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HEXO will continue to underperform, AltaCorp Capital says

HEXO

HEXO AltaCorp Capital analyst David Kideckel is staying cautious on Canadian cannabis company HEXO (HEXO Stock Quote, Chart, News TSX:HEXO) after its latest earnings, saying headwinds in the industry and share dilution are reasons to keep his “Underperform” rating while sightly dropping his price target.

Gatineau, Quebec’s HEXO released its fiscal third quarter 2020 results on Thursday for the period ended April 30, 2020. The company saw net revenue improve by 30 per cent from the previous quarter to $22.1 million and an adjusted EBITDA loss of $4.3 million compared to a loss of $8.5 million over the Q2. Adult-use sales volume grew by 42 per cent sequentially to 9,338 kg while gross margin before fair value adjustments grew by seven per cent over the prior quarter to $8.8 million.

HEXO incurred an inventory write-down of $0.2 million while operating expenses dropped to $26.8 million compared to $46.9 million a year earlier. In terms of its production, management said it has shifted towards those flower strains most in demand by consumers, with the company now working to get Cannabis 2.0 products on the shelves.

On the COVID-19 front, management said demand has picked up, first due to stockpiling in March but then also related to overall increased usage during the stay-at-home period.

HEXO said their goal is to be EBITDA-positive during the first half of its fiscal 2021. “While we continue to operate during a pandemic, we continue to be cautious about future expectations.  Our plans to achieve adjusted EBITDA positive in the first half of fiscal 2021 will depend on the growth of retail stores in our two largest markets, Ontario and Quebec. It is difficult to determine the timing of new licenses for new retails stores in Ontario and the build out of additional stores in Quebec. We await additional information from the authorities of each Province and Territory,” the company said in its press release.

Kideckel said HEXO’s quarter came in better than expected, with the $22-million top line beating his $16-million estimate and the consensus $20-million, while the adjusted EBITDA loss of $4.3 million was also better than his forecasted loss of $4.7 million and the Street’s loss of $7.7 million.

The analyst said he’s encouraged by HEXO’s better gross margin at about 45 per cent, which he said was likely driven by lower labour costs due to packaging automation and the company’s cultivation rightsizing efforts focusing on selected strains.

A couple of point of concern for Kideckel are the derivatives market, where HEXO lags behind other Canadian LPs, according to the analyst, and HEXO’s ability to gain market share outside of the province of Quebec, with Kideckel saying that expanding its presence in provinces like Ontario and BC is “critical” to the company’s stated goal of becoming a Top 2 Canadian LP.

“In our view, the limited retail infrastructure in these provinces may be a bottleneck for HEXO’s expansion over the near-term,” Kideckel said.

“Though we view the [quarterly] results as positive, we remain cautious due to the shareholder dilution caused by the conversion of a portion of HEXO’s outstanding debentures at an exercise price materially lower than the Company’s current market price,” Kideckel said.

“In addition, we believe that near-term headwinds affecting the Canadian cannabis industry, a lack of derivative products, and the COVID-19 global crisis continue to impose uncertainty to HEXO’s outlook. As such, we have chosen to remain on the sidelines until the overall market environment improves and HEXO’s management shows consistent execution,” he wrote.

The analyst’s new 12-month target of $1.00 (previously $1.05) represented at press time a projected return of negative 22 per cent.

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About The Author /

Nick Waddell
Cantech Letter founder and editor Nick Waddell has lived in five Canadian provinces and is proud of his country's often overlooked contributions to the world of science and technology. Waddell takes a regular shift on the Canadian media circuit, making appearances on CTV, CBC and BNN, and contributing to publications such as Canadian Business and Business Insider.

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