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2 Reasons to Stay Away From HEXO After Its Blowout Third Quarter

By Prosper Junior Bakiny – Jun 21, 2020 at 6:44AM

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This cannabis stock isn't worth the trouble, even with its shares trading for about $1 apiece.

HEXO (HEXO 6.07%) released its earnings report for the third quarter of fiscal year 2020 on June 11, and the pot grower managed to impress investors for a change. During this quarter, HEXO's net revenue of 22.1 million Canadian dollars increased by 70% year-over-year and 30% sequentially. The cannabis company also seems to have gotten its expenses under control. During the third quarter, HEXO's operating expenses came in at CA$26.8 million, significantly better than the CA$281.5 million operating expenses the company recorded during the second quarter. 

Further, HEXO's net loss of CA$19.5 million shrunk from the CA$298.2 million net loss recorded during the previous quarter. One of the catalysts for the company's higher sales during the third quarter was its leading market share in the province of Quebec, the second-largest Canadian province by population. According to HEXO CEO Sebastien St-Louis, the company holds a greater than 30% market share in this province.

Red maple leaf surrounded by cannabis leaves.

Image source: Getty Images.

The company is hoping that thanks to the launch of several products -- including the recent introduction of a large-sized (30-gram) format of its popular Tsunami cannabis flower -- its sales will continue growing. HEXO can also count on its partnership with Molson Coors Brewing (TAP 1.20%). Back in 2018, the two entities penned a deal to form a joint venture, called Truss Beverages, to develop and sell nonalcoholic cannabis-infused drinks. Molson Coors owns 57.5% of Truss, while HEXO owns the remaining 42.5%.

This opportunity could turn out to be lucrative, as the market for cannabis derivative products (known as "cannabis 2.0" in Canada) continues to evolve. Even with these potential tailwinds, though, I think investors had better stay away from HEXO. Here are two reasons why. 

HEXO's share dilution problems

Over the past few months, HEXO has relied on dilutive forms of financing to raise capital on several occasions. Here's a short rundown of these rounds of fundraising.

  • HEXO raised CA$70 million by issuing convertible debentures between October and December 2019.
  • In late December, the company issued new shares (and warrants) and raised $25 million in a round of financing that closed in early January.
  • HEXO issued new shares (and warrants) again and raised $20 million in a round of fundraising that closed in late January.
  • The pot grower raised CA$46 million in an underwritten public offering in April, issuing nearly 60 million new shares (and even more warrants) in the process.
  • Lastly, HEXO raised CA$57.5 million in May in yet another public offering.

These rounds of fundraising could eventually come back to haunt HEXO and its shareholders. Even if the company performs well, and its stock price increases significantly as a result, once investors decide to exercise their warrants, doing so will dilute existing shareholders. That is something those thinking about buying shares of HEXO cannot ignore. 

Could HEXO get delisted?

HEXO's stock has been hovering around the $1 mark for a while. In fact, the company's shares spent enough time below this threshold for HEXO to receive a notice from the New York Stock Exchange (NYSE) that its shares could be delisted from the exchange. Specifically, the average closing price of HEXO's shares was less than $1 per share for 30 consecutive trading days. If HEXO does get delisted from the NYSE, it could mean trouble for the company. Sure, the pot grower could always switch to an over-the-counter exchange, but those are less likely to attract attention from investors. 

Getting delisted would mean that HEXO would have a harder time raising capital. Fortunately, HEXO has until Dec. 16, 2020, to remedy this situation, and the company said it could conduct a reverse stock split. This move would decrease HEXO's number of outstanding shares and proportionally increase its share price. Aurora Cannabis (ACB 1.62%) recently resorted to this option to avoid being delisted. While HEXO will probably prevent the worst-case scenario in this debacle, I don't think the company's prospects justify buying its stock, considering this and other issues -- like the aforementioned share dilution problems -- HEXO is facing. 

The key takeaway

In my view, there are vastly more attractive investment prospects in the cannabis industry than HEXO. In particular, multistate operator Trulieve Cannabis (TCNNF 5.07%) and cannabis-focused real estate investment trust Innovative Industrial Properties (IIPR 5.34%) have both recorded consistent profits and both present strong growth prospects within their respective markets. Investors looking to buy cannabis stocks would be much better off with either Trulieve Cannabis or Innovative Industrial Properties than they would with HEXO. 

Prosper Junior Bakiny owns shares of Aurora Cannabis Inc. The Motley Fool owns shares of and recommends Innovative Industrial Properties. The Motley Fool recommends HEXO. The Motley Fool has a disclosure policy.

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Stocks Mentioned

HEXO Stock Quote
$0.18 (6.07%) $0.01
Molson Coors Beverage Company Stock Quote
Molson Coors Beverage Company
$49.16 (1.20%) $0.58
Aurora Cannabis Stock Quote
Aurora Cannabis
$1.25 (1.62%) $0.02
Innovative Industrial Properties Stock Quote
Innovative Industrial Properties
$96.05 (5.34%) $4.87
Trulieve Cannabis Stock Quote
Trulieve Cannabis
$9.12 (5.07%) $0.44

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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