Hexo Corp. (NYSE:HEXO) has fallen substantially since my article in August 2019 on the stock. HEXO stock has lost over $700 million in market value in that period, falling from $1.1 billion to $360 million over that period.
That’s the sign of a loser stock and unimaginative management that don’t understand how markets work. Your best bet is to stay away.
At the time I warned investors that the company’s cash flow burn rate would be unsustainable for the stock. Moreover, its merger with Newstrike at the time, along with the capital raise only made the matter worse for shareholders. Not only did the cash flow burn rate increase, but the additional dilution put more pressure on Hexo stock.
As a result, Hexo stock is down 65% over the past year and has also dropped over 53% year-to-date. Now its stock trades below $1 per share and the company thinks a reverse stock-split will cure that problem. It may actually just encourage more short sellers.
For one, they typically can’t short stocks with prices below $5 per share. But the vote to “consolidate” 1 share for every 8 shares are to be voted on by shareholders on Dec. 8, as William White, my InvestorPlace colleague writes.
Therefore, at 74 cents today, the new price would be $5.92. This will be just high enough for short sellers to get approval from their broker-dealers to short more shares.
The Problem With Hexo Stock
On Oct. 29, the company issued another in a long line of miserable earnings reports. Despite the company reporting a large increase in revenues, its earnings and cash flow losses continued.
I am a deep skeptic when I see complicated earnings statements. Statements that talk about adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) losses like at Hexo are usually hiding much bigger burn rate problems.
For example, the company reported that its cannabis-related adjusted EBITDA loss was only 3.25 million Canadian dollars CAD ($2.48 million) in the quarter ending July 31. That was apparently a 25% improvement over the losses in the prior year-ago quarter.
But the reality is that the burn rate at Hexo is still completely out of control, just like it was a year ago. For example, if you turn to the company’s cash flow statement, not its earnings and adjusted EBITDA numbers, you see a different picture.
Cash Outflows, Burn Rates, and Cash Position
It shows that for the year ending July 31, the cash flow from operations was a loss of CA$94 million. In addition, the company spent CA$109 million in capital expenditures. That makes a CA$203 million nut it had to cover. Moreover, Hexo decided had to spend about CA$10 million in debt service. That means its total burn rate was CA$213 million for the year.
To make financial matters worse, Hexo decided to spend CA$31 million on acquisitions. Now we are up to CA$244 million in cash outflow.
So, to cover this the company had to issue more equity during the year. It issued a net CA$186 million in new shares and borrowed another CA$70 million. It now has CA$88 million in debt and lease obligations. Moreover, Its cash position of CA$192 million won’t be able to survive another year of CA$213 million to CA$244 million in outflows.
In other words, there is going to be more debt and equity issuance this year. That is not the kind of financial picture that inspires a lot of confidence.
What To Do With HEXO Corp
If you have never shorted a stock, this might be a good one to try it with. Just wait until after the reverse split goes through, and try to time it with some positive news associated with the stock.
Of course, shorting is tricky and you need to be very careful since you can lose a lot of money if the stock takes off. But it seems highly likely, given the odds, and the company’s track record, plus the fact that short seller will be chomping at this one again, that you will make money.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Mark Hake runs the Total Yield Value Guide which you can review here.
