The Hydropothecary Corp has a 68 per cent upside, PI Financial says

Analyst Devin Schilling of PI Financial sees good value in cannabis producer The Hydropothecary Corporation (TSX:HEXO), which he says boasts a low cost operating model, a history of product innovation and, so far, has locked up the largest provincial supply agreement among Canada’s licensed producers.

In a coverage launch on Thursday, Shilling has rated HEXO a “Buy” with an $8.50 price target, representing a 68.0 per cent 12-month return at the time of publication.

Gatineau, Quebec’s The Hydropothecary Corp graduated from the TSX Venture to the senior board on June 21, a testament to the five-year-old company’s ability to execute, says CEO and co-founder Sebastien St-Louis.

“Since 2013, our company has demonstrated our continuous commitment to providing industry-leading, innovative products while never compromising the quality or consistency that we are known for. We are thrilled to represent this on the TSX,” St-Louis said.

Over the past year, the company, which intends to change its name to HEXO Corp., has raised over $240 million, funds that will fuel its expansion plans. HEXO aims to have its 1.3 million sq. ft. facility up and running, which is expected to produce 108,000 kg of dried cannabis per year.

Schilling likes HEXO’s low operating costs, stemming from Quebec’s power and labour costs which are lower than most other regions in Canada, but he also makes note of the company’s product innovation, which over the last year included the release of Decarb marijuana powder and cannabis oil sublingual spray Elixir, both of which won awards for “best new cannabis products” at the 2017 Lift Canadian Cannabis Awards.

“Based on our selling price assumptions and HEXO’s projected capacity levels, we are forecasting sales to reach $94.3 million by FY19,” says Schilling. “We view our forecast as being very conservative as the SAQ agreement accounts for ~95 per cent of our FY19 volume forecast. Our sales forecast for FY20 is $209.5 million, a 122 per cent increase over FY19 with the SAQ agreement now accounting for ~75 per cent of our FY20 volume forecast.”

“We believe HEXO represents good relative value in the cannabis sector,” says Schilling. “The company’s five-year supply agreement with the SAQ is larger than any of the provincial supply agreements announced to date, yet HEXO’s market cap is just a fraction of the industry heavyweights.”

The analyst’s price target stems from an EV/EBITDA multiple of 21x his FY20 estimates, while his “Buy” recommendation comes with a “Speculative” risk rating.