HEXO Corp is Becoming a Cannabis Sector Sleeper Hit

HEXO Corp (TSX:HEXO), one of the Canadian marijuana stocks, appears underappreciated by the market despite a more than 86% year-to-date return

Sean Mason | June 12, 2019 | SmallCapPower: HEXO Corp. (TSX:HEXO), one of the Canadian cannabis stocks, is set to report its third quarter 2019 financial results after markets close on June 12, 2019. Despite HEXO’s year-to-date return of nearly 87%, based on the current share price of C$8.80, its stock seems to fly under the radar as the Company has relatively little news flow compared with its peers in the C$1 billion-plus market cap cannabis club.

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So, why should investors appreciate HEXO stock? First, the Company has secured the single largest forward supply contract among licensed producers in Canada, with its 20,000 kg supply deal with the province of Quebec for the first year post legalization. HEXO estimates this agreement will equate to $1 billion in potential revenue over five years. Quebec is the second most populous province in Canada and HEXO says its market share there exceeds 30%.

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HEXO has also made a big move into English Canada with its recently-closed acquisition of Newstrike Brands Ltd, which is expected boost HEXO’s production capacity to 150,000 kg annually, diversify its domestic market penetration to provinces including Ontario, British Columbia, Alberta, Saskatchewan, Manitoba, Nova Scotia, and Prince Edward Island, and add infrastructure with four cutting-edge production campuses totaling ~1.8 million sq. ft. of cultivation space. Furthermore, the combined entity is estimated to realize annual synergies of $10 million. Newstrike was one of the first Canadian cannabis companies to realize the value of branding with its association with The Tragically Hip, the iconic Canadian rock and roll group.

Finally, its joint venture with Molson Coors Canada for creating non-alcoholic, cannabis-infused beverages for the Canadian market could pay off big for HEXO Corp once cannabis edibles become legal in Canada, sometime this year or early next. Molson Coors has the infrastructure to penetrate international markets in jurisdictions where cannabis ingestion is legally permissible.

Back in September 2018, Riposte Capital, LLC, one of HEXO’s largest shareholders, released a letter to the Company, expressing concern over what it considered the “current depressed valuation” of HEXO stock. At the time, Riposte calculated the intrinsic value for HEXO at $18 per share, which translates into $3.5 billion in market cap based on 198.3 million shares outstanding. Riposte also ascribed $500 million to its Molson Coors JV, noting that it is modest compared to $12 billion in market cap ascribed to Canopy Growth’s Constellation deal. Other positives noted by Riposte included Hexo’s strong balance sheet and its lowest production costs owing to low energy prices in Quebec.

And, in April 2019, Bank of America analyst Christopher Carey named HEXO as his Top Pick in the cannabis space, citing the Company’s strong fundamentals, innovation efforts and potential for additional value-add partnerships, which makes its valuation, in his opinion, compelling.

During Q2 2019, HEXO reported gross revenue of $16.2 million, a 144% quarter-over-quarter increase during the Company’s first full quarter following the legalization of adult-use cannabis in Canada.

Disclosure: Neither the author nor his family own shares in the company mentioned above.

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