HEXO keeps “Sector Perform” rating at ATB Capital

ATB Capital Markets analyst Frederico Gomes believes HEXO Corp. (HEXO Corp Stock Quote, Chart, News TSX:HEXO) still has some work to do, as he maintained a “Sector Perform” rating and target price
$1.10/share, implying a 39.2 per cent return in an update to clients on Thursday.

Founded in 2013 as The Hydropothecary Corporation and headquartered in Ottawa, 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 released its financial results for the second quarter of its 2022
fiscal year, which Gomes noted to be mixed.

“We view this as a noisy quarter amid a major operational turnaround as the new management takes
measures to right-size the Company through “The Path Forward” plan,” Gomes said.

HEXO Corp’s quarter was headlined by $52.8 million in net revenue, providing a slight miss in relation to the targets set out by ATB Capital Markets ($56.1 million) and the consensus ($58.1 million) despite yielding 5.2 per cent sequential growth driven by an increase in international sales from $6 million to $8.2 million.

Gomes attributes the miss to lagging overall performance in the Canadian cannabis market, along with a 29 per cent sequential decrease in sales of Redecan due to logistical issues and competition in the pre-roll market in Ontario.

Meanwhile, from a margin perspective, the company reported adjusted gross profit of $18.8 million, which was ahead of the ATB projection of $15.1 million and mirroring the consensus target, for a margin of 35.6 per cent.

The margin was driven by a Canadian margin of approximately 37 per cent and an international margin of almost 57 per cent.

However, the company’s adjusted EBITDA came in at a loss of $5.6 million, which still came in ahead of the consensus projection of a $6.6 million loss and the ATB estimate of an $8.5 million loss.

It was also an expensive quarter for HEXO, having paid $4.5 million in expenses related to severance and restructuring charges, $4.6 million in integration and acquisition costs, and a further $616 million worth of impairment losses to goodwill, intangible assets, redundant assets, and suspended capital projects.

All told, the company ended the quarter with $37.7 million in unrestricted cash, with an additional $134.3 million in restricted funds, with Gomes estimating the company has approximately $78.5 million remaining in its $150 million ATM facility.

However, under the proposed partnership agreement with Tilray and KAOS Capital, HEXO could help its financial picture by gaining access to $5 million a month in equity backstop cash for the next three years, as well as approximately $100 million in restricted funds.

“This has been a transformational quarter for the Company and we’re very pleased with the progress we’ve made on a number of fronts,” said Mark Attanasio, Chair of the Board and Executive Chair of HEXO in the company’s March 18 press release. “We’ve finalized terms of a number of proposed agreements, including the recently announced strategic investment from Tilray, that will, once finalized, restructure the more onerous repayment and liquidity terms of the Secured Note. We expect this much improved structure will allow us to accelerate our growth path and unlock the full potential of the organization.”

For the time being, Gomes has left his financial projections identical to his December 15 analysis, meaning he continues to project revenue of $235.7 million for a year-over-year increase of 90.4 per cent. From there, the analyst 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 projecting a $29.8 million loss for 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 been on a ride over the last 12 months, plummeting 91.4 per cent in that time period and 14.3 per cent since the calendar turned to 2022. A year ago today, HEXO was at a 52-week high of $9.05/share, but after its precipitous drop, it has shown some life since hitting a 52-week low of $0.60/share on
January 27.