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Why Did Hexo (TSX:HEXO) Fall 4.1% in August?

Shares of Hexo (TSX:HEXO)(NYSE:HEXO) fell 4.1% last month. Despite the loss in market value, Hexo managed to outperform the cannabis index and peers. Horizons Marijuana Life Sciences ETF fell 13% last month, while major players such as Aurora Cannabis, Canopy Growth, and Cronos fell 11%, 27%, and 19%, respectively, in August 2019.

Hexo accounts for 3.9% of HMMJ. Canopy Growth, Aurora, and Cronos account for 11%, 10%, and 9.5% of HMMJ, respectively. Hexo was impacted by the overall weakness in the cannabis industry.

Investors were spooked after Canopy Growth posted underwhelming quarterly results. Last week, Canopy’s major investor Constellation Brands too reported an expected loss of $54 million and attributed it to its investment in Canopy Growth. The regulatory issues that drove CannTrust stock to its 52-week low have made investors cautious as well.

Hexo stock should move higher

Stocks in the cannabis industry have lost significant value since October 2018. Hexo shares fell 51% from $8.82 in October 2018 to $4.26 by the end of December last year. The stock then made a strong comeback in the first four months of 2019, gaining 158% in that period.

Since the start of May 2019, Hexo has lost 52%. Hexo shares are trading 30% above its 52-week low and 53% below its 52-week high. Analysts are optimistic about the stock and have a 12-month target estimate of $10.37. This indicates an upside potential of 94% from the current price.

But what will drive Hexo’s stock price higher? The company is estimated to increase sales by 1,110% to $59.67 million in 2019 and 452.3% to $329.5 million in 2020. This revenue growth will propel Hexo towards profitability as well.

Analysts expect Hexo’s net margin to reach 13.4% in 2020 and 17% in 2021. Hexo stock is trading at a forward price-to-earnings multiple of 45 which is not too high given the company’s expected revenue and earnings growth estimates.

Hexo aims to be a market leader in cannabis

Hexo is focused on gaining traction in the cannabis segment. It aims to be among the top three cannabis players in the world by focusing on operational scalability, brand leadership, and product innovation.

The company has invested heavily in research & development, technology, and infrastructure to achieve its financial goals. Similar to peer companies, Hexo has grown via partnerships and is looking at the medical marijuana market in Europe to drive sales higher going forward.

Hexo has a multi-year extraction contract with Valens. Hexo will be able to extract about 30,000 kgs in cannabis and hemp biomass in the first year of contract and this is expected to rise to 50,000 kgs in the second year. The upcoming legalization of edibles will expand Hexo’s production to 150,000 kgs.

The verdict

Hexo shares will be able to surpass analyst price target estimates and move significantly higher if the company manages to beat analyst sales and target expectations in the upcoming quarters. Stocks in the cannabis sector should again move higher if companies manage to regain investor trust and confidence, especially after the recent CannTrust scandal.

The growth story for cannabis stocks remains solid. It is now up to companies to deliver on promises without compromising on integrity.

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Fool contributor Aditya Raghunath has no position in any of the stocks mentioned.

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