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Marijuana Producer

This Quebec-based company, which recently changed its name, has been a producer of medical marijuana since 2014.

It is expanding its production facilities and has secured contracts with three provinces and several corporate partners to enter the recreational cannabis market. While the company stands to benefit from these contracts, it needs big revenue growth to justify its high market cap—and faces fierce competition that could result in an oversupplied market and lower cannabis prices.

HEXO CORP., $5.86, symbol HEXO on Toronto (Shares outstanding: 193.6 million; Market cap: $1.1 billion; TSI Cannabis Quality Rating (CQR):   ; www.thcx.com) is a Canadian-based producer and distributor of medical cannabis with production facilities in Quebec. In addition, the company plans to branch out into the recreational and consumables markets when it becomes legal.

Hydropothecary listed on the TSX Venture Exchange in March 2017 and moved to the main Toronto Stock Exchange on June 22, 2018.

The company changed its corporate name from Hydropothecary Corp. on August 29, 2018. It will continue to use the Hydropothecary name for its medical products; any of its products directed at the recreational market will carry the new Hexo brand.

Under license from Health Canada, Hexo started production of medical cannabis in 2014 and subsequently gained approval to transport and sell marijuana in various formats. That includes oils.

Its production facilities are located in Gatineau, Quebec, on a 143-acre lot. The 300,000-square-feet of greenhouse facilities have a production capacity of 25,000 kilograms per year. Further expansion is underway, and the company plans to add another 1 million square feet by the end of 2018. Altogether, the facilities are expected to have a production capacity of 108,000 kilograms per year.

Currently, Hexo’s distribution of medical cannabis is through 134 clinics with which it has agreements. It also sells through its online store.

The company’s initial goal was to achieve scale of production and distribution from its base in Quebec. Hexo would then penetrate other Canadian markets (especially Ontario) after building its brand. Currently, the company only offers cannabis for medical purposes, but it will soon expand into the recreational market.

Hexo, through its Hydropothecary brand, offers patients two dozen medical cannabis products under four product lines: Time of Day (premium dried cannabis); H2 (mid-market dried cannabis); Decarb (cannabis powder); and Elixir, a peppermint-based cannabis oil sublingual (applied under the tongue) mist.

In March 2018, the company announced an agreement with Shopify, symbol SHOP on Toronto, to use that firm’s e-commerce platform for cannabis products. The company believes this is an important component of its Canadian distribution strategy.

Hexo aims to be a meaningful participant in the Canadian recreational market when it becomes legal on October 17, 2018. The company has already concluded a five-year supply agreement with the Quebec provincial government to deliver an estimated 200,000 kilograms over 5 years. The agreement calls for the delivery of 20,000 kilograms in year one, growing incrementally every year to about 55,000 kilograms by year five. Under the contract, Hexo expects to realize revenue of more than $1 billion in cannabis sales. That equals about $5 per gram.

In addition, the company was also among the 31 producers selected by the B.C. government to supply recreational cannabis to the province. It has also now entered into a supply agreement with the Ontario Cannabis Store—run by the provincial government. However, Alberta did not select Hexo as one of its suppliers.

The company recently made a $10 million investment in the independent cannabis retailer Fire & Flower. That firm aims to operate retail stores in all provinces that allow private sellers.

Apart from the medical and recreational markets, Hydropothecary recently concluded a joint venture agreement with Molson Coors, Toronto symbols TPX.A and TPX.B. Under the terms of that deal, Molson will own 57.5% of a new joint venture focused on developing cannabis-infused non-alcoholic beverages. Edible cannabis products, from drinks to brownies, should become legal as early as mid-2019.

Hexo continues to report rising sales: revenue jumped 118.9%, to $4.1 million for the fiscal year ended July 31, 2017, from $1.9 million a year earlier. Even so, the company’s loss jumped to $12.4 million, or $0.21 a share, from $3.4 million, or $0.11.

For the three months ended April 30, 2018, overall revenue rose 4.9%, to $1.24 million from $1.18 million a year earlier. Losses fell to $2.0 million, or $0.01 a share, from $11.8 million, or $0.17.

Hexo’s balance sheet is strong: on April 30, 2018, it held cash of $248.9 million and had no debt. To better serve the recreational market, it will use around $80 million of that to complete the expansion of its facilities at Gatineau.

The company should benefit substantially from the large supply contract for the Quebec Government as well as its agreements in B.C. and Ontario. However, it faces aggressive rivals in the Canadian market. That fierce competition could eventually result in an oversupplied market and put downward pressure on cannabis prices.

The agreement with Molson Coors also raises the possibility that Hexo may eventually be acquired by that much larger alcoholic beverage maker. Alone, that’s not reason enough to buy the stock, but it adds appeal.

Note that like most marijuana producers, the company needs huge revenue growth to justify its current market cap. If its revenue growth stalls, Hexo could drop sharply as momentum traders unload the stock.

Hexo Corp. has a 3-Leaf Cannabis Quality Rating (CQR). The stock is a speculative buy for aggressive investors who want exposure to the marijuana industry.