Replies to post #1623 on Cannabis Investment Club

[JohnCM]

HEXO Stands Strategically Ready For U.S. Cannabis Industry And European Markets

Jan. 26, 2021
Seeking Alpha

Summary

Hexo grows and sells cannabis throughout all of Canada and operates large-scale cultivation and distribution facilities; they are entering the US markets.

Their recent partnership between Hexo and Molson Coors, as well as the EU granting Hexo a trademark for "Powered by Hexo", promise great growth in revenue and serious expansion into.

Hexo's fundamental metrics are strong in their Q1 2021 financial reports and revenue from their cannabis-infused drink sales in Canada are on the rise.

The technical analysis of Hexo's stock price performance indicates a double-top breakout pattern and signals investment opportunities.

I predict a price movement increase for Hexo of 45% by June ($6.57 X 1,45 = $9.53) and offer long-hold and call option strategies. (Note: JohnCM $14.50 June 1st, 2021)

HEXO (HEXO) has made recent news concerning their partnership with Molson Coors and planned entry into the Colorado CBD beverage market. The company is preparing their distribution in the event of US legalization. They may take on another foreign market, since they just received a trademark from the European Union for their brand "Powered By Hexo." Their stock recently underwent a reverse split and has since restabilized with daily movements. It is important to consider Hexo in light of the recent bullishness in the market surrounding cannabis stocks.

The cannabis industry is an emerging market and one should hold an investment basket of different cannabis and cannabis support stocks. Hexo should be held along with its sister stocks. Each stock chosen for the basket should be weighed based on fundamental and technical performance.

I recommend Hexo as a member of the investment basket and consider how one can play the stock with a long position and through its call options. The strategy is to hold the stock as it goes through uptrend and price stabilization. I recommend a call option strategy for leveraged movement on any cannabis rallies that will occur over the months.

The assumption behind this strategy is that American national legalization will either be a discussion throughout 2021 or will become a reality. Some of the Canadian cannabis companies are ready to expand into legal American markets. The cannabis investor wants to be positioned for these movements and events.

Current Physical Operations of Hexo

Hexo is a small-cap ($826 million) Canadian cannabis company, traded on the NYSE in the Healthcare Sector and Pharmaceutical Industry. NASDAQ is their index. During Q1 2021, they grew 38,500 pounds of cannabis flower. They grow, process, package, and distribute cannabis flower, cannabis extracts, and cannabis infused products in all provinces of Canada.

They sell dried and packaged cannabis flower, packaged pre-rolls, vape cartridges, disposable vape pens, infused sublingual spray, pressed hash, softgels, tinctures, distillate / extracts / concentrates, and infused beverages (both THC and CBD). They carry four different product brands and a beverage brand to meet the different demands of cannabis connoisseurs and regular users.

They currently operate out of four large facilities. They have a grow facility in Gatineau, Quebec with 1.3 million square feet of cultivation space. They maintain a 932,190 square feet processing facility in Belleville, Ontario for processing flower, packaging flower, producing extracts, beverages, and other infused products. They have a 58,000 square feet distribution facility in Montreal, Quebec for storage and delivery throughout the province.

They run a 14,000 square feet research and development facility in Brantford, Ontario, where they breed new strains. Hexo has two more facilities that are not yet operational: a high-tech cannabis extraction laboratory and an R&D test-kitchen for innovating cannabis edibles. Their corporate offices are located in Ottawa.

Hexo and Molson Coors Partnership and Strategic Expansion

Hexo has a fit strategy for their current operations and an innovative one for their future operations. They sell within the top 4 positions of the Canadian market for adult use cannabis. The Molson Coors partnership set them in the top position for Canadian market for cannabis beverages. Their Q1 2021 financials already reflect this new expansion and their balance sheet is positive in terms of revenue versus cost of sales.

They formed a new company with the partnership, named Truss. Currently, Truss operates out of Hexo's processing facility. The new drink company already sells cannabis and CBD drinks throughout Canada. The next step for this enterprise is to introduce a CBD drink in Colorado, while using Molson Coors connections and distribution lines in America.

The Molson Coors deal gives HEXO operating leverage for expansion. When the United States goes legal, they will be ready with a product line and distribution network. Hexo will get started on day one of national US legalization. Until then, they will begin to take a share of the US CBD drink market. Since they have not yet entered the Colorado CBD market, it is at present unclear what the new venture will bring in terms of revenue. I will speculate below the possibilities based on Hexo's own financials.

The other new expansion concerns the European markets. The European Union just granted Hexo a trademark for their "Powered by Hexo" brand. Although there are not reports on their strategy for European expansion, we can rely on their overall cooperate strategy to guess how this expansion will occur. Hexo wants to partner with large corporations in order to spread their brand and widen their distribution. We can speculate that Hexo will try to partner with major corporations throughout Europe in countries were CBD and THC are allowed.

