HEXO (NYSE:HEXO) doesn't get as much attention as some of its peers, but it probably should. This Canadian cannabis producer has the means to grow 150,000 kilograms annually. Plus, the company markets popular branded concentrates that carry wide profit margins.
HEXO recently made a big acquisition that it thinks can jolt sales by 739% next year. Soaring growth expectations will encourage some investors to run out and buy some shares of this risky marijuana stock. Before doing anything rash, though, we should weigh HEXO's opportunities against incoming threats.
The case for HEXO
HEXO has production facilities that take up millions of square feet across Canada, and a processing plant in Greece that it hopes will supply EU members with a variety of products that could differentiate the company from its peers. The company's Hydropothecary subsidiary is relatively popular among light users in Canada who pay a whopping CA$69 for a tiny bottle of its sublingual spray. The amount of THC in the bottle could be squeezed from just a couple of grams of mid-grade flower.
During the three-month period ended Jan. 31, HEXO sold CA$16.2 million worth of cannabis, and operations only lost CA$6.9 million. While investors would prefer a profit now, the losses weren't nearly as bad as what some of HEXO's peers experienced.
HEXO's expanding its product offerings and the number of places they'll be available for sale. The company has a chance to enter the beverage market through a joint venture formed in partnership with Molson Coors (NYSE:TAP) last summer.
More recently, HEXO acquired Newstrike for CA$263 million to increase its retail footprint and production capacity. The transaction allows HEXO to produce around 150,000 kilograms of cannabis per year, plus it gives the company an interesting new strategic partner.
Newstrike is partially owned by surviving members of The Tragically Hip, a celebrated Canadian rock band. The members will receive 2.5% of sales on cannabis strains named after popular Hip songs.
America did its best to ignore HEXO's new strategic partners, but the company thinks the branding relationship can drive top line sales to CA$479 million during its next fiscal year.
Top-line revenue reached an annualized CA$65 million during the first quarter since adult-use sales began in Canada. HEXO's fiscal 2020 begins on Aug. 1, and reaching expectations would probably thrill investors.
Reasons to be nervous
The Newstrike acquisition will increase production capacity and the number of sales channels available to HEXO, but additional sales are far from guaranteed. During the nine-month period ended last September, Newstrike spent $2.35 million making products that it sold for just $3.42 million.
As long as marijuana's illegal under federal law, HEXO products will be even less popular in the U.S. than the band promoting them. That means the vast majority of HEXO's sales will come from the Canadian market, at least until the company's toehold in the EU expands.
Unfortunately for HEXO, Canada's new adult-use market already appears to be running out of gas. Legal sales of cannabis flower in January were 3.7% lower than December's figures. That hardly looks like a sales explosion that will help HEXO get anywhere near its lofty expectations.
HEXO isn't losing money as quickly as some of its peers, but operations did come up short by CA$6.9 million during the first full quarter following Canada's roll-out of adult-use marijuana sales. If demand for legal cannabis doesn't begin rising again, it's hard to see how the company will make ends meet.
Reasons to be frightened
HEXO didn't have CA$263 million in cash, so it created around 33 million shares to acquire Newstrike. That will raise the company's outstanding share count by around 17%, and in turn, it will shrink the slice of future profits shareholders are entitled to down the line.
In just two short years, HEXO's increased its share count 193% to pay bills, build greenhouses, and acquire companies like Newstrike. That means anyone who has held the stock that long has seen the company's market cap jump 1,110% to $1.3 billion, while the price of their shares rose just 309%.
If Canada's market for licensed cannabis sales continues to disappoint, HEXO's going to have a hard time justifying its valuation. Unfortunately for HEXO and its Canadian peers, the country's thriving illicit market is going to be tough to beat unless mail-order marijuana services start paying taxes.
According to Statistics Canada, legal marijuana sales reached $768 million in the fourth quarter of 2019. That's impressive, considering the cost per gram for licensed cannabis was 49% higher than illicit marijuana purchased at unlicensed dispensaries or online.
Once investors realize HEXO and dozens of its peers will need to fight for their share of a market that probably won't total more than $4 billion each year, things could get ugly. It's best to stay away from this stock until we see what happens after HEXO and friends pump millions of kilograms of product into a market that has just 2.1 million daily users.