Hexo Stock May Bottom Here, but It Probably Won’t

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My thesis on small Canadian cannabis producer Hexo (NASDAQ:HEXO) and Hexo stock has been very simply for a long time. It goes something like this.

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There are a lot of pot stocks out there. When all is said and done, only a few of them will survive and become global cannabis giants — while most of them will end up in what will soon be an overpopulated pot stock graveyard. Given its small size, lack of differentiation and lack of investment firepower, HEXO stock is more likely to end up in that graveyard than to be a huge pot stock one day.

Because of this, I’ve told investors to stay away from Hexo stock over, and over, and over and over again, as shares have plunged from around $8 in early 2019, to a $1.85 price tag today.

To be sure, as a long-time bear, I admit that there is finally some hope for HEXO investors in early 2020. That is, there is reason to believe that, at $1.85, HEXO stock has bottomed. And that favorable fundamental developments will power a sizable HEXO stock turnaround over the next 12 months.

However, that bull thesis lacks visibility and conviction. So, while HEXO stock may bottom here, it probably won’t — and the most likely path forward is still lower.

Thus, I retain my overarching bear thesis on HEXO stock. In the long run, this stock is likely going to zero. And it’s not worth buying until proof emerges that zero is an unlikely outcome here.

HEXO Stock May Have Bottomed

In a nutshell, here’s the 2020 bull thesis on HEXO stock.

Global cannabis market fundamentals will improve in 2020. The introduction of Cannabis 2.0 products, like vapes and edibles, will stimulate demand trends in Canada. Supply challenges will fade, as legal producers spent most of 2019 building out production capacity. Improving demand and supply trends will converge to spark a growth reversal for many legal producers like Hexo; i.e. sales will start growing again, and gross margins will stabilize.

At the same time, with respect to HEXO specifically, the company: 1) plans to push into the U.S. market in 2020, a move which could add revenue firepower and boost investor sentiment; 2) just sold 15 million shares to institutional investors at a $1.67 average price tag, so there is some semblance of stock price support up at that level; and 3) could reach positive adjusted profits in 2020, behind growth trend improvements and cost discipline.

Against this favorable backdrop, it’s tough to see HEXO stock not rising over the next 121 months, especially considering that shares are down 74% over the past year and trade at their cheapest valuation in recent memory.

But, will this favorable backdrop actually materialize for HEXO in 2020? Probably not.

It Probably Didn’t

HEXO stock most likely hasn’t bottomed because the company’s growth trends will likely remain challenged in 2020.

Over the next 12 months, the cannabis market will rebound behind improving supply and demand dynamics. But, this rising tide won’t lift all boats. Instead, in 2020, we will start to see a clear divergence between cannabis winners and cannabis losers. The cannabis market rebound in 2020 will center entirely around big players like Canopy Growth (NYSE:CGC), while smaller players will be increasingly squeezed out of the equation because they do not have the size, resources or capacity to compete at scale.

Additionally, Hexo is one of the smallest, less well-equipped players in the cannabis market. Their projected $60 million in sales this year, pales in comparison to the $300 million-plus sales bases over at Canopy and Aurora (NYSE:ACB). Meanwhile, Hexo has less than $60 million in cash and investments on its balance sheet to absorb losses and invest in new growth opportunities, while Canopy and Cronos (NASDAQ:CRON) have balance sheets that are supported by multi-billion dollar investments from Constellation Brands (NYSE:STZ) and Altria (NYSE:MO), respectively.

In other words, Hexo is too small and lacks sufficient resources to adequately compete in the investment-heavy cannabis market.

Overall, this will become obvious in 2020. The cannabis market will rebound. Revenue growth rates at Canopy, Aurora and Cronos will rebound, while margins will expand. But at Hexo, sales and margin trends will remain pressured by competition.

This divergence will not push HEXO stock higher. Instead, it will likely only pull HEXO stock lower.

Bottom Line on HEXO Stock

As I’ve said, the cannabis market will rebound in 2020. While this rebound could also push HEXO stock higher, it likely won’t. Instead, Hexo’s growth trends will likely remain under pressure as the company struggles to grow in the face of increasing competition.

If so, HEXO stock will only go lower in 2020.

As of this writing, Luke Lango was long CGC.