Like all stocks in the cannabis sector, HEXO (HEXO) has seen its stock sell sharply after the initial euphoria wore off. The company, like most in the sector, saw too little initial demand from consumers while so many companies were producing too much product. However, the company has remained focus on growth and its core products, EBITDA profitability, and gaining market share in existing markets and new markets nationwide (in Canada). In its latest quarterly teleconference, the company continues to iterate that they are very close to achieving their goal of profitability and have achieved a 30% revenue growth rate QoQ. Given the stocks brutal sell off from its top, and the potential of achieving positive earnings, I am bullish on the stock over a long-term basis.
Here is a recap of the company’s stock price since inception:
This is the weekly chart of HEXO since inception. The company went public in March 2017 to little fanfare. The stock bottomed out and then surged in the euphoria of cannabis legalization in Canada, only to fall again during the “hangover” phase of the cannabis sector. The stock is currently trading at $0.765 per share.
Achieving Growth
As mentioned, in the most recent teleconference for the company’s quarterly results, HEXO continued with its plan of achieving EBITDA profitability by year’s end. Highlighted in the teleconference, the company is on the verge of profitability. For now, the company posted net revenue of C$30.1M, up C$7.1M QoQ and up C$15M YoY; however, net income was -C$19M (you can read the transcripts here and all figures in this analysis related to the company are from this teleconference).
Without going too far into the financial details for last quarter, I wanted to look at the projections for a couple of reasons. The projections are differing from different sources, but, if we take an objective view, we get a glimpse of where this company will be in just a couple of months/quarters.
The first thing is the rate of growth of the company’s earnings. The company posted ~30% QoQ increase in revenue which is a hefty number. When you look at the state of Canadian cannabis, this is in line – if not significantly below the increases of usage in Canada.
MJDaily has Canada’s increase in sales of cannabis with an increase of ~30% from the previous month (whereas the HEXO increase was QoQ). But, if you compare the numbers for adult use in Canada from just 5 months ago (at the start of COVID in March), Canada has increased ~90%:
This is a tremendous amount of growth, and I suspect that since cannabis usage in Canada is starting to increase as quickly as it is, cannabis stocks are going to be en vogue once again and quickly. Given this growth rate, the potential of a key player in this segment to grow exists. That growth is where I am focusing.
In the province of Quebec alone, HEXO boasts a 30% market share. The province is increasing significantly as well with C$110M run rate in sales – putting HEXO revenue from this province alone at C$33M.
As stated in their teleconference, the Canadian government posits that the run rate for all of Canada puts the entire adult use sales at C$2.6B annually. However, HEXO, boastfully, claims that internal and external metrics have the industry at a run rate closer to C$7-10B. That seems to be a Grand Canyon of a gap in disparity. So, which is it?
Statistics Canada has their run rate factored to the end of year projections. This is fairly in line with the numbers we are seeing. MJDaily has this year’s run rate number coming in at just below C$3B. As for HEXO’s numbers, they are projecting from this point in time forward. However, they are using that run rate at that exact rate for 12 consecutive months, it is a linear projection which I cannot fully buy into.
There are a limited number of Canadians who smoke cannabis (about 15% for adult use). Eventually, the run rate will start to decline over time as more and more individuals gain access to government-run dispensaries in their surrounding areas. What they will not do is continuously consume cannabis in increasing numbers; their individual use will level off at some point to each person’s respective normal level. So, the projection of 30% increase, ad infinitum, becomes a bit of an overstatement as you get closer and closer to saturation.
The question becomes a matter of the growth of the company’s numbers this quarter coming up. Given Statistics Canada and MJDaily are in line with each other as they are, we can use these projections to determine where growth will come in for HEXO in the next two quarters.
With the Statistics Canada and MJDaily projections for year end about in line with each other, these projections represent the same linear rates over the short term. These are the same rates that we’ve seen over the past few months. This should equate to the same run rates for HEXO that gave them a 30% increase in revenue the previous quarter.
With a 30% increase in revenue, this puts HEXO’s forward projections of gross revenue at ~C$40M with net revenues coming in at ~C$26M. Over the past four previous quarters, HEXO has done a very good job of reversing course on their total operating expense, which, of course, includes SG&A. The company has seen its operating expense with a peak at C$35.5M then C$26.6M, C$23.1M, and C$16.1M. If HEXO can maintain this level, then they are set to have an earnings positive quarter coming forward. HEXO’s main focus was to achieve their goal through simultaneously increasing their revenue and continuing to cut SG&A costs. They look to achieve this in their next quarter’s returns.
But, COVID
No discussion of growth of any kind cannot be complete without the review of COVID. The company did highlight their own concerns of COVID and being able to get licensing through the bureaucratic process. While the company did highlight these concerns, there was no mention of what kind of difficulties this would impart on the future of business growth.
For now, what we can tell is that there had been an initial period where COVID took a toll on the world’s economies. You can see this in the chart published above. In the initial months where the world locked down in order to prevent the spread of the virus, the data for that period was mostly flat. However, once the lockdowns started to dissipate, cannabis usage jumped upwards to average the 90% increase that I mentioned earlier – maybe it was fatigue?
Given this, we have been living in the COVID era for a few months and there does not seem to be a factor in the sales of cannabis just as long as we don’t lock down. However, anyone paying attention to the news will notice quickly that the COVID numbers are spiking and are hitting new, all-time records. It may be that governments push for another halt to all activities given this pandemic’s spread. That would be the ultimate risk in the growth scenario and would put a halt to this company’s ability to grow continuously at any level. If governments shut down their respective economies, this may very well put a halt on this thesis.
Conclusion
Over the past few weeks, there have been a few cannabis companies to produce positive numbers; they are now profitable. There are also a few companies out there that are close to profitability like HEXO. What is happening is that over time, the Canada’s various provincial governments have slowly opened up dispensaries. It is a lengthy and time-consuming process. Now that dispensaries are working their way through the process of opening up their respective stores, more and more consumers are going to these stores and buying up product. HEXO is finally benefiting from this.
These growth rates are impressive. This is going to drive the cannabis companies to getting closer and closer to profitability. HEXO looks set to achieve this very soon. I also expect that with these growth rates and as more and more cannabis companies become profitable, cannabis stocks are going to become popular again with investors; this will likely drive prices upward.
I believe that HEXO’s stock was beaten down pretty far below where it should be. Now, as the company begins to earn a profit, the stock should see some interest.
I am bullish on HEXO and am likely to pull the trigger on a new position in this stock. I will be looking to hold this stock for a very long time.