Like many of the publicly traded Canadian cannabis companies, Hexo is not showing a positive EPS per quarter and instead is suffering a net loss. Their Q1 2021 net loss and Q1 2021 negative EBITDA are significantly lower than their Q4 2020 results. Between Q4 2020 and Q1 2021, their revenue and cost of sales stayed about the same. Their revenue from cannabis beverages increased while the cost of sales of these beverages decreased.

On the positive side, they have plenty of cash, assets, and capital versus their overall debt. So long as revenues continue at the same pace, the company will make its obligations and continue to grow. Their revenue from cannabis beverages reflects their high share of the Canadian cannabis market. Business is good, but to make a positive EPS, it must be better.

The benefit of their 4:1 reverse split can be seen in their increased market cap and enterprise value. These items, taken with their P/B ratio, indicate great potential to come. Their Q4 2020 performance was still better than their Q3 2020 performance. The pandemic obviously had an impact on their Q3-Q4 2020 revenues. As public society reopens, we expect their revenue to increase.

There is still speculation on how much the Quebec growing contacts will bring in, since, by Hexo's own admissions, Quebec government is not buying as much as they promised. Hexo is confident that they will overcome this setback, since they are acting as preferred clients to Quebec cannabis system and running distribution for all Quebec online cannabis orders. These are government buying contracts versus private distribution, which Hexo undergoes with the other provinces.

Let's look closer at their cannabis beverage revenue and try to estimate what a Colorado CBD drink will do for their financials. They already have firm distribution in all provinces of their cannabis-infused drinks and their CBD infused drinks. Within one quarter (Q4-Q1), they increased revenue from drinks by one million dollars. Their cost of selling these drinks decreased during the same time. Their infused drink sales are only a proportion of their overall adult cannabis sales. This should be noted for predicting their Colorado CBD market move and the possibility for US national legalization.

To analyze their potential with CBD drinks, I shall share my personal experience with CBD drinks in Colorado, so you know from where my analysis originates. Understand that a CBD drink does not have a psychoactive effect on the user and these drinks can be sold anywhere and be consumed by anyone. CBD is a micronutrient in human development. All human bodies produce CBD and intake CBD from various sources. It is used as a medicine and as a micronutrient health supplement.

When Colorado began to allow CBD drinks in their retail and service establishments, these types of drinks suddenly appeared everywhere. At the time, I was working in one of the largest coffee shops in Denver with respect to revenue. A large venture capitalist firm ran the shop, so it stayed in touch with and tired out all the new drink trends. These CBD drinks had a high price point and customers loved them. They were an instant hit and still thrive all over Colorado.

There are many competing CBD drink companies and products in Colorado. I am confident that Molson Coors has the right distribution networks to gain a serious stake in the CBD drink market in Colorado. It is unclear what revenue it will produce in a quarter and whether it would be in the one-million-dollar range. The CBD drinks are a lucrative venture, but they are not as lucrative as THC drinks.

THC or cannabis-infused drinks sell at a very high price point (about $16 or more per bottle) and are popular at the dispensaries. They are infused with psychoactive cannabis and have an instant effect on the user. These drinks are health conscious because ingestion does not require smoking and they are not as powerful as edibles. The cannabis drink has many advantages to the user.

We can assume that Hexo will benefit from the Colorado CBD market by up to a million dollars or more per year. This increase will help their fundamental metrics overall, but nothing close to the increase of revenue, if the United States passes legalization. Before national legalization occurs, Hexo will likely expand from CBD drinks in Colorado to CBD drinks across the US. That move will bring its own chance at greater revenue.

The Molson Coors partnership has already provided an increase in revenue and additional revenue streams for Hexo. It remains as a smart move by the company. If they partner with European companies and distribute throughout Europe, this only guarantees greater and more revenue streams. The good news is that Hexo is very minded to make these types of expansion into new and foreign markets.

Technical Analysis of Hexo's Stock Price Performance
Hexo underwent a 4 to 1 reverse split last December and, since then, their stock price has stabilized between $6 and $7 per share. Its one-year range is $1.38 to $7.28. It is currently trading at $6.98 per share. Before analyzing its technical metrics, let's consider the cannabis stock market strategy.

Many people will say, "why not play cannabis stock X with better performance" or "why not play stock X from a different sector with better performance." Cannabis stocks as an investment basket do not outperform the more popular electric vehicle stocks or renewable energy. Hexo does not outperform the rest of the cannabis stocks like Canopy Growth (OTC:CGC), market cap of 12.641 billion, whose 6-mo performance is over 95%. I will cover it in a future article.

Hexo's 6-mo performance is 141.73%, although their year performance is only 17%. Their stock price, as with other cannabis stocks, have experienced a recent bull run due to the election outcome. Hexo's uptrend began shortly after the split and continued; it has only recently begun to test lower supports. The flux has been within $1 ($6 - $7 per share).

