HEXO Corp is still a pass, says ATB Capital

ATB Capital Markets analyst Frederico Gomes is pleased with the headway made by HEXO Corp. (HEXO Corp Stock Quote, Chart, News TSX:HEXO), raising his rating from “Underperform” to “Sector Perform” and raising his target price from $0.80/share to $1.10/share, with the target implying a 45 per cent return in an update to clients on Thursday.

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 announced a partnership agreement with Tilray Brands.

“We believe the agreement is positive for HEXO’s shareholders, as it materially de-risks the Company’s balance sheet, removes the going concern overhang on the stock, and provides additional liquidity to execute “The Path Forward” plan,” said Gomes, who noted his target change came from lowering the discount rate on the stock from 18 per cent to 14 per cent.

Under the terms of the agreement, Tilray has agreed to acquire up to US$211 million of HEXO’s Senior Secured Convertible Notes held by HT Investments. If the transaction closes, the notes will be amended to set a conversion price of C$0.90/share, which represents approximately 37 per cent ownership of HEXO’s basic shares if converted. The deal would also extend the maturity of the notes by three years to May 1, 2026, and bear annual interest of ten per cent, to be fully paid in cash during the first year and half in cash through the residue period, with the remaining portion accruing to be paid in cash or shares at the time of maturity or upon conversion.

“Restructuring HEXO’s debt is a critical first step in allowing the Company to move forward with its Path Forward strategy and to begin to unlock significant shareholder value,” said Mark Attanasio, Chair of the Board of Directors of HEXO in the company’s March 2 press release. “The company has endured a crippling overhang for the past twelve months, due to punitive redemptions and discounted dilutive financings, and we needed to solve this issue in order to make positive progress. This new deal accomplishes this and places HEXO solidly on a path to growth.”

As part of the agreement, HEXO will gain access to US$80mm in cash that is currently restricted on its balance sheet. Both companies are expecting to save up to $50 million from cost synergies, which would be split evenly, and the savings would come from the cultivation and processing services, certain cannabis 2.0 products, and establishing a joint venture to provide services to both companies.

“We believe the proposed transaction is a win-win for Tilray Brands and HEXO as it would launch a strategic partnership between two leading Canadian cannabis producers with complementary brand portfolios,” said Irwin D. Simon, Chairman and CEO of Tilray Brands. “For us, it provides a path for meaningful future equity ownership of HEXO and enables us to participate in HEXO’s share price appreciation as it continues to execute on its growth initiatives.”

HEXO has also entered into an agreement with KAOS Capital for an equity backstop of $180 million in the form of $5 million monthly subscriptions for 36 months, issued at a ten per cent discount to the 20-day VWAP at the time the demand is made.

Despite the target increase, Gomes has left the majority of his financial estimates untouched. From a revenue perspective, after the company completed its 2022 fiscal year at $235.7 million, Gomes projects an increase to $307.2 million in 2023 for a potential year-over-year increase of 30.3 per cent. Looking ahead to 2024, Gomes forecasts another jump to $392.7 million, suggesting a year-over-year increase of 27.8 per cent.

Meanwhile, after reporting a $29.8 million loss in fiscal 2022, Gomes projects HEXO’s adjusted EBITDA figure to turn positive in 2023 at $31.8 million for an implied margin of 10.4 per cent. Gomes projects the margin to get wider in 2024, with the $69.4 million projection implying a margin of 17.7 per cent.

Gomes also expects the company’s gross margin to drop from 29 per cent in 2021 to seven per cent in 2022, then rising again to a projected 32 per cent in 2023.

HEXO’s stock price has plummeted to a 91.1 per cent loss over the last 12 months, and is down 18.7 per cent since the start of 2022. After hitting a 52-week high of $9.80/share on March 15, the stock has been on a downward trend since the start of June, eventually dropping to a 52-week low of $0.60/share on January 27.