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Why Hexo, Cronos Group, and Tilray Surged as Much as 76.5% in November

By Billy Duberstein – Dec 7, 2020 at 10:50AM

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It was a great month for pot stocks, but these massive moves seem like ill-informed speculation to me.

What happened

Shares of Canadian cannabis companies Hexo (HEXO -0.74%), Cronos Group (CRON 2.65%), and Tilray (TLRY) rocketed 76.5%, 65.6%, and 58.3% higher, respectively, during November, according to data from S&P Global Market Intelligence.

The surge in these Canadian cannabis companies was due to the November U.S. elections, which will bring a more cannabis-friendly administration into the White House. Just as importantly, marijuana ballot measures went five for five in the U.S. election across both red and blue states, indicating broad support for cannabis decriminalization in the massive U.S. market.

Still, it's curious that these three Canadian companies surged so much on news from a neighboring country, especially given that their recent operating results have mostly been lackluster, and an incoming administration is unlikely to decriminalize cannabis at the federal level.

A hand drops a coin into a piggy bank with a marijuana leaf painted on its side.

Image source: Getty Images.

So what

Hexo likely surged so much because its stock was down massively coming into November. In fact, Hexo's stock was actually down some 90% from levels reached as recently as April 2019, before the Canadian market fell into a grave oversupply situation. Hexo's stock had even fallen under $1, and the company recently considered a reverse split -- never a great sign.

Sure, Hexo's recent earnings showed better-than-expected 76.5% growth, but that was off a relatively tiny base, and it's still losing a ton of money. The company also wrote off 42 million Canadian dollars' worth of inventory, as well as CA$46 million of property, plant, and equipment -- a worrying sign that demand isn't catching up to Hexo's past investments.

So why is the U.S. election a big deal? Well, Hexo has a partnership with Molson Coors Brewing (TAP -0.02%) to develop CBD-infused beverages for the U.S. market, but that's a far cry from having full vertically integrated cannabis operations in the U.S.

Cronos Group appears to be doing somewhat better, and its November earnings report showed impressive 96.3% growth. Still, like Hexo's, that growth was off a minuscule base, as the company made just $11.4 million in net revenue last quarter and actually recorded negative gross margins. Cronos still gets a majority of its revenue from the beleaguered Canadian market, as it only sells CBD products in the U.S.

Investors are likely excited about Cronos' partnership with Altria (MO 0.27%), which invested $1.8 billion in the company back in late 2018 and has given Cronos a great cash-rich balance sheet, which is unique among its overstretched Canadian peers. Still, while Cronos has global ambitions, it currently can't enter the U.S. cannabis markets outside of CBD until there is legalization. Investors may be getting ahead of themselves here.

Finally, Tilray also rocketed on U.S. election news but then fell sharply after it reported lackluster earnings the following week. Despite its large full-month gains, Tilray's stock is still below its early-November levels between the election and its earnings announcement.

The company actually missed revenue expectations, only growing revenue 0.6% last quarter, though losses improved due to a focus on higher-margin products. And while Tilray does export its products to other countries, like the others mentioned here, it's still limited to CBD products in the U.S. Tilray's balance sheet is also a mess, with nearly half a billion dollars in combined convertible and senior debt.

Due to its tepid growth and the possibility of having to raise more capital, Tilray's stock fell after the announcement as analysts downgraded it. Yet the company still finished higher for the month due to speculation around changing U.S. cannabis laws.

Now what

While I'm bullish on U.S. multistate operators postelection, I would steer clear of these Canadian cannabis companies right now. The November surge seems like wild speculation that these three companies will somehow vastly benefit from a more cannabis-friendly Biden administration, yet that enthusiasm seems misplaced. An incoming administration might be able to roll back some restrictions for existing U.S. players, such as passing the SAFE Banking Act or even the STATES Act, but full federal legalization seems unlikely if the Senate remains in Republican hands.

That means that while business could improve for their U.S. counterparts, these Canadian companies will still likely be limited to the smaller and competitive U.S. CBD market. Meanwhile, the Canadian market is still a mess due to the slow rollout of retail licenses, vast overproduction, and the thriving black market. In contrast, U.S. cannabis companies are thriving, as they are not only growing much faster but are also much more profitable than their Canadian counterparts.

It's likely that the Canadian pot stocks surged in November because they are the only pot stocks available on certain trading platforms; they trade on major U.S. exchanges, while the still-"illegal" U.S. companies only trade in Canada or over the counter.

In other words, don't go chasing these stocks on the wild postelection speculation. Over the long haul, business results and balance sheets will matter, and none of these Canadian companies look like great businesses today.

Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool recommends HEXO. The Motley Fool has a disclosure policy.

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