Simply put, Hexo (NYSE:HEXO) is in trouble. Revenue growth has disappointed in each of the last two quarters. The company’s own expectations for 2019 and 2020 were missed. The balance sheet is starting to look stretched. And the HEXO stock price, even with recent stabilization, still sits 74% below its 52-week high.
As a result, Hexo needs to deliver a strong earnings report on Monday. There’s still a path for the company to bounce back as more retail stores come online in Canada and “Cannabis 2.0” products drive sales. Hexo’s cash balance is a concern, but if the company can meet its fiscal 2020 targets, there’s room to muddle through until growth resumes.
At the same time, there’s little room for error. Recent disclosures show that cash has dwindled significantly in just the last six months. Raising capital may be difficult without a higher HEXO stock price. Hexo’s survival literally is at stake.
Q1 earnings won’t definitely dash the company’s hopes, or prove its viability. But they will have a huge impact on how investors view Hexo’s odds of making it through this rough patch.
Revenue Growth Key for HEXO Stock
The first goal in Hexo earnings is simple: the company needs to grow net cannabis revenue on a quarter-over-quarter basis. Excluding the contribution from the acquisition of Newstrike, net sales actually have declined sequentially in each of the last two reporting periods.
Wall Street expects Hexo to hit that target — but barely. The consensus estimate is for 15.75 million CAD in revenue, up from 15.4 million in the fourth quarter of fiscal 2019. The figure sits about in the middle of the company’s guided range of 14 million to 18 million. That narrow expected growth — a little over 2% — sets up two very different narratives.
Strong sales will not only beat expectations, but drive growth. Conversely, if sales miss estimates and decline for a third consecutive quarter, the story coming out of earnings seems very different.
On the profit front, Hexo just needs to make progress. The company eliminated 200 positions in late October in a cost-savings move. On the Q4 conference call, management forecasted lower general and administrative expense, and “significantly” lower marking spend as well. The company is targeting positive EBITDA (earnings before interest, taxes, depreciation and amortization) for the full year, and a narrower loss would drive confidence in that target.
Again, this is not a quarter that is going to fix Hexo’s problems. Cannabis 2.0 products haven’t been launched yet and regulatory backlogs persist. Investors aren’t expecting torrid growth yet.
A Miss Will Be Punished
The risk to HEXO stock is that anything less could drive significant selling. It’s become rather clear that Hexo has an increasingly significant cash burn problem. Mark Hake highlighted the issue back in August, and recent disclosures confirm the risk to Hexo’s balance sheet.
According to the company’s fourth quarter release, Hexo finished fiscal 2019 (ending July 31) with 139.5 million CAD in cash, cash equivalents, and short-term investments. By Oct. 28, when the company issued its management’s discussion and analysis, the figure had shrunk to 64 million CAD.
Less than six weeks later, Hexo closed on a 70 million CAD convertible bond issuance. In the release, CEO Sebastien St-Louis said the raise “increas[ed] our cash on hand to over $70 million [Canadian].” That phrase implies that much of the 64 million CAD held at the end of October already had been spent.
Hexo does have a 65 million CAD credit facility available, per the MD&A. But including that facility, there’s still maybe 150 million CAD in liquidity. Capital expenditures alone are guided to 100-110 million CAD in fiscal 2020. Hexo could use up most, and in a worst-case scenario all, of its cash this year if it fails to meet its EBITDA target.
On the Q4 call, several questioners asked about the cash problem, and Hexo management was firm in believing the company could make it through the year and to profitability without selling more stock. But this is a company that also expected 400 million CAD in revenue this year; current estimates sit at just 109 million. If Hexo disappoints in FY20, as it has of late, it will at least have to sell more stock through its at-the-market program, diluting shareholders and further pressuring the HEXO stock price.
A Critical Earnings Report
And so this is an enormously important release for Hexo. The options market supports that take, with prices implying a roughly 20% move in HEXO stock next week.
A good report eases liquidity worries and raises hopes that the company can return to growth and hit its full-year targets. A higher HEXO stock price also helps the company raise capital via equity offerings should it so desire. With Cannabis 2.0 on the way and a partnership with Molson Coors (NYSE:TAP), decent results in this environment will open a path toward significant improvement once the Canadian market rights itself.
A miss, however, brings legitimate concerns of bankruptcy to the fore. It increases the likelihood that Hexo will have to raise significant capital — which, as Hake noted, can cause a vicious cycle for the stock. A weak first quarter puts fiscal 2020 targets in doubt immediately, and adds to concerns about whether management truly is on top of the business and industry dynamics. Q1 results aren’t going to seal Hexo’s fate one way or the other, but they will drive the sentiment toward HEXO stock into 2020.
As of this writing, Vince Martin has no positions in any securities mentioned.