ratio is 31.9. Aphria’s forward sales ratio comes in at a cheap 2.5.

But how much faith can we put into these forward sales estimates? Hexo missed its last quarterly sales estimate ($9.76 million actual vs. $10.8 million analyst estimate). Since August, pot stock quarterly results have been disappointing. Aurora, Canopy, and others saw material declines after releasing actuals. However, MKM Partners’s Bill Kirk doesn’t believe the market is giving Hexo enough credit for their 2020 sales projections.

Hexo Stock Price Rides on Infused Beverage Success

The Hexo stock price looks cheap. But this is assuming the company will meet expected FY2020 sales of $259.2 million. All of this rides on the success of Truss. In the meantime, earnings are next released later this month. This would provide a clearer picture of whether the company is on track to meet expectations.

I remain on the fence with pot stocks, and Hexo is no exception. But if we finally get the anticipated market correction, the stock could be a buy. Keep it on your radar, and pounce if the Hexo stock price falls to a lower valuation.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/10/hexo-stock-cheap-forward-basis-success-not-guaranteed/.

©2020 InvestorPlace Media, LLC