HEXO Corp is downgraded by GMP Securities

On the basis of reduced visibility going forward, analyst Robert Fagan of GMP Securities downgraded HEXO Corp (HEXO Corp Stock Quote, Chart, News TSX:HEXO) on Friday from “Buy” to “Hold” and reduced his price target from $9.50 to $4.00 per share, saying that his forecasts reflect the now-lowered 2020 guidance from management.

Last Thursday, Gatineau, Quebec licensed cannabis producer HEXO Corp announced that it has withdrawn its 2020 revenue guidance and lowered its sales estimates for the quarter ended July 31, citing a number of issues, including slower store rollouts across Canada, a delay in the emergence of the cannabis derivatives market and early signs of pricing pressure. The company said that its fourth quarter results, to be reported on October 24, will show revenue of between $14.5 million and $16.5 million rather than the previous forecast of $26 million.

“Fourth quarter revenue is below our expectation and guidance, primarily due to lower than expected product sell through,” said CEO and co-founder Sebastien St-Louis in a press release. “While we are disappointed with these results, we are making significant changes to our sales and operations strategy to drive future results. Over the past quarter, we began re-configuring our operations to focus on high-selling strains and initiated a new sales strategy that we believe will meaningfully improve performance. We plan to discuss these in more detail on our upcoming earnings call.”

HEXO Corp downgraded: new forecast at GMP

Fagan says that the roughly 40-per-cent cut in its Q4 top line is now well below his prior forecast of $26 million and the consensus call for about $25 million.

“While the Q4 reduction is disappointing (prior guidance held steady in June), the FY20 withdrawal is not entirely surprising given street estimates,” wrote Fagan.

The analyst says that the lower product sell through points to a drop in market share, which suggests that HEXO’s product assortment was “not well matched to consumer demand,” Fagan writes.

“At the new guidance midpoint ($15.5 million), this would translate to quarter-over-quarter growth of ~20 per cent for Q4, after Q3 sales were roughly flat vs. Q2 levels. This compares to overall sell-in REC volumes in Canada which were up ~23 per cent and ~37 per cent quarter-over-quarter over the same periods,” he writes.

The analyst says that risks to the company’s outlook emerge with the removal of its fiscal 2020 guidance.

“We previously noted that HEXO’s FY20 $400-million sales guidance hinged upon delays to Cannabis 2.0 rollouts, and/or licensing of the Belleville facility to boost extraction capacity. These risks have materialized, which combined with lower retail store penetration, limits to product formats in QC, and signs of pricing pressure prompted HEXO to withdraw its FY20 guidance. While we believe this outlook was aspirational, we view HEXO’s choice to not simply revise FY20 guidance points to increasing uncertainty around the outlook,” Fagan writes.

“While we expected risks to FY20 sales guidance, with the Q4 reduction, HEXO has now missed consensus for two quarters, notably in opposition to the company’s track record of good execution. We are also concerned with HEXO’s need to rework its sales strategy which could take time to perfect,” he writes.

Fagan’s new forecast calls for fiscal 2019 revenue and EBITDA of $47.6 million and negative $43.2 million, respectively, and for fiscal 2020 revenue and EBITDA of $205.9 million and $10.2 million, respectively. His $4.00 target represents a projected return of 6.4 per cent at the time of publication.