The Motley Fool
Cannabis stocks are showing much needed signs of life after the election of Joe Biden and the legalization of recreational marijuana in four new states. Since Nov. 1, the Horizons Marijuana Life Sciences ETF is up over 20%, which is even higher than the S&P 500’s 8% gains this month. The excitement from the voting results has lit a fire under many stocks, both in the U.S. and across the border in Canada.
Shares of HEXO (NYSE:HEXO) are up around 28% over the same period, hitting highs it hasn’t reached since June. Let’s take a closer look at the stock to see whether this rally is likely to continue and if you should consider adding shares of HEXO to your portfolio today.
The company is coming off an improved quarter
Ontario-based HEXO released its quarterly results for the fourth quarter ending July 31 on Oct. 29. Net revenue of 27.1 million Canadian dollars grew 76% year over year and was up 23% from the third quarter. HEXO’s adult-use beverages provided the standout numbers, contributing CA$2 million in net sales during the period, well above the CA$431,000 that they generated in Q3. HEXO saw decent growth in other segments in Q4, as well: Non-beverage net sales climbed 15.8% to CA$25.1 million.
In 2018, HEXO partnered with Molson Coors’ Canadian arm in a joint venture called Truss to create cannabis-infused beverages for the Canadian pot market. In 2020, it’s finally been able to begin reaping rewards from that deal. A few months ago, the company announced the launch of five new brands under Truss that offer consumers a variety of options, and are either infused with tetrahydrocannabinol (THC) or cannabidiol (CBD). Its XMG brand, for instance, is high in THC and marketed toward special occasions, while Veryvell is focused on CBD and overall wellness. Truss beverages are available in all major Canadian provinces.
Unfortunately, further down its financial statements, HEXO’s numbers didn’t look as promising. Its net loss of CA$169.5 million was a mammoth increase from the CA$18.8 million loss it incurred in the previous period. Impairment losses, writedowns, write-offs, and a loss on convertible debt crushed what may have been an otherwise strong quarter for the company as they added CA$146.8 million in additional costs.
When backing out those items and making adjustments to other non-cash items, non-recurring expenses, and investment gains and losses,the company’s adjusted earnings before income, taxes, depreciation, and amortization (EBITDA) was a much lighter loss of CA$3.3 million. And while it’s easy to discount many of those items and say that impairment and writedowns are non-cash items, investors shouldn’t disregard them entirely, because they could suggest the company’s inventory isn’t being sold quickly enough and that its assets are overvalued.
Impairment charges were a modest CA$200,000 in Q3, but in the second quarter, they had totaled CA$250.2 million. The impairment challenge is an ongoing one for HEXO, and investors should keep a close eye on these items in future periods to see if they continue popping up.
Will the election results help the stock?
Although a win for Biden and the legalization of recreational pot in New Jersey, Arizona, Montana, and South Dakota (plus Mississippi’s passing of a medical marijuana initiative) will help the cannabis industry grow in the U.S., it may not have much of an impact on a Canadian producer like HEXO.
Without the U.S. government legalizing marijuana at the federal level, HEXO’s cannabis products can’t cross the border into the U.S., making it moot whether individual states have legalized marijuana or not. And while Biden is in favor of decriminalizing marijuana, stating on his website that “getting caught for smoking marijuana shouldn’t deny you a good-paying job and career, a loan, or ability to rent an apartment,” he doesn’t go so far as to say that cannabis should be legal.
Should you buy shares of HEXO today?
When compared to other notable pot stocks, shares of HEXO are trading at a decent price-to-sales (P/S) multiple of 3.8:
HEXO PS Ratio Chart
Using the price-to-sales multiple can be effective in gauging a stock’s value when a company isn’t yet profitable, as is the case with many cannabis stocks. HEXO’s stock has been falling heavily this year and is down around 50% in 2020 as of Nov. 12, while the Horizons Marijuana Life Sciences ETF has fallen by a more modest 18% over the same period. It’s gotten so bad that the Canadian pot producer is the latest cannabis company to announce that it plans to do a reverse 1 for 8 stock split to help it stay listed on the New York Stock Exchange (NYSE). That is not as significant as the 1 for 12 reverse split Aurora Cannabis did earlier this year, but still doesn’t show shareholders that internal confidence at HEXO is high.
HEXO could be full of potential, especially if its beverage brands show continued success. But given the impairment charges and recent noise surrounding its financials, cautious investors might opt to avoid this stock for now — at least until HEXO is able to report a few periods of clean financials without significant writedowns or non-operating charges.