The case for cannabis producer
Hexo (NYSE:HEXO) has
been based in part on the idea that investors have missed the
story. When pot stocks started taking off early last year, the HEXO
stock price still languished.
More recently, pot plays like Canopy
Growth (NYSE:CGC) and
Tilray (NASDAQ:TLRY) have
dominated the headlines; Hexo seemed to get a fraction of the
coverage of those peers.
Thatâs clearly starting to change. The story
behind Hexo is gaining a broader reach â and the Hexo stock price
is responding in kind. The question at this point is whether thatâs
a good thing â and whether a strong YTD is starting to price in at
least some of the opportunity here.
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While cannabis stocks soared in 2018, HEXO mostly
was left out of the gains. The stock gained just 5% for the year,
as a rally that began in September quickly fizzled.
Itâs been a different story in 2019. HEXO has
gained 101% YTD as of this writing. And there are some fundamental
reasons for the gains. The announced acquisition of
Newstrike Brands (OTCMKTS:NWKRF) was
well-received. Hexo raised cash at the beginning of the year,
putting its balance sheet in good shape. Second-quarter results in
March looked impressive: sales increased over 1,200%.
But a big part of the story with HEXO stock in
2019 is that its story has spread. Thatâs most apparent
when looking at the stockâs trading volume. At the end of last
year, 30-day average daily volume was under 400,000 shares. Four
and a half months later, itâs at 5.3 million.
The companyâs listing on the New York Stock
Exchange has been a huge driver of that volume. And itâs helped the
HEXO story become more widely known. That, along with the Newstrike
deal and the strong Q2, has been why HEXO stock has outperformed
other pot stocks.
CGC shares are up 70% so far this year, and
Aurora Cannabis (NYSE:ACB) about
the same. (Interestingly, an NYSE listing had the opposite effect on
ACB stock, albeit in a very different market for marijuana stocks.)
Cronos Group (NASDAQ:CRON) is
up 47% in 2019; TLRY shares actually have declined 30%.
So the interesting question here is whether
thereâs more outperformance on the way with HEXO â or if the market
has caught up with the story at this point. Josh Enomoto wrote last month, with
the HEXO stock price not far from current levels, that the stock
still looked compelling.
And Enomoto makes several solid points. The
Newstrike deal adds capacity. The combined companiesâ total
production capacity is 150,000 kilograms of cannabis annually.
But the companyâs focus on edibles and beverages
â including a joint venture with Molson Coors
Brewing (NYSE:TAP) â
also limits its exposure to oversupply concerns Iâve previously
Increasingly, it appears that simply producing
weed isnât going to be the path to enormous profits. Cannabis plays
need to be differentiated. Hexoâs goal of becoming âthe premier
branded ingredients for food cannabis companyâ, as it put it in
a recent presentation, creates that
At the same time, the gains in HEXO stock have
moved its valuation to the nosebleed levels seen elsewhere in the
space. Its market capitalization, pro forma for the Newstrike deal,
is likely nearing $2 billion. (Itâs not clear exactly how many
shares will be issued to Newstrike shareholders. Hexoâs most recent
filing with Canadian regulators also cites nearly 50 million shares
subject to warrants not included in the current diluted share count
of nearly 200 million.)
Meanwhile, Q2 net revenue, as impressive as
growth was, came in at just C$13.4 million (~$10 million). HEXO
stock, then, is trading at something like 50x its current revenue
The combination of valuation and trading volume
suggests that HEXO no longer is an âunder the radarâ play. And that
makes the case a bit tougher from here.
At this point, investors have no shortage of
options when it comes to investing in cannabis. And the choice
largely comes down to how an investor sees the space playing out.
Those looking for scale should choose Canopy or Cronos, both of
which are backed with billions of dollars from
Constellation Brands (NYSE:STZ) and
Tens of smaller, high-risk plays still sit on
over-the-counter markets. Aurora offers the most
diversification. Tilray might be getting cheap after its long
decline. Another alternative is the 40-pot-stock ETFMG
Alternative Harvest ETF (NYSEArca:MJ), which
includes HEXO stock among its top 10 holdings, at 3.76% of the
portfolio. CRON is the largest holding, at 8.71%.
The case for HEXO is intriguing, particularly for
those (like Enomoto) who see big growth in edibles and beverages.
But the story is out there â and the edge might not be quite what
it was just a few months ago.
As of this writing, Vince Martin has no
positions in any securities mentioned.
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