“I’m from the government and I’m here to help.” These were the mocking words that former President Ronald Reagan used to describe government incompetence and inefficiency. In many ways, they perfectly describe the plight of Canadian cannabis firm Hexo (NYSE:HEXO) and other, more esteemed players like Cronos Group (NASDAQ:CRON) and Canopy Growth (NYSE:CGC). Indeed, government incompetence may be the biggest factor for why the Hexo stock price tanked in 2019.
One of the commonly cited explanations for the hemorrhaging in the Canadian cannabis market was the lack of fiscal credibility. Undoubtedly, all weed competitors enjoyed a compelling and overriding narrative: the transition of a black market into a viable (as in taxable) market. Generally, recreational cannabis is a personal, victimless endeavor. Thus, the rational thinking goes, both corporations like HEXO and the underlying government should benefit from it.
However, investors aren’t in the business of talking about their feelings at their local book of the month club. Rather, they may enjoy a good story but only to the extent that it brings about profitability. Unfortunately, most cannabis firms are far from being in the black. Instead, weed players eschewed profitability for growth. Wall Street accepted this for a while, driving up the Hexo stock price and similar investments.
But patience grew thin. As cannabis companies delivered disappointing earnings results, many stakeholders saw the writing on the wall. Making matters worse, many organizations, including HEXO, sought dilutive measures to continue their growth strategies. That was the last straw for the remaining believers, cratering the Hexo stock price.
What turned a market which held so much promise into a veritable embarrassment? The answer: government inefficiency.
Canada Doing No Favors for Hexo Stock
Source: Chart by Josh Enomoto
Now, I’m not breaking new ground when I mention the Canadian government’s role in hurting HEXO. Many analysts have cited the administrative backlog that has unnecessarily stymied the burgeoning weed market. However, performing a deeper dive into the subject reveals shocking inefficiencies that deserve consideration.
For starters, the Canadian cannabis market is quite robust. In the first calendar quarter of 2018, 4.18 million Canadians ages 15 and older used cannabis. By Q3 2019, that figure grew to nearly 5.2 million. By itself, this is good news for Hexo stock. However, the year-over-year growth rate in the trailing three quarters slipped from 27% to 14%.
This slowdown in growth suggests that external factors are weighing on cannabis usage. In my opinion, the biggest such factor is the irrational distribution of marijuana licenses across Canada’s provinces.
If you look at the market share of cannabis usage by province in the above chart, you’ll see that Ontario makes up the lion’s share of pot users. Between Q1 2018 through Q3 2019, Ontario took an average of nearly 41% market share. No other province comes close.
Yet as of October 2019, Ontario had 75 cannabis stores that were approved and open for business (or scheduled for such). However, Ontario also has over two million cannabis users. Thus, each store serves a whopping 26,972 users. To put this into perspective, that’s well more than the average per-game attendance of U.S. professional soccer.
Now consider British Columbia. It has 830,000 cannabis users but 104 stores to serve them. That’s just under 8,000 users per store. Surprisingly, the city of Calgary now has 200 stores, but only 1.34 million residents. If we assume 17% of them are cannabis users, that translates to 1,139 stores per user.
Something is very wrong here!
Risky but Compelling
Before you jump into Hexo stock with reckless abandon, let’s note the obvious: cannabis stocks remain a mess. Furthermore, all the criticisms that have been leveled at the sector at least have a ring of truth to them. Finally, the fiscal stability of most sector players hardly offers a reason for confidence.
Again, narratives are great, but they have a time limit. Right now, Wall Street is in no mood to hear more stories.
However, the case for Hexo stock is a compelling one because of the unnecessary government-level headwind. In all likelihood, if the country’s regulatory agency had focused more time on approving applications from high-volume markets like Ontario, HEXO and others may look a lot different today.
From another angle, the Canadian market has a hidden catalyst that is going untapped. Should the government apply the hard lessons learned, Hexo stock could make a comeback. If you have the stomach to endure choppiness and volatility, this is a name to watch for 2020.
As of this writing, Josh Enomoto is long Hexo stock.
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