The case for cannabis producer Hexo (NYSE:HEXO) has been based in part on the idea that investors have missed the story. When pot stocks started taking off early last year, the HEXO stock price still languished.
That’s clearly starting to change. The story behind Hexo is gaining a broader reach — and the Hexo stock price is responding in kind. The question at this point is whether that’s a good thing — and whether a strong YTD is starting to price in at least some of the opportunity here.
HEXO Stock Price Soars
While cannabis stocks soared in 2018, HEXO mostly was left out of the gains. The stock gained just 5% for the year, as a rally that began in September quickly fizzled.
It’s been a different story in 2019. HEXO has gained 101% YTD as of this writing. And there are some fundamental reasons for the gains. The announced acquisition of Newstrike Brands (OTCMKTS:NWKRF) was well-received. Hexo raised cash at the beginning of the year, putting its balance sheet in good shape. Second-quarter results in March looked impressive: sales increased over 1,200%.
But a big part of the story with HEXO stock in 2019 is that its story has spread. That’s most apparent when looking at the stock’s trading volume. At the end of last year, 30-day average daily volume was under 400,000 shares. Four and a half months later, it’s at 5.3 million.
The company’s listing on the New York Stock Exchange has been a huge driver of that volume. And it’s helped the HEXO story become more widely known. That, along with the Newstrike deal and the strong Q2, has been why HEXO stock has outperformed other pot stocks.
CGC shares are up 70% so far this year, and Aurora Cannabis (NYSE:ACB) about the same. (Interestingly, an NYSE listing had the opposite effect on ACB stock, albeit in a very different market for marijuana stocks.) Cronos Group (NASDAQ:CRON) is up 47% in 2019; TLRY shares actually have declined 30%.
Is There Juice Left in HEXO?
So the interesting question here is whether there’s more outperformance on the way with HEXO — or if the market has caught up with the story at this point. Josh Enomoto wrote last month, with the HEXO stock price not far from current levels, that the stock still looked compelling.
And Enomoto makes several solid points. The Newstrike deal adds capacity. The combined companies’ total production capacity is 150,000 kilograms of cannabis annually.
Increasingly, it appears that simply producing weed isn’t going to be the path to enormous profits. Cannabis plays need to be differentiated. Hexo’s goal of becoming “the premier branded ingredients for food cannabis company”, as it put it in a recent presentation, creates that differentiation.
At the same time, the gains in HEXO stock have moved its valuation to the nosebleed levels seen elsewhere in the space. Its market capitalization, pro forma for the Newstrike deal, is likely nearing $2 billion. (It’s not clear exactly how many shares will be issued to Newstrike shareholders. Hexo’s most recent filing with Canadian regulators also cites nearly 50 million shares subject to warrants not included in the current diluted share count of nearly 200 million.)
Meanwhile, Q2 net revenue, as impressive as growth was, came in at just C$13.4 million (~$10 million). HEXO stock, then, is trading at something like 50x its current revenue run rate.
Just Another Pot Stock?
The combination of valuation and trading volume suggests that HEXO no longer is an “under the radar” play. And that makes the case a bit tougher from here.
At this point, investors have no shortage of options when it comes to investing in cannabis. And the choice largely comes down to how an investor sees the space playing out. Those looking for scale should choose Canopy or Cronos, both of which are backed with billions of dollars from Constellation Brands (NYSE:STZ) and Altria (NYSE:MO), respectively.
Tens of smaller, high-risk plays still sit on over-the-counter markets. Aurora offers the most diversification. Tilray might be getting cheap after its long decline. Another alternative is the 40-pot-stock ETFMG Alternative Harvest ETF (NYSEArca:MJ), which includes HEXO stock among its top 10 holdings, at 3.76% of the portfolio. CRON is the largest holding, at 8.71%.
The case for HEXO is intriguing, particularly for those (like Enomoto) who see big growth in edibles and beverages. But the story is out there — and the edge might not be quite what it was just a few months ago.
As of this writing, Vince Martin has no positions in any securities mentioned.
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