The stock has experienced a double-top breakout pattern, which is currently in a new price range stabilization. It has traded above its moving average 20/50/200 days and it experiences daily runs. Volume has increased significantly and about 10% of its shares is held by large institutions. The stock is undergoing uptrend and there is no bottoming in sight. Its On Board Volume (OBV) and Accumulation / Distribution lines have been greatly increasing. These signs indicate investor confidence in the stock and stabilization of its price.

There are some danger signs in its technical metrics. The bullish conditions in the market over cannabis and the possibility of cannabis legalization have given Hexo and other cannabis stocks some rally days. The rallies may be seen in Hexo's Relative Strength Index (RSI) and how the stock has at times been overbought, thus overvalued. This peak in RSI causes a rapid destabilization of price. Constant overvaluation due to hype may cause an overinflated price. Let's hope there is room to grow and the excitement over-expansion has not already been priced-in.

The RSI, which did maintain some stability for the month of December, indicates to the investor to buy the dips and stay away from re-loading when the stock is hitting new highs. The price point of the stock is impressive for investment and will sooner or later move into the $10-$30 range, like other cannabis stocks.

Hexo's longest uptrend recently in December moved the price $2 per share, and I predict that it will continue upwards movement. New bottom supports will be tested, and the movements may not occur as fast or as often. Let's say its next stabilization price is $7.00-$8.00 and it maintains this price with upward break-outs. Accordingly, I predict the stock to be sitting between $9.00 and $10.00 by June, assuming there is no rapid destabilization due to news or other events. This will amount to a price increase of about 40%.

Investment Strategy

There are a few different ways to profit from Hexo's price movements. I have been holding the stock since before the split and reloading it since its recent uptrend. Look for dips or low days to reload the stock. The long-hold strategy includes the possibility of a major rally from national legalization. Only hold as much as is proportionate to the rest of your cannabis investment basket and overall portfolio diversity.

Hexo has an interesting call options tier and their call options are at impressive prices, but there may not be enough daily movements to play a short call option strategy. The call options are tiered at once per month strike dates and .50 cent intervals between strike price. The volume in options plays are enough for action and option volume has been increasing.

An interesting strategy would be to buy a call option in-the-money or the tier above and to buy it with a strike date out four to eight weeks. Only buy a Hexo in-the-money call option within a three-week strike price, if the stock is experiencing rally conditions. The price may not move beyond .50 cents in three weeks. The idea here is to hold the option and sell it when a rally occurs and the option moves.

I predict at least a 40% price increase for Hexo over the next five months. How you realize that movement is up to your investment preferences and strategies. I would play it as a long-hold and employ a call option strategy as well as hold a proportionate percentage of other cannabis stocks including cannabis support stocks. My advice is to find a way to profit from future cannabis news and legalization. Take advantage of the bull conditions around cannabis stocks.

Risk Moderate to High

As with the rest of the cannabis stocks, there are serious risks in playing Hexo. Only use money that is earmarked for moderate to high risk investments and do not invest too much. The risk must be proportionate. Hexo has only recently begun this upward price trend. Before the reverse split, the price was down trending. We want to see price stabilization and new highs with Hexo and an increase in institutional interest.

Cannabis is an emerging market, quasi legal in many locations, and still delicate as to government acceptance. The conditions in this market can change rapidly in America or Canada. If Hexo loses its license to grow and distribute, then the business becomes insolvable regardless of economic moat. Currently, there are no serious threats to Hexo's legitimation nor Canadian national legalization.

Other risks with Hexo are unforeseeable, for instance a bad growing season or further pandemic conditions. They are no more high-risk than other cannabis stocks. All the same, strategies concerning Hexo must proceed with caution and proportion.

I've already covered the issues with their stock's Relative Strength Index. The risk here is rapid price destabilization. The daily movements on Hexo are small, so one will want to see better signals and green lights before going "whole hog" or committing to short selling strategies. Emerging markets are fragile, and cannabis has a history of stigma with the general public, but times are quickly changing.

Conclusion

To conclude, recent bullish conditions over cannabis in the stock market require cannabis investors to take a closer look at the different publicly-traded cannabis stocks. Hexo's new partnership with Molson Coors and the chance of growing into new markets, makes Hexo's stock worth considering and an investment strategy applied. Their fundamental metrics are strong and their potential for growth even stronger. They are strategically posed to enter the US market with or without national legalization. The technical analysis of their stock price performance indicates an uptrend with rally days, due to news about possible legalization and about the company's own recent growth.

I predict a 40% increase in price of stock, stabilizing around $8 - $9 by June. You may play a long-hold strategy or try your hand at semi-short call option spreads. There is defiantly a reason to watch Hexo's price movements and to await more great news from the company about expansion into new foreign markets. We should maintain a close eye on the cannabis investment basket and hope for a national green rush.

Disclosure: I am/we are long HEXO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.