HEXO is a stock to avoid right now, AltaCorp says

Headwinds will continue to batter licensed cannabis producer HEXO (HEXO Stock Quote, Chart, News TSX:HEXO), according to AltaCorp Capital analyst David Kideckel, who reviewed the company’s latest quarterly results in an update to clients on Monday.

Shares of Gatineau, Quebec’s HEXO rose slightly on Monday as the company reported its first quarter fiscal 2020 financials for the period ended October 31, 2019. HEXO saw total revenues grow to $14.4 million from $5.7 million a year earlier while adjusted EBITDA went from a loss of $29.8 million over the previous quarter to a loss of $24.6 million.

The company said it is working towards profitability in 2020.

“The choices that we have made and implemented have already led to a 25 per cent reduction in our operating expenses,” said Sebastien St-Louis, CEO and co-founder. “Cost control combined with our multi-brand approach, an updated strain mix, as well as the introduction of new products, will help us increase our market share and total revenue, leading us towards great results in 2020.”

Kideckel said the $14.4-million top line was lower than his $15.0-million estimate as well as the consensus $15.7 million and at the bottom end of the company’s guidance of between $14 and $18 million. Gross margin of 31.5 per cent was lower than his 33.7-per-cent estimate, while the adjusted EBITDA loss of $24.6 million was below his estimate of $18.9 million and the consensus $21.4 million.

The analyst said HEXO continues to face margin pressures due to a decline in the company’s net selling price per gram, a trend which he sees as pervasive across the sector. The culprit, Kideckel said, is in the main part an imbalance between supply and demand in the Canadian market, resulting in HEXO’s case in inventory write-offs, provisions for sales returns and price concessions.

“The Company continues to face near-term headwinds related to the inadequate retail infrastructure and a demand and supply imbalance in Canada, resulting in a declining average selling price per gram and margin compression,” wrote Kideckel.

“While we expect this trend to continue over the near-term, we believe that the Company may experience meaningful growth over the long-term, depending on the development of the retail infrastructure as well as the launching of derivative products into the Canadian market,” he said.

Looking ahead, Kideckel thinks HEXO’s focus on developing new products and creating strategic partnerships should give it a leg up in the newly-opened derivatives market, generating “meaningful growth” for HEXO in Cannabis 2.0.

At the same time, the analyst said regulatory bottlenecks related to the slower-than-anticipated roll-out of cannabis retail across the country will figure into HEXO’s fortunes over the mid-term.

Kideckel has rejigged his forecasts, now calling for fiscal 2020 revenue and adjusted EBITDA of $67.7 million and negative $37.9 million, respectively, and fiscal 2021 revenue and adjusted EBITDA of $104.5 million and $7.9 million, respectively.

With the update, Kideckel has reaffirmed his “Sector Perform” rating but has dropped his target price from $3.75 to $3.15, which at press time represented a projected return of 10.5 per cent.