Why Are Cannabis Stocks Plummeting?

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October 11, 2019 12:00pm NYSE:MJ

NYSE:MJ | News, Ratings, and Charts

Yesterday Hexo Corp.’s (HEXO) stock plummeted 24% — bringing much of the cannabis sector down with it — in the company’s worst-ever, single-day percentage loss. Hexo shares tumbled as the market reacted to a peak inside the companies less-than-stellar fiscal Q4 projections.

Early yesterday morning, the Quebec-based cannabis producer issued preliminary guidance for its fiscal Q4 (which ended July 31) indicating that the company’s net revenue should come in at around $14.5 million to $16.5 million.

That’s a deep departure from the approximate $26 million in Q4 net revenue it had previously forecasted.

“Fourth quarter revenue is below our expectation and guidance, primarily due to lower than expected product sell through,” said Hexo chief executive Sebastien St-Louis.

“While we are disappointed with these results, we are making significant changes to our sales and operations strategy to drive future results.”

The black market is thriving

Competition from the black market seems to be a driving force behind Hexo’s “lower than expected product sell through,” St-Louis said.     

But other sources have echoed this sentiment too. Earlier this week, Statistics Canada released crowdsourced price data for the black and legal markets. The data indicates that the average legal price in Q3 was C$10.23 per gram, nearly double the average black market price of C$5.59 per gram.

MKM analyst Bill Kirk (who still remains bullish on Hexo) said, “With surveyed consumers showing a strong sensitivity to price, we believe the widening of these price gaps limits the growth and addressable market for current legal product offerings.

“In combination with slower provincial buying and delayed Ontario openings, we still believe 3Q results for Canadian LPs [licensed producers] will likely fall short of consensus expectations.”

Kirk reiterated his buy rating on the stock and C$12 price target.

“We believe HEXO’s approach to be the working component of expert partners’ products has the best chance of creating a defensible brand (“Powered by HEXO”). It is a less commoditized approach, which should give them early access to some exciting categories,” Kirk said.

The analyst also noted Hexo’s partnership with Molson Coors (TAP) as a strategic positioning in the cannabis drink space.

Regulatory uncertainty is weighing down on Hexo

Regulatory uncertainty is another factor weighing down on Hexo stock, causing the company to rescind its financial outlook for fiscal 2020. Slower-than-expected store rollouts and delays in government approval for cannabis derivatives seem to be the drivers behind this uncertainty.

“The delay in retail store openings in our major markets has meant that the access to a majority of the target customers has been limited,” St-Louis said.

“Withdrawing our outlook for fiscal year 2020 has been a difficult decision. However, given the uncertainties in the marketplace, we have determined that it is the appropriate course of action. We are also placing a greater focus on profitability.”

St-Louis added that the company would be “re-configuring our operations” to initiate a new sales strategy and focus on high-selling strains.

RBC Capital Markets analyst Douglas Miehm said Hexo’s revised Q4 expectations “will catch much of the Street off guard, especially since the company started shipping products to provinces outside of Quebec during the quarter.”

“We also contend that this provides a readthrough for other LPs (licensed producers), which … could face challenging growth prospects in the months ahead,” Miehm said.

HEXO Corp. (HEXO) was trading at $2.73 per share on Friday morning, down $0.12 (-4.21%). Year-to-date, HEXO has declined N/A%, versus a 12.29% rise in the benchmark S&P 500 index during the same period.

About the Author: Eric Bowler

eric-bowlerEric Bowler is an accomplished journalist providing in-depth insights for more than two decades. Over the past several years his focus has been on the marijuana industry, with a special interest in cannabis growth stocks. His daily coverage of the industry keeps him on top of the key trends with the goal of helping investors make well-informed decisions.

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