Since the beginning of the year, shares of consumer cannabis company HEXO (HEXO +0.00%) have declined by more than 50%. Compared to the S&P 500's decline of just 3% year to date, HEXO's share performance is abysmal.
Indeed, although the company's core business is growing, HEXO's total number of shares outstanding has been diluted by 75% since January , and the company continues to raise cash with no end in sight.
While investors are concerned about HEXO's capital woes, the company has been making significant progress with its expansion. More and more investors are beginning to show interest in the stock now that its annual production capacity may expand significantly. Let's look at why everyone is talking about HEXO's stock and why it is a solid buy.
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A growing leader in the cannabis industry
On June 1, HEXO announced that its 2-million-square-foot cannabis production facility in Belleville, Ontario, had received its sales license from Health Canada. If all goes well, HEXO should be on track to achieve more than 150,000 kg in its annual production capacity. Its cannabis products are 40% less expensive than those of its peers, with a net sell price of $3,190 Canadian dollars per kilogram on its key products.
With these metrics, HEXO has become the fourth largest cannabis producer by volume in Canada, earning more than 30% market share in the province of Quebec.
HEXO's financial performance has also been superb, with revenue more than doubling to CA$30.1 million in the third quarter of 2020 compared with the same period last year.
While sales grew, HEXO's losses also narrowed. In the third quarter of 2020, the company saw its year-over-year net losses decrease to CA$20.7 million from CA$23.2 million, and its core expenses decrease to CA$25.7 million from CA$23.2 million.
I do not expect the company to be negatively affected by the COVID-19 pandemic. On the contrary, sales have been growing as more and more people turn to marijuana to deal with the effects of anxiety, loneliness, and isolation brought on by measures designed to contain COVID-19. Remember, Canada has not yet fully lifted its quarantine and lockdown measures.
In March alone, Statistics Canada reported total cannabis sales of CA$181 million, representing an annual run rate of CA$2.2 billion for 2020. However, it is essential to keep in mind that sales of marijuana are still growing, and real industry estimates for the total market size in Canada range between CA$7 billion and CA$10 billion. There also has been a strong demand for marijuana in the months following March.
Takeaways for investors
Given that HEXO's losses have been narrowing, I expect management to dial back its share dilution. Currently, the company has more than CA$95.3 million in cash and investments, notwithstanding additional financing of CA$25.5 million in June.
Even if the company continues to dilute its shares, HEXO's stock is cheap enough to offset such risk. At an annual run rate of CA$120 million in sales and a market cap just north of $300 million, HEXO is trading at a little over 3.5 times price-to-sales.
The stock is certainly cheap at this point. It is very close to a turnaround, with the company recognizing less than a $5 million loss in earnings before interest, taxes, depreciation, and amortization (EBITDA) for the third quarter of 2020 with expectations that EBITDA will be positive for the full year.
With its gross margin improving to 40%, and a joint venture with Molson Coors (TAP 0.46%) to develop cannabis-infused beverages, I think HEXO is an excellent cannabis growth stock that can offset much of its dilution risk.
