It was an ugly October for shares of Canadian cannabis producer HEXO (NYSE:HEXO). Early in the month, the company announced preliminary fourth quarter fiscal 2019 numbers that fell short of expectations. At that time, management also withdrew its full-year fiscal 2020 revenue guide amid mounting cannabis market challenges and uncertainties.
Later in the month, HEXO proceeded to report actual fourth quarter numbers that were roughly in-line with expectations, but also included a first-quarter fiscal 2020 guide that was unimpressive.
HEXO stock sunk from $4 at the beginning of October to $2 by the end of the month. Zooming out, the 50% haircut in October is part of a bigger downtrend in HEXO stock which started about six months ago. During that stretch, the HEXO stock price has dropped from $8 to $2. Unfortunately for bulls, I don’t see things getting better anytime soon.
During this whole sell-off, I’ve sounded a bearish tone on HEXO stock for one very simple reason: this seems like just another overvalued, undifferentiated pot stock with greatly limited visibility to sustainable growth and profitability in the long run. This bearish rationale remains true today. So long as it does, HEXO stock will continue to trend lower.
As such, I don’t think it’s time to buy the dip. Instead, investors should continue to stay away.
Beware the Gold Rush Hype
The big picture backdrop on HEXO stock projects to remain bleak. In short, emerging growth markets are like a gold rush in that everyone wants to move into the market to strike it rich, but only very few do. The most notable example? The internet.
Back in the late 1990s, the internet was the world’s hottest emerging growth market, birthing thousands of companies like Boo.com, Webvan, Pets.com, Kozmo, and Geocities.
Most of those companies were valued as if they were going to strike it rich in the internet gold rush. But they didn’t. Of the thousands of dot-com companies that were launched during the late 1990s, only a handful — like Amazon (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) — survived and thrived over the long-term.
The same logic can be applied to the cannabis gold rush of the late 2010s. There are hundreds of cannabis companies out there. All of them are saying the same thing: there is a $200 billion global cannabis market opportunity out there, and we are best positioned to dominate that market because of X, Y, and Z.
But, the harsh reality is that the cannabis market will not sustain hundreds of cannabis producers. Instead, the market at scale will consolidate around a few very large players — see the tobacco and alcoholic beverage markets, which are essentially oligopolies. The rest will go bankrupt.
In other words, there are two types of pot stocks out there. One type is pot stocks that could take over the world, and the other type is pot stocks that could go under. About 5% of pot stocks belong in that first group. The other 95% belong in the second group. That’s simply how market consolidation works.
Nothing Special About HEXO
At this point in time, HEXO belongs more in the bucket of “pot stocks that could go under,” than “pot stocks that could take over the world.”
That’s because there’s nothing special about HEXO. The company isn’t big. Revenues were under $50 million last year. Growth is relatively muted. Revenues are expected to rise just 4% quarter-over-quarter next quarter. There isn’t any multi-billion dollar support from a consumer staples giant, which companies like Canopy Growth (NYSE:CGC) and Cronos (NASDAQ:CRON) have. The numbers aren’t terribly impressive, with gross margins weak and losses piling up.
Considering 95% of this space projects to go under, “nothing special” means that HEXO stock belongs in the group of “pot stocks that could go under.” So long as Hexo stock remains in that group, shares won’t rebound from their secular downtrend.
HEXO is just an another undifferentiated, overvalued pot stock with limited long-term growth visibility. So long as the numbers reaffirm this bleak reality, Hexo stock will remain weak, and investors should stay away.
As of this writing, Luke Lango was long CGC.