HEXO’s target slashed by ATB Capital

ATB Capital Markets analyst Frederico Gomes has taken a hack to his assessment of HEXO Corp. (HEXO Corp Stock Quote, Chart, News TSX:HEXO), slashing his target price from $6.00/share to $1.50/share while maintaining an “Underperform” rating in a client update on October 30.

Founded in 2013 as The Hydropothecary Corporation and headquartered in Gatineau, Quebec, HEXO is a cannabis producer, marketer and retailer offering its adult-use and medical products under the HEXO brand, cannabis beverages under the Little Victory, House of Terpenes, Mollo, Veryvell and XMG brands and cannabis products under UP Cannabis, Original Stash and Up brands.

Gomes’s latest analysis comes after HEXO reported its fourth quarter financial results, though they also come amidst a wave of corporate uncertainty, according to Gomes.

“HEXO is undergoing an uncertain corporate transformation as it integrates three acquisitions with a recently appointed CEO,” Gomes said. “Funds on hand are insufficient to support debt repayment, therefore increasing dilution risk.”

The company’s financials were headlined by net revenue of $38.8 million, beating the ATB estimate of $29.6 million and the consensus projection of $33.6 million, with Gomes noting that the 71 per cent sequential increase was driven by a $6.8 million international shipment, as well as the consolidation of Zenabis Global Inc., which came into the HEXO family along with Redecan, Canada’s largest privately-owned licensed producer, and 48North, a brand-led, consumer-centric licensed cannabis producer. 

HEXO’s adjusted gross profit came in at $8 million, beating the ATB projection of $6.9 million while missing the consensus estimate of $12.2 million. Meanwhile, the company’s quarterly EBITDA was a miss from all sides, with the $13 million loss compared to the ATB estimate of a $10.2 million loss and the consensus expectation of a $5.5 million loss. The loss was largely attributed to higher costs from integrating its recent acquisitions, which Gomes believes has actually hindered HEXO’s overall progress, to an extent.

“We believe that HEXO’s recent performance in the Canadian recreational cannabis market has been impacted by the Company’s M&A integration efforts,” Gomes said. “In other words, we believe that HEXO’s resources were allocated to integrating acquisitions, therefore distracting management from driving organic growth. We believe that the company may be in a good position to regain some of its lost market share over the coming quarters.”

The company recently appointed Scott Cooper as its new President and Chief Executive Officer, though he will remain in his previous role as CEO of Truss Beverage Co., a joint venture between HEXO and Molson-Coors Canada, for a maximum of six months in an aim to ensure a seamless transition for the company.

Cooper brings experience to the table, having held several senior roles at Molson-Coors, including Chief Innovation Officer, as well as with Sobeys, Unilever and several other publicly traded CPG companies.

“Without question, HEXO presents one of the most exciting opportunities in the cannabis industry,” Cooper said in the October 20 press release announcing his hiring. “I look forward to working with the team to build upon the strong foundation already built, particularly through the Company’s recent acquisitions and to drive growth and profitability through the efficient commercialization of cannabis consumer packaged goods.”

One of Gomes’s bigger overarching concerns is that the company could be looking at share dilution in relatively short order, as the company has Senior Secured Convertible Note outstanding at a redemption amount of $459 million, repayable at $25 million a year in either cash or equity, with cash potentially being required if HEXO’s 20-day VWAP drops below US$1.50/share, with Gomes noting that the company would have to effectively double its share issue to repay the note.

The recent reports have prompted Gomes to revise some of his financial projections, as he has lowered his 2022 revenue projection to $253.8 million from his initial $270.8 million estimate, though the new number is still a potential 105 per cent year-over-year increase over the reported 2021 revenue of $123.8 million. Looking into 2023, Gomes provides a more significant reduction to a projected $321.3 million from $378.7 million, which would still be an increase of 26.6 per cent year-over-year.

Meanwhile, Gomes projects the company to move into positive EBITDA range in 2023 at a reduced figure of $32.1 million and a 10 per cent margin (previously $43.2 million and a margin of 11.4 per cent), though before that, he projects a 2022 loss of $38.6 million after initially estimating $2.6 million in positive EBITDA. At press time, Gomes’s new $1.50 per share target represented a projected one-year return of negative 17 per cent.

Overall, HEXO Corp’s stock price has drifted downward for most of the year as it has produced a loss of 68 per cent in 2021, as it was unable to sustain its high point of $13.05/share from February 10, and is presently at its lowest point of the year, trading at $1.64/share at press time.