Hexo (NYSE:HEXO) stock has taken a beating and things don’t look much better going forward. Shares of the marijuana stock are down more than 50% from late April, with the Hexo stock price sliding from $8.40 per share down to under $4. With recent developments, investors are thinking twice before bidding up cannabis stocks. But does this short-term decline equal a buying opportunity in Hexo stock? Or should investors continue to wait on the sidelines before taking a position?
Revenue grew exponentially after the Canadian legalization. But based on the most recent financial results, growth has stagnated.
Total net sales for the quarter ending April 30, 2019 were C$13 million. This is a slight decline compared to the prior quarter (C$13.4 million). Without a major catalyst, this weak growth does not bode well for Hexo’s next earnings report.
However, there may actually be some material growth catalysts coming down the pipeline. With the launch of edibles and infused beverages later this year, Hexo has a chance to capture some short-term gains in its stock price.
If both of these new markets meet expectations, investors could see the Hexo stock price bounce back.
Hexo’s Clear Strategy for Growth
Like its peer Canopy Growth (NYSE:CGC), Hexo has a strategic partner to help scale operations. Partnering with beverage giant Molson Coors (NYSE:TAP), Hexo has the financial support and operational expertise to build a significant consumer product business. Through its joint venture, Hexo will launch a brand of cannabis-infused beverages. The product line is expected to hit shelves later this year. Coupled with the expected Canadian rollout of edibles, Hexo Corp stock may have material catalysts to move the short-term needle.
The company is making other smart moves to scale up their business. The recent acquisition of Newstrike Brands adds the Up Cannabis brand to their portfolio. The merger expands capacity, and includes cost synergies. Hexo is catching up to its larger Canadian peers.
Before we get ahead of ourselves, remember that Hexo has its work cut out for it. While the company has significant runway, they need tangible results to justify a buy. With Canadian market headwinds and an inflated valuation, there are many reasons to avoid buying HEXO stock at the current trading price.
Numerous Risks Threaten Hexo’s Bull Case
As I have discussed in a prior article about Aurora Cannabis (NYSE:ACB), the Canadian market is flooded with oversupply. However, with Hexo Quebec’s preferred supplier, the company has potential to sell its inventory into a large market (23% of Canadians live in Quebec). Nevertheless, Hexo needs the edibles and infused beverage markets to pay off in order to soak up oversupply.
Looking to the United States, federal legalization is a work-in-progress. Changes in federal laws are needed to make it a scalable business. With legislation going through Congress, there is progress. But it could be years before the American market fully opens up. Without full U.S. legalization, it is tough to justify buying Hexo stock at the present time.
Another major risk is valuation. Even after a 50% drop, shares remain overvalued. However, HEXO stock trades at a discount to larger peers. Hexo trades at an Enterprise Value/Sales (EV/Sales) ratio of 32.83, compared to 54.26 for ACB, and 54.28 for CGC. With a lower valuation, Hexo may be a takeover candidate down the road.
Buying Hexo could be a smart move for Aurora Cannabis. In addition to helping them scale operations, buying Hexo would give ACB access to Molson Coors as a strategic partner. But I do not suggest buying HEXO stock on takeover potential. Investors should assess Hexo Corp on its merits as an independent company. As a standalone company, Hexo has potential, but needs to work through short-term challenges before the stock becomes a buy.
Hexo Stock Is Not a Buy Today
Like the rest of the cannabis space, HEXO stock needs to show tangible results. Investors should practice caution before entering a position. With the next earnings release anticipated for October, investors have plenty of time to assess the merits of Hexo stock in the short-term. While in the long-term Hexo’s stock price could see appreciation, the short-term picture remains murky. The cannabis space needs improved investor sentiment to turn around price declines.
The Canadian market has runway with edibles and beverages. But the real growth driver is the United States. Once Hexo and its competitors can expand south into America, investors will have a clearer picture of the industry’s growth potential. Until then, the stock is not a buy. But long-term, HEXO stock may be a smart way to play the cannabis growth story.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
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