It could be tempting to lump all Canadian marijuana stocks together. This temptation could lead you to think that if there's a problem with one cannabis producer, it's affecting all of the others as well. Granted, in some cases that's true -- such as the retail environment constraints that are hurting the entire industry. But it's not always true.
For example, HEXO (HEXO) reported on Nov. 15 that it had grown cannabis in an unlicensed area. At first glance, this could stir up concerns that HEXO is guilty of the same issues that have plagued CannTrust (CNTTQ) for months. But HEXO's licensing issues aren't even in the same league as CannTrust's problems and don't appear to be anything for investors to worry about.
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What happened with HEXO
HEXO announced last Friday that it discovered on July 30, 2019, that cannabis had been grown in a part of the Newstrike Brands facility in Niagara known as Block B that was not licensed. That might sound bad, but there's more to the story.
Newstrike received a license from Health Canada for its Niagara facility in November 2018. That was well before HEXO completed its acquisition of Newstrike Brands earlier this year. The Newstrike team assumed that Block B was licensed like the rest of the Niagara facility because it was included in the license application.
Health Canada even inspected the Niagara facility in February 2019, with cannabis being grown in Block B. This inspection didn't reveal any concerns from the agency about the cultivation of cannabis in this space.
However, after the Newstrike acquisition closed, HEXO learned that Block B wasn't appropriately licensed. The company immediately halted growing cannabis in the area. It notified Health Canada as soon as the problem was discovered. HEXO also held up any shipping of cannabis from the area and scheduled it for destruction. The company stated that Health Canada "was satisfied with HEXO management's corrective actions."
Since then, HEXO has discontinued operations at the Niagara facility -- not due to these issues but rather as part of an overall right-sizing of operations. The company could resume production at Niagara in the future, though, if demand increases enough to warrant such a move.
Totally different from CannTrust
Based on HEXO's account of what happened, there are stark differences between the issues and actions taken between it and CannTrust.
Most importantly, members of CannTrust's management team, including its then-CEO Peter Aceto, were fully aware that the company was growing cannabis in unlicensed grow rooms and hid the fact from Health Canada. The issue only came to light after an audit was conducted by the Canadian regulatory agency. Aceto was subsequently fired and CannTrust's chair of the board of directors pushed out.
Health Canada later yanked CannTrust's licenses. CannTrust replaced much of its management team and board of directors and slashed its workforce. The company eventually presented a remediation plan to Health Canada but still hasn't regained its license to produce cannabis.
HEXO, on the other hand, seems to have taken immediate action as soon as the licensing issue was discovered. There's no reason to think that its management team had any knowledge of the problem, especially with Health Canada's February inspection not raising any yellow flags about Block B.
The one knock against HEXO's management is that it didn't disclose the issue earlier. The company said that it chose "to proactively address this occurrence." But reporting the issue more than three months after it happened isn't exactly being proactive. HEXO even acknowledged that it announced the details of the issue because it "recently became aware that false information was being circulated to damage the reputation of the company." That's reactive, not proactive, but HEXO's handling of the licensing issue is still completely different from the mess that CannTrust made.
Big challenges
While HEXO's recently revealed licensing issue doesn't appear to be anything for investors to worry about, there are other challenges that do warrant concern. Topping that list is HEXO's path to profitability.
CEO Sebastien St-Louis said in the company's Q4 conference call in late October that HEXO can achieve positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) "by calendar 2020." But St-Louis provided few details for exactly how HEXO will achieve this goal.
He also stated that HEXO needs to capture a 20% market share in Canada to become profitable. The company's strategy for reaching this level appears to be waiting for other companies to stumble. While there's been plenty of stumbling going on with other Canadian cannabis producers, there's no reason at this point to expect that HEXO will vault into the top two players in the industry and capture 20% of the overall market.
HEXO's not in the same predicament as CannTrust. But the company still faces some big challenges of its own that aren't nearly as easy to address as its Block B licensing issue.
