Investors tend to treat all cannabis stocks the same. That’s pretty common in an emerging market. However, this “one size fits all” mentality means one bad stock can spoil things for the bunch. Case in point, Hexo (NYSE:HEXO) had a bad second quarter. Awful, in fact. But when looking at the company as an investment, you have to look at their business model, which is distinct from other major players like Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB).
For example, Aurora is concentrating its efforts on the medicinal marijuana market. Canopy, on the other hand, is dominating the recreational use market. Cultivating one or more niches is a hallmark of the cannabis market. And it’s no different for Hexo.
Hexo is focusing on the edibles and beverage market. While this is a small niche at the moment, the cannabis-infused beverage market may be worth up to $3 billion by the end of 2019. The first example of this model paying dividends occurred in the fall of 2018 when Molson Coors Brewing (NYSE:TAP) partnered with HEXO. The Canadian brewer is building a cannabis beverage brand, and the first drinks will be available for sale on Dec. 16. That’s the date when these products become legal in Canada.
The partnership between Molson Coors and Hexo may not seem much different than Constellation Brands (NYSE:STZ) forming an alliance with Canopy. However, it’s worth noting that Molson chose Hexo over both CGC and Aurora Cannabis — among other cannabis companies it met with. One reason for this was the company’s history of innovation. It’s also worth noting that Hexo will have a deliverable for this space that the other cannabis companies will not. That deliverable can be significant for Hexo stock when, pending regulatory approval, it can launch these CBD-based drinks in a limited U.S. market in 2020.
Hexo Is Beating Some of the Big Players at Their Own Game
In terms of sales growth, Hexo is one of the best cannabis stories around. The company is delivering trailing 12-month revenue growth of 245%. This number is even more impressive when you consider that for quite some time, Hexo has been limited by its own production capacity.
That situation, however, appears to be changing.
Hexo recently completed a 1-million square foot expansion of its Gatineau, Quebec facility which previously operated at approximately 310,000 square feet of capacity. This growth will allow Hexo to become one of the top-10 cannabis producers in Canada by 2020. The company also recently acquired Newstrike Brands which will eventually push Hexo’s production capacity to 150,000 kilograms.
But what good is supply if you don’t have demand?
Not to worry. The Quebec-based company also has a large supply deal with the province that will insure about 30% of Hexo’s distribution over the next five years. There are few certainties in the cannabis industry. However, locking up 30% of Canada’s largest cannabis market should have a positive effect on Hexo stock.
Why Does HEXO’s Share Price Continue to Fall?
Since hitting its all-time high in mid-April, Hexo stock has declined over 50%. This selloff has taken the company below the symbolically important $1-billion valuation mark. And at its current price near $3.90 per share the stock is getting perilously close to going negative for the year. By all indications, this would make Hexo stock look like a classic falling knife, but I’m not so sure this is accurate.
Regulation in the Cannabis Market Will Remain an Anchor
Both medicinal and recreational use of marijuana is gaining mainstream acceptance. But voter approval is only the first step. The obstacle that all cannabis companies face is regulatory hurdles. Hexo has been stymied by Health Canada. Canada’s regulatory agency is swamped by the large amount of companies filing licensing applications for cannabis. And all of these new products must have compliant packaging which is creating another delay.
But as frustrating as this is for cannabis companies and their would-be investors, it’s not unexpected. The U.S. faces similar regulatory issues as it tries to assimilate products that still make many consumers wary.
What’s in Store for Hexo Stock?
The company provides its next quarterly earnings report on Sept. 12. The market will be looking to see if the regulatory environment improves and all systems are go for a successful launch of their CBD-infused beverages. If so, Hexo stock should get a nice lift going into 2020. If not, it’s still hard to ignore the potential of this stock — which investors can get at a sizable discount.
Hexo is a stock for the long haul, and like all cannabis stocks, it’s not for the faint of heart. But if you look at how Hexo is different from its competition, you’ll find a strong case for owning HEXO shares.
As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
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