HEXO is still undervalued, Beacon Securities says

Gatineau, Quebec’s HEXO Corp (HEXO Corp Stock Quote, Chart TSX:HEXO) came up with a solid top line and healthy guidance in its latest quarterly report, according to analyst Russell Stanley of Beacon Securities, who on Thursday reiterated his “Buy” recommendation and 12-month target price of $14.00.

Cannabis play HEXO Corp released its third quarter fiscal 2019 (July 31 fiscal year end) financials on Wednesday, showing gross and net revenue of $15.9 million and $13.0 million, respectively. Both were ahead of Stanley’s forecast of $12.3 million and $10.2 million, respectively. The analyst estimates HEXO’s Q3 EBITDA as a loss of $14.7 million, which compares to his forecast of negative $6.2 million and the consensus negative $7.5 million. Stanley chalks up the EBITDA miss to softer than expected gross margins (40 per cent of gross revenue versus the 53 per cent forecasted) and higher than expected OPEX.

The analyst notes that over the quarter, approximately 91 per cent of the company’s adult-use revenue came from sales to Quebec, with the other nine per cent in Ontario and BC, but Stanley sees more diversification ahead for HEXO.

“While the agreement with the SQDC ensures that Quebec will be HEXO’s number one customer for the foreseeable future, we expect the production ramp up, and the sales relationships that Newstrike brings with other provinces, to help diversify the revenue base over time,” writes Stanley in a client update.

“Importantly, management reiterated its F2020 guidance for net revenue of $400 million and predicted that its Q4/19 net revenue would 2x Q3/19 levels, implying net revenue of over $26 million (versus consensus of approximately $29 million (gross), which includes some contribution from Newstrike,” he says.

Stanley notes that cash used in operations (i.e., cash outflow) improved to $5.9 million from an outflow of $15.1 million in the previous quarter and that at the end of the quarter HEXO had cash and cash equivalents of $173.1 million and total debt of $33.7 million.

The analyst is now calling for fiscal 2019 revenue and EBITDA of $63.2 million and negative $30.0 million (was negative $21.3 million), respectively, and fiscal 2020 revenue and EBITDA of $450.0 million and $157.2 million, respectively.

Stanley’s $14.00 target represented a projected return of 77 per cent at the time of publication.

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