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Why Did HEXO’s Stock Price Fall 16% After Releasing Q4 2020 Earnings Results?

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Marijuana producer HEXO (TSX:HEXO)(NYSE:HEXO) released a mixed set of earnings results for its fiscal fourth quarter of 2020 after market hours on Thursday. A combination of some discouraging data points in the earnings report and perhaps the news of a share consolidation announced the following morning could be behind the 15.78% fall in the company’s share price by midmorning on Friday, October 30.

A mixed-results quarter?

The company’s fiscal year ended on July 31, 2020. During the fourth quarter, HEXO reported record revenues. Gross revenue increased by 17% sequentially and was up 76% year over year to $36.1 million. Newly launched products, including vapes, cannabis-infused beverages, and new exports supported this growth. Likewise, net revenue for the quarter increased by 23% sequentially to $27.1 million. Exports and increased wholesale sales had a better effect on net revenue, as these lines do not incur excise taxes.

Adjusted EBITDA improved with revenue growth and contained operating costs after the company’s restructuring exercises. An adjusted EBITDA loss of $3.25 million during the fourth quarter was a 21% improvement from a quarter ago.

Unfortunately, the company reported a massive fourth-quarter operating loss of $106.2 million. This was caused by increases in one-time non-cash expenses. The company recorded a $43 million inventory write-down due to “deemed inventory balances in excess of internal and external demand.” The company also impaired its properties and production assets by $46.4 million to adjust for “idle and redundant assets.”

The net loss for the quarter was a staggering $169.5 million. That was horrible!

Why did HEXO stock fall 16% on Friday?

The massive operating loss and unsettling net losses during the fourth quarter upset the market more than the double-digit sequential growth rates in revenue impressed growth-focused investors.

Moreover, a subsequent announcement of an eight-to-one reverse stock split on Friday, before markets opened, could have been viewed as a negative sentiment inducer. The company intends to implement the announced share consolidation as soon as it gets necessary approvals and after a shareholder vote in December this year.

Stock splits don’t have any material impact on a company’s fundamentals. They only increase or decrease the number of outstanding shares. However, investors usually read a stock split that increases share count as a bullish signal, which usually appears on very good companies that have seen a surge in valuation — management could be expecting the share price to grow in the future.

On the contrary, a reverse stock split is usually associated with a history of declining share prices, and management could be trying to consolidate shares to meet minimum listing requirements on the world’s top exchanges. This is actually what is happening at this marijuana firm. The company is consolidating shares so as to comply with the NYSE’s minimum US$1 a share continued listing standard. Shares in HEXO have lost nearly 93% of their value on the U.S. exchange since their peak value at US$8.40 on April 29, 2019.

Should you buy the dip?

The latest plunge in the cannabis firm’s stock price could tempt contrarian investors to buy the dip for a few reasons.

Firstly, revenue is growing nicely. The company has found a new market in Israel and its launching new products in the Canadian cannabis edibles market, a new growth frontier in partnership with Molson Coors Canada.

Secondly, the company’s latest horrible losses are mostly driven by non-cash accounting charges and adjustments. The latest inventory impairments and charges on production assets could mean improved gross margins (as lower value inventory is sold) and lower depreciation charges in the next several accounting periods. Higher margins and lower operating cost charges could mean better income statement numbers over the next few years, everything considered. You may as well pardon anyone who claims we might just have witnessed the most legal earnings management tactic in the latest earnings report.

As for me, persistent inventory charges and write-offs are a sign of a very bad business. I wouldn’t be comfortable buying into a business that is struggling to sell its products to the extent that some shelf items become obsolete. This should make one reconsider the buy decision on a beaten-down HEXO’s stock.

The company keeps changing its CFOs, and that’s usually a sign of leadership instability. It recently installed another CFO, again! Such instability on key finance and strategic leadership role could be concerning for long term investors who want to see a clear strategy and methodical execution.

That said, the company is most likely going to report stable growth and realize its goal for a positive adjusted EBITDA by January 2021. Shares may find new love when quarterly earnings results start improving over the next year. Perhaps this is a good short-term trade.

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Fool contributor Brian Paradza has no position in any of the stocks mentioned. The Motley Fool recommends HEXO. and HEXO.

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