I’m a big-time cannabis bull, and have been for quite a while. But that doesn’t mean I’m a bull on every cannabis stock. Hexo (NYSE:HEXO), and HEXO stock, is one of the names I’d avoid.
Again, I see a bright future for the industry worldwide. I have a service — Cannabis Cash Weekly — dedicated solely to the sector. Even as cannabis stocks struggled in 2019 and 2020, I kept my long-term bullish outlook.
Since early November, the group finally has found a rally. HEXO stock has come along for the ride, doubling from late October lows.
But this looks like a case of a rising tide lifting a leaky boat. There are a number of cannabis stocks out there that I recommend, but HEXO isn’t one of them.
The Case for HEXO Stock
I can see why some investors see HEXO stock as attractive here.
This is a company that was struggling significantly. HEXO stock in fact dropped below $1, leading the company to execute a 1-for-4 reverse split to satisfy stock exchange requirements.
But fiscal first-quarter results look better. Net revenue more than doubled year-over-year. Losses narrowed as well. Hexo finished the quarter with 150 million CAD in cash.
Meanwhile, optimism toward the sector has built since late October. Part of that optimism comes amid a broader rally in small-cap stocks, but the cannabis sector has outpaced the market. Big wins in the U.S. for marijuana legalization no doubt have added to the broader “risk-on” sentiment.
Even the low share price probably helps the case. A stock with a lower price isn’t necessarily “cheaper,” but some investors see it that way. Add up everything that’s gone on over the past couple of months and it’s not really a surprise that Hexo stock has doubled.
The Case Against the Rally
The problem is that the story gets a bit weaker as investors look closer.
For instance, Hexo’s revenue did double year-over-year. But the same is true for most Canadian cannabis plays. The period between Q1 FY2020 and Q1 FY2021 (the most recent quarter) saw a massive expansion of retail shops in Canada, along with the release of so-called Cannabis 2.0 products.
Quarter-over-quarter revenue growth, meanwhile, was just 8%, somewhat disappointing given the recovery from the novel coronavirus pandemic.
Meanwhile, Hexo’s growth came entirely from adult-use products in Canada — which, again, is a market that’s growing. Elsewhere, Hexo struggled. The medical business saw revenue decline 11% quarter-over-quarter to just 486,000 CAD. International sales fell 13% versus Q4, to 1.125 million CAD. Wholesale revenue fell sharply as well, though that’s less of a surprise given the glut of capacity across the industry.
Hexo has done a decent job building out its beverages business, but at 3 million CAD in sales for the quarter that business still has a long way to go.
Broadly speaking, Hexo just doesn’t really stand out from the pack. It’s not terribly big. Its growth isn’t particularly impressive. The company did get adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) near breakeven in Q1, but it’s still unprofitable on a net basis. Free cash flow for the quarter was negative 7.8 million CAD.
The U.S. Problem
Meanwhile, Hexo has joined in the rally over U.S. legalization — but I’m not convinced that really makes much sense. There are bigger companies set to the enter the U.S. market with more resources, more products and stronger brands.
Hexo will have an uphill climb. Its current international business is limited to a single agreement for medical marijuana sales in Israel. Admittedly, solid performance in beverages could provide a beachhead in the U.S. But the company’s 150 million CAD in cash is likely to dwindle further given the combination of 58 million CAD in debt and negative free cash flow. That lower cash balance will limit the company’s ability to go full-bore into markets outside of Canada.
That’s a problem, as Canada clearly isn’t enough. Growth is decent but not spectacular, and profitability remains elusive.
To be sure, this isn’t a terrible company. I’m not by any means recommending that investors short HEXO stock. Rather, the point is that there simply are far better options elsewhere in the sector — for any kind of investor.
There are bigger companies. There are a number of rivals with far larger cash hoards that can drive needed international expansion. Some cannabis companies already have reached profitability. Others are cheaper on a price-to-revenue basis.
In contrast, nothing about Hexo really stands out. It’s growing at a decent clip. The beverages business is intriguing. So is top market share in Quebec. But after a 100% rally, there just isn’t enough here. Cannabis investors can do better.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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