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1 Cannabis Stock to Avoid At All Costs

By Prosper Junior Bakiny - Jan 19, 2020 at 12:00PM

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The cannabis industry could rebound this year, but HEXO shouldn’t be atop your buy list.

Cannabis company HEXO (HEXO -5.11%) has several things going its way. For instance, the pot grower teamed up with alcoholic beverage maker Molson Coors (TAP 0.89%) in 2018, and out of this partnership was born a joint venture, dubbed Truss Beverages. HEXO is looking to make a dent in the potentially lucrative cannabis derivative market in Canada via this joint venture.

Through its acquisition of Newstrike Brands for 263 million Canadian dollars (about $201 million) in March 2019, HEXO was able to increase its production capacity. With a projected peak output of about 150,000 kilograms per year, HEXO now ranks in the top 10 pot growers in Canada by production capacity.

Furthermore, HEXO holds the leading market share in the adult-use cannabis market in Quebec, which is the second-largest Canadian province by population. Despite these advantages, HEXO -- which saw its shares plunge by 53.6% last year -- shouldn't be on the list of cannabis stocks you want to buy. Here's why. 

Word "avoid" spelled with letter blocks with toy car carrying block letter "D."

Image source: Getty Images.

HEXO's share dilution

Over the past few years, many of the top pot companies have raised significant amounts of capital through dilutive forms of financing, including issuing such securities as stock and convertible debentures. On the one hand, dilution can sometimes be a necessary evil. Cannabis companies don't always have the means to fund their expansion efforts through traditional financing methods, due to the shaky regulatory landscape that has characterized the marijuana industry. However, resorting to dilutive forms of financing is a bit of a double-edged sword. Doing so increases the outstanding shares count of a company, thus decreasing the value of existing shares.

Last year, HEXO announced two rounds of fundraising within a mere two months. First, in late October, the company announced it would be raising CA$70 million (about $53 million) by issuing convertible debentures. This round of fundraising closed in early December. Then, in late December, HEXO announced it would be raising $25 million by issuing new shares, and this round of fundraising closed on Jan. 2, 2020. It just announced another round of shares on Jan. 17, to the tune of $20 million. These dilutive rounds of financing make HEXO's stock less attractive. 

Disappointing financial results

On Oct. 10, 2019, HEXO released an update with preliminary results for the fourth quarter of its fiscal year 2019. While these preliminary results were disappointing, that wasn't the biggest story. In this update, the company mentioned several problems it was encountering in the Canadian cannabis market, including a slow rollout of retail cannabis stores, regulatory uncertainty, and "signs of pricing pressure."

HEXO withdrew its revenue guidance for its 2020 fiscal year. The company initially promised investors revenue in excess of 400 million Canadian dollars ($306 million), but "given the uncertainties in the marketplace," HEXO felt it could no longer deliver on that promise. Naturally, investors weren't pleased, and the company's shares plunged by 21% after it released this update. 

Note that for the fourth quarter of its fiscal year 2019, HEXO recorded net revenue of CA$15 million ($12 million) -- lower than the consensus analyst estimates -- and the company recorded a total net loss of CA$44.7 million ($34.2 million). HEXO didn't perform much better during the first quarter of its fiscal year 2020. The company's net revenue was CA$14.5 (about $11 million), and its total net loss was CA$60 million ($46 million).

HEXO's poor financial results and its decision to withdraw its guidance for its fiscal year 2020 aren't good signs.

Can HEXO make a comeback?

HEXO could benefit from several tailwinds. The province of Ontario -- the largest one by population -- will be opening more retail cannabis stores. This is because the government will be making some changes to the process of applying for retail cannabis licenses. For instance, while there was previously a cap on the number of retail cannabis stores allowed in Ontario, that cap will be removed.

HEXO could also benefit from the cannabis derivative market, thanks to its partnership with Molson Coors. Even taking these factors into account, however, there seems to be too much stacked against HEXO at the moment, and for that reason, the cannabis company is better avoided. 

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Stocks Mentioned

Molson Coors Beverage Company Stock Quote
Molson Coors Beverage Company
TAP
$51.23 (0.89%) $0.45
HEXO Stock Quote
HEXO
HEXO
$0.28 (-5.11%) $0.02

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