Cannabis Corner: Cut Through the Hexo Haze

Hilary Kramer

Hilary Kramer is an investment analyst and portfolio manager with 30 years of experience on Wall Street.

I think we’re seeing something like capitulation play out in Big Cannabis stocks. While that’s a healthy sign of firmer fundamentals over the horizon, investors simply need to weather the industry storms in the here and now.

Hexo Corp. (NYSE:HEXO) is this week’s sick canary in the cannabis field. Like many start-up companies, it’s growing fast and Wall Street has rewarded it for that growth. But when that growth falters, the punishments are severe.

With Hexo, the mood was already anxious after the chief financial officer quit suddenly because he was tired of commuting across Canada. Then the revenue warning hit.

Apparently, sales of pre-rolled cigarettes, sprays and enhanced cannabis products aren’t ramping up as fast as analysts wanted to see. They were looking for $25 million in sales this quarter. Hexo isn’t committing to more than $16 million.

And that simple confession triggered a blast of panic selling throughout the industry. In the last two days, Hexo is down 27 percent, losing $170 million in market capitalization to compensate for that $9 million in revenue that isn’t going to come in right away.

Naturally I think the reaction is overdone. We’re dealing with a company that didn’t even take in $5 million in the entirety of 2018 and is now on track to generate 9X that much revenue this year even after lowering its 4Q19 target.

What’s changed? The company investors were happy to hold above $4 because it was raising the top line 990 percent is now on sale below $3 to cover what’s shrunk to a mere 820 percent growth rate.

When a business is expanding this fast, these fluctuations aren’t even rounding errors in a marathon measured in years. A few good months or even weeks can get Hexo back on course and then those who sold at $4 will envy those who bought at $3.

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For us, however, what’s important isn’t the fate of Hexo but what reaction to this little company says about broader market sentiment. People leaping to conclusions have dumped all cannabis stocks across the board.

And the results have been extreme. Hexo’s miss took roughly $3 billion in market cap away from the bigger cultivators we track like Canopy Growth Corp. (NYSE:CGC) and Aurora Cannabis Inc. (NYSE:ACB).

Since Hexo was only an $800 million stock, the industry has now lost far more money here than it would if the ambitious little start-up had simply gone bust. Fundamentally, that just doesn’t add up.

When the selling doesn’t match the fundamentals, irrational sentiment is in control. We’ve seen these stocks attract plenty of froth in the past. Now I suspect the mood has moved too far in the opposite direction.

After all, Hexo doesn’t blame a downswing in demand for its products. You can’t stand behind an 820 percent growth year if your market is actively deteriorating.

They blame delays. When those regulatory hurdles and retail bottlenecks resolve, they’ll get that lost $9 million back and more.

If not, someone in the industry will grab it instead. Maybe that will be one of the giants, in which case the contagious selling we saw this week is a true buying opportunity.

Either way, my Turbo Trader Marijuana Millionaire Portfolio is nimble enough to keep pivoting to the opportunities. Unlike most cannabis investors, we’ve booked our share of profits in the last few months. We’ll keep doing it.

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