CanadaEarningsHexo’s October Freefall Continues After Pot Firm Reports $56.7 Million Loss

Shares of Hexo have tumbled 45 per cent since early October after the embattled cannabis producer has drawn negative headlines including a larger-than-expected fourth-quarter loss
Jared Gnam Jared GnamOctober 29, 20199 min

Hexo Corp‘s (TSX:HEXO) rough October continued this week after the cannabis producer posted a fourth-quarter net loss of $56.7 million — a loss roughly three times higher than analysts’ estimates.

Shares of Hexo dropped as much as 11 per cent Tuesday on the news, sinking to its lowest price since 2017. Even though the pot stock recovered somewhat closing down 3 per cent, shares have tumbled 45 per cent since markets opened Oct. 5.

The Gatineau, Quebec-based company reported late Monday its fiscal quarter ending July 31, 2019, posting total net revenue of $15.4 million, up from $13 million in its third quarter and $1.4 million in the year-ago quarter before legalization began in Canada.

But investors were focused on Hexo’s fourth quarter adjusted loss of $43.7 million, which missed the average analyst estimate of $13.2 million loss by a long shot.

Worse yet the company also took a $17 million writedown, which Hexo cited “price compression” for the inventory loss.

Bank of Montreal analyst Tamy Chen called the inventory write-down “an unsettling development considering the sizable amount of unfinished inventory” held by licensed producers across the country. According to Health Canada, there is just under 330,000 kilograms of unfinished cannabis stocked up as of August. Weed sales in the same month were just under 13,000 kilograms by comparison.

The company attributed the overall net loss to the “significant scale of operations” and increased research and development expenses.

“Our company’s still young, despite all that we’ve accomplished, we’ve had some shortfalls … We hold ourselves accountable to that,” Hexo chief executive Sebastien St-Louis said in a Tuesday conference call.

Hexo’s brutal month

The earnings came less than a week after Hexo announced it will be laying off 200 employees — close to 20 per cent of its workforce — to cut costs and gear towards profits. The layoffs included the departure of executives Arno Groll its chief manufacturing officer and chief marketing officer Nick Davies.

The company also suspended cultivation at its Niagara facility, and 200,000 square feet at its Gatineau facility. It said the move was due to “current market conditions in Canada,” including a lack of stores in populous Quebec and Ontario, but the suspensions are temporary.

Hexo’s share price started its month-long dive after chief financial officer Michael Monahan abruptly resigned Oct. 4 after about four months on the job.

Almost the cannabis entire sector was hit when the company said in early October its fourth quarter revenue guidance to be in the range of between $14.5 million to $16.5 million. That was more than 40 per cent lower than its previous forecast of $26 million.

The pot firm also withdrew its previously issued outlook of up to $400 million in net revenue during its 2020 financial year.

Hexo needs more cannabis stores open

Hexo has places most of the blame on the lower-than-expected revenues on the lack of physical cannabis stores.

In Ontario, there are 25 stores running — roughly one shop for every 500,000 citizens — but the province plans to open 50 more by the end of the year, including eight on First Nations reservations.

In Hexo’s home province of Quebec, 21 stores are open, and the government there expects to have 43 in operation by March 2020.

The company had signed a five-year supply agreement last year with Quebec’s provinical cannabis retailer SQDC, with a total of 20,000 kilograms to be provided in the first year of legalization. But the company said the lack of stores in the province has meant only half of that has been sold.

Hexo has been able to maintain a 33 per cent market share in Quebec throughout the year, but that’s down from 60 per cent when recreational cannabis first became legal last October.

Hexo’s revenue increased by 19 per cent from the previous quarter, but its gross margins dropped to 33 per cent from 49 per cent.

Company’s future forecast

Chief executive Sebastien St-Louis said his goal is to make Hexo a top-three Canadian cannabis company by locking up 20 per cent of the nation’s market share.

“As competitors fail in the next 12 months, and we’ll have lots of them failing, especially the small ones, I think that opens up space” in the market, St-Louis said.

Hexo said projects first quarter revenue to come in between $14 million and $18 million and the company is “targeting to achieve positive adjusted Ebitda in calendar 2020.”

As higher margin second generation cannabis products come online, it also expects gross margins to climb back to the low-40 per cent range moving forward.

Cannabis short sellers have cleaned up the last six months, according to financial analtyics firm S3 partners. Short interest in Hexo as of last week stood at 12 per cent of its regular shares or US$68.5 million.

“The challenge right now is not if cannabis will be a huge industry, we know that (it will). What is less clear is which companies will survive…. I’m more confident than ever as we see the number of licensed producers dwindle drastically, we are almost certain to be one of those survivors,” said St-Louis.

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