Is It Too Late to Buy HEXO Stock?

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Shares of Canadian marijuana grower HEXO (NASDAQ:HEXO) plunged by 7% on June 14 after the release of subpar earnings for third-quarter 2021 (ended April 30). As the soon-to-be largest marijuana producer in Canada and its top producer of cannabis-infused drinks, investors had pretty high expectations for the company.

Instead, HEXO’s revenue growth stalled, its losses continued, and its debt ballooned. So should investors double down on the dip? 

People smoking cannabis at an outdoor party.

Image source: Getty Images

What went wrong? 

HEXO’s revenue grew by just 2% year over year in Q3 2021 to $22.6 million Canadian dollars. Meanwhile, its loss from operations decreased slightly from CA$21.1 million to CA$16.1 million during the same period. The results were disappointing in the context of the 94% year-over-year revenue growth HEXO achieved in the second quarter.

The company blamed the bad timing of strain cultivations and the overproduction of hash for the sub-par performance. On top of that was the poor handling of the coronavirus pandemic in Quebec (Canada’s second-most populous province) in the first half of the year. Despite implementing a strict curfew, shutting down outdoor facilities, closing down a vast majority of retail stores, and banning the sale of “non-essential” items, Quebec still ranks No. 1 in terms of COVID-19 deaths per capita in Canada. 

Quebec is HEXO’s biggest market with about 50% market share, and the disruptions to supply chains and consumer demand creamed its bottom line. But, excluding the province, the company’s sales grew by a stunning 169% year over year. 

Is now the time to buy? 

The good news is that Quebec has begun lifting its restrictions as massive vaccination programs are in full steam. As a result, HEXO’s sales will likely return to growth as early as this quarter. The company also has a lot of upcoming mergers and acquisitions.

On May 17, HEXO announced a CA$50 million buyout of 48North Cannabis. During Q3 2021 (ended March 31), 48North improved its revenue by 94% year over year to CA$5.2 million.

On June 1, the company closed its acquisition of fellow pot-producer Zenabis Global. The CA$235 million deal will add CA$59.3 million in sales and CA$3.5 million in operating income less non-cash items (EBITDA) to HEXO. Zenabis grew its sales by 95% compared to 2019 last year. 

In the latter half of the year, the company will be closing its CA$925 million buyout of Redecan, one of Canada’s largest and most profitable private pot producers. Redecan ranks among the top three in sales of prerolls, oils, capsules, and vapes in major provinces and generated CA$110 million in sales in the past 12 months. With all of its acquisitions combined, HEXO will account for a 17% market share in the Canadian cannabis market. This places the company at the top position, beating Tilray‘s (NASDAQ:TLRY) 15.5% market share, which briefly held that title from last December to late May. 

Right now, HEXO has an enterprise value (EV) of CA$2.294 billion compared to about CA$264 million in total revenue. That gives the stock an EV-to-sales multiple of 8.7. Shares are pretty cheap from a growth standpoint, as the company could see as much as 40% to 50% sales rebound in the fourth quarter. 

However, keep in mind that none of the companies HEXO acquired, save for Redecan, are profitable. In addition, HEXO took on CA$539 million worth of debt for these mergers (with only about CA$178 million of cash and investments on hand), so there’s a lot at stake. More cautious investors might wait for HEXO to turn a profit first before opening a position. There’s just too much leverage at this point for HEXO to be a truly safe cannabis stock to buy now.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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