It looked like HEXO (HEXO +0.00%) might be one of the top pot stocks of 2020 when the company reaffirmed in June that it was projecting sales for fiscal 2020 to hit $400 million Canadian dollars. Things have changed significantly since then, however, and not only is the stock a worse buy today, but it could be even riskier than beleaguered CannTrust Holdings (CTST +0.00%).
HEXO's rough year
Where there's smoke, there's usually fire, and HEXO has been putting out a lot of fires. In October, the company made headlines when it announced that it was abandoning its CA$400 million sales forecast for fiscal 2020and that its CFO had resigned. This was just weeks before the company released its Q4 results, which continued to disappoint investors. HEXO reported a sizable net loss of CA$57 million, more than five times the CA$11 million loss it incurred in the prior-year quarter.
Then, in November, the company revealed that a "limited quantity" of pot was grown at one of its facilities in a room that wasn't licensed to grow pot. HEXO inherited the facility through its acquisition of Newstrike earlier in the year. The company claims that once the unlicensed cultivation was discovered, HEXO immediately notified Health Canada officials and took steps to stop the growing activities and it destroyed the affected inventory. HEXO hasn't provided specifics as to how much pot was grown illegally, only saying that a "tiny" amount of marijuana would have made it into the market. Health Canada indicated it will not take any action against HEXO.
While the stock has been rocked by collateral damage with the broader cannabis industry suffering this year, HEXO played a significant role in that instability, and its wounds have been largely self-inflicted. Although HEXO would still likely be down even without the bad press, it has lost two-thirds of its value since June, which is worse than the 48% loss that the Horizons Marijuana Life Sciences Index ETF suffered during that time. And HEXO's stock price could plummet even further.
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More room to fall
The reason HEXO might be a more dangerous stock than CannTrust today is that where HEXO will go from here is anyone's guess. With CannTrust, investors know what they're getting: a lottery ticket. If it regains its license to sell cannabis, the stock skyrockets. If it doesn't, it's just a waiting game before the company is either sold or shuts down for good.
While it's possible that CannTrust's stock will get to zero, a further decline could prove an enticing opportunity for a rival like Canopy Growth that wants to buy the company at a steep discount, if for no other reason than to acquire its facilities and expand its cultivation capacity. Earlier this year, Canopy's former CEO Bruce Linton told Sundial Growers executives that Canopy was looking at acquiring CannTrust. Although that sale didn't materialize, other companies like Aurora Cannabis could see it as a way to expand their operations quickly, easily, and on the cheap. That's why CannTrust's stock might rise from the ashes if a rival company were to make a bid.
HEXO isn't in that dire a situation, and it might never be. But with many question marks surrounding its operations and future, all it could take is another bad news release to send the stock into a further decline. Currently, the stock is trading at more than 15 times its sales -- which is still a very high multiple. If shares of HEXO were to fall to a valuation of 10 times the company's sales, that would result in another one-third decline in its price, and even then, the stock would still be very expensive given the problems the company is facing today.
That's why HEXO's stock could still see steep declines in the months ahead. In CannTrust's case, that might be less likely to happen simply because a buyout could come first.
Should investors avoid HEXO stock?
There's little reason to take a chance on HEXO today. The low price is no reason to invest in the company because there's no guarantee it won't sink even lower.
With a lack of profitability and HEXO withdrawing its sales forecast for fiscal 2020, it's hard to gauge what the stock is worth. That's why simply avoiding it is the best course of action. HEXO has gone from being one of the more promising stocks in the industry to being one of the more dangerous ones, even among marijuana stocks.
Investors would be better off sticking with an investment in Canopy Growth. While it has also struggled this year, at least investors know what they're getting: one of the top pot stocks in the world.
