The TSX Index had a great 2019, but not all Canadian stocks fared as well as the overall market, and some are starting 2020 with an uncertain future.
Let’s take a look at the current situation at HEXO (TSX:HEXO)(NYSE:HEXO) to see if it deserves to be on your contrarian buy list.
Losing fans
HEXO is the leading cannabis company in Quebec and has licensing agreements with eight provinces.
The stock found favour with investors in the past couple of years for its overall coverage of the emerging areas of growth in the marijuana industry, despite its relatively small size compared to the larger players in the market.
HEXO entered an agreement with a partner in Europe to build a production facility in Greece that will serve as the base to supply medical marijuana in the region, as European countries adjust their cannabis policies.
In Canada, HEXO acquired Newstrike Brands in 2019 in a move that expanded its reach across the country. HEXO also secured a position in a two-million-square-foot facility in Ontario that is designed to serve as its base for the manufacturing and distribution of cannabis-based products.
HEXO’s partnership venture with Molson Coors Canada led to the creation of Truss, which will market cannabis-infused beverages.
Through much of the volatility in the marijuana sector, HEXO had remained relatively stable. That changed, however, in the second half of 2019, and things could get worse in 2020.
What’s up?
At the time of the Newstrike purchase, HEXO initially told investors it was targeting fiscal 2020 revenue of $400 million. The position was maintained again in June, and HEXO even said it anticipated fiscal Q4 results, which covered operations to the end of July, would show revenue of roughly $26 million, or double the previous quarter.
In the fall, the company had to abandon its fiscal 2020 outlook and revised down its expectations. Fiscal Q4 revenue came in at just $15.4 million, and fiscal Q1 2020 revenue, which covered the three months ended October 31, was just $14.5 million. The company had a net loss of $62.4 million in the quarter.
HEXO slashed 200 jobs in October and raised $70 million from insiders. The fact that it had to turn to the CEO and board members for funding was a warning sign. In late December, HEXO announced it was issuing 15 million new shares at at US$1.67 per share for gross proceeds of US$25 million.
The stock plunged from $2.60 per share to $2.00 on the TSX Index in the following two trading days, taking HEXO to new lows for the year and bringing the market capitalization down to $515 million.
At the current revenue rate, HEXO is set to generate less than $60 million in fiscal 2020, which is well off the $400 million it anticipated just six months ago. As such, the management team has a credibility issue, and that is keeping investors and lenders on the sidelines.
Upside?
HEXO is slashing expenses to get operations in line with the current revenue stream. Ontario is planning to open more cannabis retail shops in 2020, and that should help the industry. The launch of the edibles market could also provide a nice revenue boost.
As such, a rebound could occur in 2020, and HEXO might turn out to be a great buy at the current price.
2020 outlook
Is it too little, too late?
In the event the broader stock market goes through a correction in the first part of 2020, HEXO and its peers will likely come under additional pressure. Another share issue to raise cash isn’t a reasonable option given the low stock price, so the company could run into a cash flow problem in the coming months.
In the event the management team isn’t able to turn things around in time, HEXO could potentially disappear. A white knight might emerge to acquire the business, but that probably wouldn’t occur at a premium.
Contrarian investors might want to start nibbling on the hopes of a recovery, but I would probably seek out other opportunities today.
