Hexo (NYSE:HEXO) stock is nearing the danger zone. Since Nov. 7, the HEXO stock price is down 10%. That’s the continuation of an ongoing slide. In the last six months, the stock is down over 70%.
Some of this drop is due to investors’ ongoing retreat from cannabis stocks. HEXO for the most part has not been tainted by a particular scandal. However, like all the cannabis stocks, they have yet to show a profit. And with full legalization still some time away in the U.S. (not to mention the unknowns regarding regulation), investors are backing away from this industry.
However, a greater concern regarding HEXO is investors struggling to understand exactly what the company is and where it fits in the cannabis sector. And that is leading to the larger question of whether or not the company will be acquired. As I look at HEXO, I see acquisition as not only probable, but likely.
HEXO Is the Goldilocks of the Cannabis Sector
The term “Goldilocks” is colloquially used to describe an economy that is not too hot and too cold. If you’ll indulge me, I’m borrowing the Goldilocks word to describe HEXO. I believe that the company is in an interesting space in the cannabis sector. It’s not large enough to compete with the big producers like Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB). However, the stock is not so small as to be irrelevant.
The cannabis sector is about to embark on a consolidation phase. As the cannabis market emerged, many companies popped up. Many have and will fail. Others, like Canopy and Aurora have a lot of cash that ensure they will be part of the next stage of the business cycle.
HEXO Is Not a Significant Producer
HEXO is not a major producer of cannabis. And frankly, their attempt to increase their production capacity is causing problems to the company’s balance sheet. During their 2019 fiscal year, the company purchased 25 million CAD of dried cannabis to keep up with demand. The company subsequently wrote down that purchase to 8.1 million CAD.
Write-downs like that are one reason that the company continues to report steep losses even as revenue is slowing. For example, in their most recent quarter, HEXO was expecting net revenue to come in around 14 million CAD to 18 million CAD after accounting for returns and retroactive inventory adjustments.
HEXO Has Some Compelling Partnerships
But HEXO has never been a major cannabis producer. And they haven’t wanted to be. Instead, HEXO has focused on trying to form partnerships to get products to market. This is presenting two opportunities for HEXO stock to grow in the short term. But it’s these same opportunities that make HEXO a desirable addition for another cannabis company.
HEXO has a joint venture with Molson Coors Brewing (NYSE:TAP). The venture, called Truss has a partnership to produce Flow Glow, which is essentially cannabis-infused water (albeit in miniscule amounts). But HEXO is not alone in this space. Tilray (NASDAQ:TLRY) has a partnership with Anheuser-Busch (NYSE:BUD) and Canopy has its much publicized partnership with Constellation Brands (NYSE:STZ).
And in May 2019, HEXO made an acquisition of its own with its 263 million CAD purchase of Newstrike Brands. Newstrike is the parent company for Up Cannabis, a brand that is gaining traction in Canada and could provide some growth. One of the reasons HEXO made this deal was the opportunity to increase its production space.
But here again, chasing production is a double-edged sword. As I pointed out above, trying to increase their cannabis supply is part of what’s leading to write-downs and losses. Those losses are beating up the stock price. In fact, the 1.8 million square feet of cultivation space that HEXO gained from the Newstrike deal is currently shuttered as part of their cost cutting plan.
HEXO Has a Limited Path to Growth on Its Own Merits
HEXO is an intriguing cannabis company because it looks like it’s at least attempting to get its balance sheet right. But being financially responsible is not giving it the opportunity to be a major player on the production side. And it may find that there just isn’t a niche in which they can find a truly competitive advantage.
But they are not insignificant, and they may very well prove to be a takeover target as the industry begins to consolidate. As recently as November 2018, Hexo CEO Sebastien St-Louis announced the company was on sale for the right price. However, with HEXO stock sinking below the $2 mark, there may be no time like the present for companies who are looking to buy the cannabis firm.
As of this writing, Chris Markoch did not have an interest in the aforementioned securities.
