HEXO Stock Can Climb Further

The shares of major cannabis stocks have been rising after Joe Biden won the presidential election. It’s generally believed that the president-elect will loosen cannabis regulations, paving the way for the drug to be legalized, both for recreational and medicinal purposes, in more states. It’s against this backdrop that Hexo (NYSE:HEXO) stock shot up after reporting respectable earnings for its fiscal first quarter of 2021.

The company’s Q1 gross revenue of CAD 41.3 million was its highest ever and represents a 14% sequential increase and a 114%  year-over-year jump. Hexo’s net revenue climbed 9% versus Q4 and 103% YOY to CAD 29.5 million. The company’s operating expenses came in at CAD 20.8 million, CAD 50.7 million lower than the previous quarter.

HEXO is looking to generate positive EBITDA in this quarter or in the  first half of 2021. Given its most recent results, I am sure that this target is well within its reach. Management has done a great job of cutting down on the company’s sales, general, and administrative expenses.

With Canadian cannabis sales on the rise and the company’s strong performance, things are looking up for HEXO stock.

Joe Biden’s Victory and the Cannabis Industry

In recent years, the cannabis sector had burned many retail investors. Several cannabis companies whose stocks were seen as very promising when they first started trading have lost two-thirds or more of their value. Although several factors caused those losses, the weakness of the Canadian market was the most important cause.

When Canada legalized marijuana, many believed it was a game-changing moment for the industry. Alongside California, the sector had gained access to the Canadian market. However, Canada wasn’t as lucrative as expected for cannabis companies.

Meanwhile, 15 states and the District of Columbia have legalized adult recreational use of cannabis. But the  political momentum of the legalization movement has stalled a bit, partly due to opiate abuse and the devastating effect it has had on families.

Plus, banks and institutional investors have tended to stay away from the space, mainly due to the volatility of its profits and competition from illegal dealers that are still more efficient than the small number of legal retail stores.

Joe Biden’s victory, however, flips the script a bit. During a Democratic primary debate, Sen. Cory Booker famously criticized Biden. “I have a lot of respect for the vice president — he swore me into my office, he’s a hero,” Booker began. “This week, I hear him literally say that I don’t think we should legalize marijuana — I thought you might have been high when you said it.”

That line elicited a lot of laughter, but it underlined how firmly certain Democrats feel about the issue. Ultimately, I don’t believe Biden will support the legalization of cannabis at the federal level. But I think more states will legalize the drug with him as President than would have been the case if Trump had won reelection.

A Sign of Hope in Canada

Even though Joe Biden’s victory is perceived as a positive for the cannabis sector, the strength of the Canadian cannabis market will ultimately decide the future of HEXO stock.

HEXO went public in March 2017 and did not advance meaningfully. However, when Canada legalized cannabis, the shares surged on erroneous assumptions regarding the resulting growth of the country’s cannabis sector. Eventually, HEXO’s stock crashed, reflecting the realities of cannabis usage in Canada.

Companies like HEXO can hope for a resurgence in the U.S. But more than anything, they need their home market of Canada to grow. And we’re finally seeing some positive developments in that area.

In fact, legal marijuana sales in Canada rose 5.1% YOY to 270 million CAD in October. The monthly sales figures imply an annual run rate of approximately CAD 3.24 billion for Canada’s recreational cannabis sector. There are a limited number of Canadians who smoke cannabis. But 5% growth is significant and will undoubtedly provide HEXO stock with a positive tailwind moving forward.

HEXO Stock Has Been Gaining Ground

Apart from these positive tailwinds, HEXO has performed well. Its management has done an excellent job of lowering the company’s operating expenses, while its sales are growing.

Looking ahead, analysts, on average, expect the company’s sales to surge 105% next year. And that is not an anomaly, but a part of a consistent pattern of growth by the company. Over the last three years, its sales have jumped by an average of 208%, comparing very favorably with the sector’s average increase of 6% and the 13.5% mean growth of companies in the S&P 500.

Plus, unlike some of its peers, HEXO has relied almost exclusively on equity to finance its operations. I am never in favor of selling a great deal of stock because doing so dilutes existing shareholders. But in the current environment, cannabis producers have had little choice but to issue more shares, as piling on debt in a weak economic environment is not a good idea.

Final Thoughts on HEXO Stock

The merger between Tilray (NASDAQ:TLRY) and Aphria (NASDAQ:APHA) has stolen all the headlines about the cannabis sector. The combined company will control 17% of Canada’s legal cannabis revenue, so the excitement surrounding the merger is warranted.

But please don’t forget HEXO amid all the euphoria about the Tilray deal. HEXO’s shares have returned 31% in the last month. And yet, they are about 50% below their 52-week high.

With the company about to become profitable, HEXO stock remains a steal.

On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. 


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