Should You Give Up or Hold Onto Hexo’s Stock After Q1 Earnings?

2021 was not a good year for the Canadian marijuana companies (except for Tilray — the merger with Aphria seems to be working in its favor). Canadian players aren’t able to generate enough revenue to achieve profitability. Even the top names like Aurora Cannabis and Canopy Growth have disappointed investors consistently this year. Last week, Hexo (NASDAQ:HEXO) (TSX:HEXO) reported its results from the first quarter of fiscal 2022 (ended Oct. 31), which wasn’t appealing to investors either.

The inadequate quarter along with executive-level changes brought down Hexo’s stock price below $1. Let’s dig into what happened in the quarter and why things don’t look good for Hexo.

A disappointing quarter

Hexo’s start to fiscal 2022 wasn’t impressive. In an attempt to become a cannabis powerhouse the company acquired Redecan, 48North, and Zenabis Cannabis over this year.

However, the acquisitions did not have much of an impact on its top line. Hexo reported total revenue of $50 million, a 70% jump from the comparative quarter of fiscal 2021 and just 29% sequentially. 

Redecan and 48North added $13 million and $1 million each to net revenue (during the two months ended Oct. 31) according to management.

These acquisitions were supposed to make Hexo a market leader but didn’t make much of a difference to Hexo’s results. Instead, they’ve brought down its stock price. Investors were hopeful, thus on the day of the announcement of Redecan acquisition, HEXO’s stock price had jumped 10% to $7.1, but has now fallen below $1 after the Q3 earnings (that included sales numbers from Redecan).

Nevertheless, the company remains optimistic. On its earnings call, management stated it has now entered the cannabis edibles (cannabis derivatives that Canada legalized in October 2019) market with the acquisition of Redecan, while still maintaining a “leading market position in beverages, capsules, concentrates, and oils.”

The company’s recreational cannabis sales (excluding beverages) grew 48% year over year to $36 million. 

Still struggling to bring in profits

Despite the revenue growth, Hexo struggled to earn any profits in the first quarter. In fact, its losses widened to 116 million Canadian dollars in the quarter, higher than the loss of CA$68 million in the fourth quarter of fiscal 2021 and a loss of just CA$4.1 million in the year-ago period.

The company’s operating expenses increased to $123 million from $63 million in the previous quarter. The added costs during the quarter included acquisitions and transaction costs of $24 million, an impairment charge (related to redundant assets and suspended projects) of $50 million and executive restructure charges of another $4 million. 

The executive-level changes aren’t helping either. Last month, Sebastien St-Louis stepped down as the director, and President and recently appointed CEO Scott Cooper replaced him. Along with the Q1 results, the company also announced that its CFO, Trent MacDonald, is stepping down and would also be leaving the company on March 11.

A slew of C-suite leadership changes doesn’t sit well with investors. Hexo’s stock is down 77% so far this year, compared to the benchmark index, the Horizons Marijuana Life Sciences ETF, which has declined 17%.

Hexo data by YCharts

The worst part now for Hexo’s stock is that it runs the risk of getting delisted from the Nasdaq Stock Market because it is trading below $1, which is against the trading compliance rules. The company was in the same position last year, when it was on the New York Stock Exchange, and did a 4-for-1 reverse split to raise its share price and save itself from getting delisted.

Will the new strategy to be cash-flow positive work?

In its Q1 results, the new CEO announced a new strategic plan, called “The Path Forward,” to become the first Canadian cannabis company by generating positive cash flows in 2022. It plans to do this by cutting costs, streamlining organizational structure, realizing cost synergies from acquisitions and unproductive plant closures, and accelerating organic revenue growth.

The company stated these strategies will bring in “the incremental cash flow of $37.5 million in fiscal 2022 and an additional $135 million in 2023 for a total of $175 million over the two years.” 

With increasing costs, declining gross margins, widening losses, and stock dilution, Hexo’s position in the industry doesn’t look good. It needs its new strategic plan to work to save itself and rebound next year. For now, my advice is to stay away from this pot stock. In the cannabis industry, the U.S. marijuana companies are in a much better position; some of them are even profitable and can bring in some fruitful returns over the long term.