More pain for HEXO, says ATB Capital

The stock is down plenty this year but there’s no good news coming from ATB Capital Markets analyst Frederico Gomes who has taken another slash to his view of HEXO Corp. (HEXO Corp Stock Quote, Chart, News TSX:HEXO). In a report on Wednesday, Gomes maintained his “Underperform” rating while dropping his target price from $1.50/share to $0.80/share, which at press time translated to a 12-month return of negative 28 per cent.

Founded in 2013 as The Hydropothecary Corporation and headquartered in Gatineau, Quebec, HEXO Corp 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 first quarter financial results for the 2022 fiscal year that missed consensus metrics, with the price drop coming just over a month after Gomes had cut his target from $6/share to $1.50/share.

“In our view, HEXO’s operating performance was impacted by the headwinds in the Canadian cannabis market—intense competition in a highly fragmented market leading to market share and margin pressure—as well as one-time items that added noise to the company’s results,” Gomes said.

The financial results were headlined by $50.2 million in revenue; despite posting a 70.2 per cent year-over-year increase, the figure missed in regards to both the consensus estimate of $53.4 million and the ATB projection of $56.1 million.

Net adult-use revenue proved to be a bright spot for HEXO in the quarter at a 47 per cent sequential increase, boosted by the acquisitions of Redecan, which contributed $12.9 million in sales, and 48North, which contributed $1.1 million in sales. Without Redecan and 48North’s contributions, however, net adult-use revenue would have dropped ten per cent quarter-to-quarter.

From an EBITDA perspective, the company’s reported $11.6 million loss missed on the consensus expectation of an $8.1 million loss while beating the $16.8 million loss projected by ATB, though it also came in significantly behind the $400,000 loss reported in the same quarter of 2021.

Gross profit produced the worst miss for HEXO in the quarter, as the company reported a $32.8 million loss, way off from the ATB projection of a $12.4 million positive gross profit, and even further off the consensus projection of a $17.3 million positive gross profit.

Gomes’s biggest concern with HEXO is the company’s reliance on equity and/or debt issuance, as HEXO’s free cash flow was a $79.1 million loss. HEXO has US$241.6 million of principal outstanding under its Senior Secured Convertible Note, though it would immediately become due if HEXO does not attain positive adjusted EBITDA by the next quarter under the terms of a default event.

“We are taking immediate steps through our new strategic plan, The Path Forward, to strengthen our capital position, improve operations, accelerate organic growth and complete our transformation to be cash flow positive from operations within the next four quarters,” said Scott Cooper, President and CEO of HEXO in the December 14 press release. “Having visited all our core sites, and in meeting with our employees and customers, I am more confident than ever in HEXO’s future and our ability to accelerate the creation of short and long-term value for shareholders.”

The new financials have prompted Gomes to modify his financial projections for the company, lowering his revenue projection for 2022 from $253.8 million to $235.7 million for a 90.4 per cent year-over-year increase, while lowering his 2023 projection from $321.3 million to $307.2 million for a 30.3 per cent year-over-year increase. His 2024 projection remains at $392.7 million, good for a year-over-year jump of 27.8 per cent.

Meanwhile, after projecting a $29.8 million loss in 2022, Gomes forecasts the company’s adjusted EBITDA to turn positive in 2023 at $31.8 million for a margin of 10.4 per cent, with a projected jump to $69.4 million and a 17.7 per cent margin in play for 2024.

In terms of adjusted gross profit, the quarterly miss prompts Gomes’s 2022 projection to plummet from $63.4 million to $17.1 million for a margin of 7.2 per cent, with the 2023 projection now set at $99.6 million instead of $103.8 million, though the margin projects a slight increase to 32.4 per cent.

Despite the company having a plan in place, Gomes believes HEXO needs to continue its overhaul.

“We view HEXO’s indebtedness as a material risk to its shareholders,” Gomes said. “We believe that a comprehensive balance sheet restructuring needs to occur for the Company to execute on its strategic plan and reduce liquidity and dilution risk.”

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. The stock is presently at its lowest point of the year, trading at $1.02/share at press time.