Hexo Corp. struggles in challenging cannabis market conditions

While the Canadian cannabis company Hexo Corp. (NYSE: HEXO) is struggling, in the neighboring US, Veritas Farms Inc (OTC: VFRM) demonstrates the potential of the North American cannabis industry.

After having worried many investors for the past three weeks, Gatineau-based cannabis producer Hexo was unable to slow its stock market decline yesterday when it presented its year-end performance.

Hexo’s shares closed down 3% yesterday, at $2.94 in Toronto. The stock has now lost about 75% of its value since its peak of $11.29 in the spring, when Hexo posted the best performance on the Toronto Stock Exchange since the beginning of the year.

Analysts and investors expected Hexo to be firmly established by now

On October 10 – just six days after the announcement of the resignation of its CFO – Hexo spooked investors by withdrawing its forecasts for the next fiscal year while revealing preliminary results.

Management had attributed the situation to the slower than expected product deployment in SQDC stores, a significant delay by the government in approving derivative products, and early signs of price pressure.

In its final results published Monday night, the company reported revenues of $15.4 million for the months of May, June and July. That was relatively in line with market expectations. However, the adjusted operating loss reached between $25 and $30 million, according to the estimates of some analysts, a level much higher than the consensus of an operating loss of $11 million.

The forecasts for the current quarter were also disappointing. Hexo’s management expects sales of $14 to $18 million. Analysts previously believed that sales would amount to about $20 million.

Finally, due to downward pressure on prices, Hexo recorded an impairment charge of $17 million. In short, analysts’ comments were not soft: “difficult quarter”, “negative results”, “profitability not up to expectations”.

Hexo CEO and co-founder Sébastien St-Louis answered analysts’ questions energetically during a one-hour teleconference yesterday morning.

“The challenge for investors is not whether or not the industry will be large in Canada. We know that. What is less clear is which of the 150 cannabis companies in the country will be Amazon and which will be Pets.com.” He adds, “I am more confident than ever that we will be one of the survivors. The market is going through a very difficult period and that is a good thing. We see the end of the first bubble and we see the real operators emerge.”

Last Thursday, Hexo announced the elimination of 200 jobs, including some management positions, to better adjust the company’s size to the expected revenues in 2020. In addition, production was suspended at the Niagara plant, and on 200,000 square feet at the company’s main facilities in Gatineau.

Last week’s announcement of a $70 million private placement of debentures convertible into shares at a price of $3.16 per share may also have raised questions about the company’s financial health.

Canadian cannabis market is still struggling

One year after the legalization of cannabis, the investors’ high hopes are proving to be a dud, says portfolio manager Philippe Le Blanc, of Cote 100, in his financial letter published over the weekend.

“It must be said that expectations were particularly high. Given the very generous valuations of many companies in the sector, disappointments could be expected.”

To get an idea of the performance of the sector’s stocks, Philippe Le Blanc uses the Horizons Marijuana Life Sciences Index (HMMJ) exchange-traded fund. “After reaching a historic high of more than $24 in September 2018, a few weeks before the official legalization of cannabis, the index has since lost nearly 55% of its value.”

The Chief Investment Officer at Cote 100 reminds us that the majority of companies in the cannabis sector do not make money. “Even today, their assessment is still based on dreams, on hopes of possible benefits.”

In his view, the Canadian cannabis market cannot justify current assessments and while there is certainly potential in international markets, competition is likely to be “fierce”.

The neighboring US cannabis market has some strong performers

Veritas Farms Inc (OTC: VFRM), a highly successful producer and distributor of CBD products, shows the potential of the international cannabis markets that Cote 100’s Philippe Le Blanc spoke of.

Veritas was founded in 2015 and has experienced impressive growth in the last year. In Q2 2019, the US-based company generated more than $2.9 million in total revenue. That is a 500% increase since Q2 2018. Furthermore, Veritas gross profits reached $1,523,413 and thanks to great results, managed to reduce the liabilities by over $1.3 million.

As its Latin name would suggest, Veritas built its brand around transparency and honesty, as well as offering high-quality products. The company announced the release of a QR code packaging that can be used by anyone who wants to check the quality of the CBD products Veritas sells. Among its nine product categories, Veritas produces gummies, lotions, tinctures and vape oils.

The diverging paths of US-based Veritas and Canada-based Hexo illustrate the different evolutions of North American cannabis companies. Investors should have a balanced view of the cannabis sector based on the performance of multiple companies.