HEXO stock is facing the perfect storm, says AltaCorp Capital

HEXO Corp (HEXO Stock Quote, Chart, News TSX:HEXO) received a downward rerating from AltaCorp Capital analyst David Kideckel on Tuesday, as the cannabis company is facing a perfect storm of negative conditions, according to Kideckel.

Shares of Gatineau, Quebec-based HEXO were down sharply on Wednesday as the market reacted to news that the company would be delaying the release of upcoming quarterly results “due to certain exceptional circumstances,” which include impairment charges that could total $280 million. The company cited a slower-than-expected rollout across Canada of retail outlets and delays in government approval for cannabis derivative products as contributing factors.

“These factors are indicators of impairment in relation to the Company’s inventory, property, plant and equipment, intangible assets and goodwill. The Company is in the process of completing its impairment assessment and has not reach its final conclusions. However, it is expected that the impairment loss will be in the range of $265 million to $280 million,” said the HEXO press release.

The release also said HEXO would be selling its Niagara facilities, acquired in the deal last year for Newstrike Brands, and that it had established a trade blackout for directors, officers and other insiders which will continue up until the company’s fiscal second quarter 2020 results are filed.

The company added that its future is in jeopardy due to the lack of available capital in the cannabis market and HEXO’s accumulated losses to date.

In his update to clients, Kideckel said the current COVID-19 pandemic adds more strain to HEXO and other cannabis companies, as the potential closure of currently operating cannabis stores, “could depress sales over the near-term and worsen the demand and supply imbalance in the Canadian cannabis market, ultimately leading to higher cash burn rates,” Kideckel said.

“We believe that HEXO is facing a storm of negative conditions which add significant uncertainty to its outlook and may thwart the Company’s ability to execute its business strategy in the near-to-medium term,” Kideckel wrote.

“We note that HEXO’s strategy for cannabis derivative products is based on a national portfolio launch, which we believe would lead to improvement in margins and revenue growth. However, given current market conditions, this revenue and margin improvement may not happen over the near-term, which adds risk and uncertainty to the Company’s outlook,” he said.

With the HEXO press release came some financial data on the company’s Q2 2020, including net revenue which was listed as $17.0 million, a 17-per-cent increase on the previous quarter.

Kideckel said the Q2 revenue came in above his $15.0 estimate and the consensus forecast of $16.7 million. The analyst said he has revised his estimates based on current market conditions and the released Q2 data and now calls for fiscal 2020 revenue and adjusted EBITDA of $63.2 million and negative $39.5 million, respectively (previously $67.7 million and negative $37.9 million, respectively).

The analyst said while conditions look strained for HEXO and the cannabis sector over the short and medium term, his long-term outlook remains unchanged.

“We believe that the launch of derivative products marks an inflection point in the history of Canadian cannabis. In our view, the entry of new products into the market should lead to significant growth in sales in the industry and a rerating of companies across the sector over the long-term. However, over the near-term, we expect the Canadian cannabis industry will continue to face headwinds from a slow retail store rollout, as well as deteriorating economic conditions due to the Covid-19 epidemic,” Kideckel wrote.

With the update, Kideckel has lowered his rating from “Sector Perform” to “Underperform” and lowered his target from $3.15 to $1.20, which at press time represented a projected return of 87 per cent.