Analyst Robert Fagan of GMP Securities says The Hydropothecary Corp (TSX:HEXO) is one of his ‘Best Ideas’ in the Canadian cannabis sector. The Gatineau, Quebec-based company has both a compelling growth profile and an attractive valuation, says Fagan, who last Friday reiterated his “Buy” recommendation and $8.50 target for HEXO.
On June 21, the Hydropothecary announced its graduation from the TSX Venture to the senior market, complete with a symbol change from THCX to HEXO. The company followed up with last week’s third quarter fiscal 2018 financials, which featured revenues of $1.2 million, up 5 per cent from Q2, and an Adj. EBITDA loss of $3.4 million.
CEO and co-founder Sebastien St-Louis underlined the importance of the company’s supplier agreement with the province of Quebec, which calls for 200,000 kg of cannabis over a five-year period.
“This gives us the second highest recreational revenue certainty among licensed producers for the first year of the adult-use market in Canada, with 20 metric tons committed, representing 35 per cent of the Quebec adult recreational market.” said St-Louis in a press release. “We also launched HEXO, a new brand that will serve the recreational cannabis market and transferred the first plants in to our 250,000 sq. ft. greenhouse expansion a month ahead of schedule.”
Fagan says that HEXO’s Q3 arrived more or less in line with expectations, but the analyst insists that at this pre-recreational market stage, the quarterly results are still preliminary and not all that meaningful.
At the same time, the analyst pointed out that HEXO came out of Q3 with a solid $9.2 million in inventory, which together with biological assets and production expected by late August should put HEXO’s in-stock position to above 5,000 kg by the time shipment to Quebec’s SAQ begins (scheduled for sometime between late August and early September).
“HEXO’s solid inventory position, growing capacity, and innovative products garnering a positive consumer response all provide the company with favourable competitive positioning to tap the Canadian recreational markets in our view,” says Fagan in a research note to clients on Friday.
“While HEXO could require some wholesale supply to effectively target provinces outside of Quebec, we believe this would be only a short-term requirement (one quarter max.), and hence not a major risk to margins in our view,” he says. “With high visibility stemming from ~$90 million in guaranteed sales embedded in the SQDC contract, a strong balance sheet (~$250 million net cash), and valuation relatively attractive at 6.8x CY20 EV/EBITDA (~45 per cent discount to peers), HEXO remains one of our Best Ideas in the Canadian cannabis sector.”
The analyst has made minor changes to his FY2018 and FY2019 forecasts to reflect slightly higher sales and marketing expenses. Fagan sees HEXO generating EBITDA and revenue in FY18 of negative $10.9 million (was negative $9.6 million) and $5.6 million (was $5.7 million), respectively, and EBITDA and revenue in FY19 of $5.6 million (was $6.9 million) and $95.8 million (was $100.7 million), respectively.
Fagan’s $8.50 target represents a projected return of 67.0 per cent at the time of publication.