HEXO is far from broke, says AltaCorp Capital

The recently-announced lawsuit from cannabis extractor MediPharm Labs (MediPharm Labs Stock Quote, Chart, News TSX:LABS) against Canadian cannabis LP HEXO Corp (HEXO Stock Quote, Chart, News TSX:HEXO) has no relation to HEXO’s liquidity position, says analyst David Kideckel of AltaCorp Capital, who commented on the event in an update to clients on Monday.

Last Friday, Barrie, Ontario’s MediPharm issued a statement saying that it had filed a Statement of Claim in the Ontario Superior Court of Justice against a Canadian Licensed Producer in relation to payment of $9.8 million from a private label cannabis oil supply agreement. As reported by BNN Bloomberg, the suit is against HEXO in connection with a supply agreement signed in February 2018 between MediPharm and Newstrike Brands, which was purchased by HEXO in March 2019.

“The contract is a supply agreement for which we had serious concerns and, in an effort to drive value for our shareholders, we attempted to work in good faith towards a resolution that was suitable for both parties. Unfortunately, these efforts were unsuccessful,” said Isabelle Robillard, HEXO’s vice president of communications, in an email to BNN Bloomberg.

According to MediPharm, HEXO is in breach of contract because it hasn’t made payments under the agreement since October 2019 even as MediPharm says it delivered cannabis resin to HEXO for October. Under the terms of the agreement, there would be a firm price for the product which would “not subject to increase for any reason, including changes in market conditions, increase in raw materials, components, labour, or overhead costs or because of labour disruptions, changes in program timing or length, or fluctuation in production volumes.”

In his note on Monday, Kideckel says that the non-payment issue is not an indication that HEXO is having money troubles.

“Based on our conversations with HEXO management, and as stated publicly by HEXO, the non-payment is related to HEXO disputing the terms of the agreement. As such, according to HEXO management, it has no relation to the Company’s liquidity,” wrote Kideckel.

“Based on our estimates, on January 8, 2020 HEXO had an estimated capital position of $158 million, including potential proceeds from options and warrants that are exercisable and in-the-money (ITM), and the pro-rated cash generated and burned up to that date,” he said.

“Our estimates also include $30 million related to an undrawn credit facility. Subsequently, we note that HEXO closed a registered direct offering by which the Company raised additional gross proceeds of US$20 million on January 22, 2020. In addition, we note that despite this dispute, based on our estimates, MediPharm Labs had a robust capital position of ~$111 million as of January 8, 2020,” Kideckel wrote.

In his most recent company update on HEXO on December 16, Kideckel reviewed the company’s fiscal first quarter 2020 financials which the analyst viewed as “mixed,” with revenue of $14.4 million coming in at the low end of guidance and below his $15.0-million forecast and the consensus $15.7 million. An Adjusted EBITDA loss of $24.6 million was also lower than Kideckel’s negative $18.9 million forecast and the Street’s negative $21.4 million.

With the December update, Kideckel reaffirmed his “Sector Perform” rating while dropping his target from $3.75 to $3.15, which at the time of publication translated to a total return of 10.5 per cent.