We all saw what happened when the popular Canadian pot stock Aurora Cannabis (ACB -7.79%) chose to initiate a reverse stock split in May. Aurora's shares had started trading below $1 on the New York Stock Exchange (NYSE), which is against the trading compliance. To save its stock from getting delisted, Aurora opted for a 1-for-12 reverse stock split. It boosted the share price for a limited period, before the stock crashed this year. Aurora's consistent unimpressive quarterly results added to the disaster. The company's stock has slumped 59% so far this year, compared to the measly 1% gain of the industry benchmark, the Horizons Marijuana Life Sciences ETF.
Another Canadian pot company in the same boat as Aurora is HEXO (HEXO), which received an NYSE listing warning in May when its shares fell and traded below $1 for 30 consecutive days. Now, to save itself from getting delisted, HEXO has proposed an 8-for-1 reverse stock split. This consolidation of its shares is subject to shareholder approval today, Dec. 11. In the face of mixed recent fourth quarter 2020 results and shares that are down 35% year to date, will this share consolidation help save the stock and give the company time to achieve profitability?
Is HEXO set up for success?
Recreational cannabis products contributed 83% to HEXO's fourth-quarter (ended July 31) total net revenue, which was up 76% year over year to 27.1 million Canadian dollars.
Cannabis derivatives, in particular, added to the top-line growth. Derivatives are additional recreational cannabis products that Canada legalized as part of the "Cannabis 2.0" legalization in October 2019. Cannabis. 2.0 products include vapes, edibles, concentrates, and beverages. HEXO offered its vape products across Canada to both recreational and medical consumers in July.
Additionally, it also launched cannabidiol (CBD) and tetrahydrocannabinol (THC) infused beverages during the quarter through Truss Beverage, a partnership venture with Molson Coors Canada (a business under the Molson Coors Beverage Company (TAP -0.39%) umbrella). These offerings, launched under five brands -- Little Victory, House of Terpenes, Mollo, Veryvell, and XMG -- brought in CA$1.9 million worth of sales in the quarter.
HEXO also created a business venture with Molson Coors to explore opportunities for offering non-alcoholic, hemp-derived CBD beverages in Colorado. The company kept all production and distribution within Colorado state lines, where recreational use of marijuana is legal. (The use of CBD in food and beverages is still federally regulated by the U.S. Food and Drug Administration.)
In July, HEXO marked its entry into the Israeli medical cannabis market by launching its products through an agreement with Breath of Life International, an Israeli medical cannabis company. The Israeli medical cannabis market is seeing a surge in patients that could bring in more consumers for HEXO's products. In the last two years, authorized medical cannabis patients have more than doubled in Israel, according to Marijuana Business Daily. Moreover, Israel has strict border controls that limit the illicit cannabis market, which could help preserve legal cannabis sales.
Both of these deals have yet to reach their full potential in adding to HEXO's overall revenue growth and profits.
Achieving profitability could still take a while
HEXO's quarterly operating expenses jumped to CA$418.6 million from CA$110 million in the year-ago period. Various impairment charges and new product launches added to the higher expenses in the quarter, according to management. The adjusted EBITDA, which stands for earnings before income, tax, depreciation, and amortization, loss of CA$3.2 million is easily explained by the rise in expenses. However, the good news is Q4 2020 EBITDA was an improvement compared to a whopping CA$28 million loss in Q4 2019.
A company that handles operating expenses in an efficient manner can bring itself close to achieving positive EBITDA. HEXO assured investors in its Q4 results that it is working its way toward achieving positive adjusted EBITDA by the first half of 2021. Peer Aurora Cannabis also expects to achieve positive adjusted EBITDA by its second-quarter fiscal 2021 ending Dec. 31.
I am highly doubtful that this will happen, since Aurora again recorded huge losses in its first-quarter along with declining revenues. It looks like HEXO is in the same boat. With the recent surge in operating expenses, its revenue growth is not enough to breakeven, at least not by the first half of 2021. Though the expenses were incurred to launch new derivatives, the sales from derivatives products don't look like they'll be enough to cover those expenses.
We will have to wait and see how HEXO lives up to its promises. For now, it remains a risky cannabis stock. But its strategies to expand into the Israel medical cannabis market and strengthen its cannabis beverage business in Canada and the U.S. could help it earn more, more quickly. If (or when) federal legalization happens in the U.S., there will be a much wider market for HEXO's derivatives products.
Stock consolidation is not always a bad thing -- it can help boost its price. But that can only happen if the company uses the money raised in a productive way. If HEXO fails to grow its earnings and revenue after consolidation, it will lead to a worse stock dilution scenario (in which the value of the stock is reduced for existing investors). With that in mind, I would advise keeping a close watch on this marijuana company's progress before putting the stock in your basket.