Do you own shares of Canadian cannabis company
Hexo (HEXO)? If so we've
got good news and bad news. (And when we say "we," what we really
mean is Canadian investment bank BMO Capital).
BMO's Tamy Chen put out a new
research report on Hexo, the upshot of which was that Hexo was
doing both better, and also worse, than anticipated -- depending on
which aspects of Hexo's business you focused on. The analyst
reiterates a Market Perform rating on ACB stock, with $9.00 price
target. (To watch Chen's track record, click here)
Good news first: Hexo's new one million square
foot greenhouse (Number 89) is ramping production "better than ...
expectations," and also better than greenhouses operated by other
licensed producers of marijuana (LPs). Chen explains that this is
because, in contrast to other LPs, which have generally created
their greenhouses by repurposing existing structures to the
cultivation of marijuana, Hexo's "89" facility is a "greenfield
build" -- a new structure, purpose-built for cultivating cannabis.
Its "climate control infrastructure" is therefore more efficient.
On top of that, Hexo has built up "multiyear" experience growing in
greenhouses, whereas some of its competitors are still learning the
On the surface, this seems like unadulterated
good news for Hexo. It's one reason Chen believes that Hexo will
hit its target of doubling its revenue between Q3 and Q4 2019, and
why the analyst has raised her Q4 sales estimate for the company to
C$26 million -- and her FY 2019 sales estimate to C$58 million.
Chen also raised her estimate for volume of marijuana to be sold in
Q4 2019, and 2019 as a whole -- to 5,640 kilograms and 12,342 kg,
But here's where we get to the bad news: While
Chen is raising her estimates for 2019 production, she is lowering
estimates for 2020 to C$266 million -- up from 2019 levels, but not
up as much as the analyst previously expected.
Simply put: Because Hexo's marijuana-cultivation
is going so well, there's a risk that it may not have the ability
to process this marijuana into higher value-added cannabis
derivatives (such as oils for vaping). Here, Chen echoes fears
voiced by other analysts recently, to the effect that Hexo's new
Belleville processing facility may experience delays in obtaining
the necessary licenses to begin production, and/or delays in
ramping production. And if such delays do occur at Belleville, at
the same time as "89" ramps marijuana production, Hexo's existing
processing facilities in Quebec may be unable to cope with the
supply coming out of "89."
Is this something that should worry investors,
Consider that Chen is currently modeling a
significant increase in marijuana retail prices -- from average
prices of C$4.50 per gram for recreational marijuana and C$7.94 per
gram for medical marijuana in 2019, to C$5.30 for recreational, and
C$8.75 for medical, in 2021. (That's about an 18% increase in
expected prices for recreational pot, and 10% for medical, in two
And yet, with pot production ramping all across
Canada, you'd ordinarily expect prices to fall as supplies
increase, not rise, right? But that's not what the analyst is
In order for this to make sense, it seems likely
the analyst is hoping Hexo will shift to processing and selling
more value-added cannabis derivatives over time -- at higher
prices, earning fatter profits. If, however, Hexo is prevented from
processing all the marijuana it would like to, into these higher
value-added products it wants to sell, then logically Hexo would be
forced to sell more of the marijuana being produced at "89" as
simple dried flower -- and at lower prices, with smaller
When you think about the dynamics this way,
Chen's decision to keep Hexo stock rated only "market perform"
makes a lot of sense -- at least, until the uncertainty surrounding
Belleville is resolved.
To read more on the nitty gritty of whatâs going
on in the rising cannabis industry, click here.
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