CIBC analysts downgraded Hexo Corp. (HEXO) stock on Friday, following the announcement that the company had laid off 200 employees in response to a lackluster Canadian legal cannabis market.
Analysts John Zamparo and Krishna Ruthnum downgraded the stock from “neutral” to “underperform,” and cut the price target from C$4 to C$3 ($2.30).
In a note to clients, the analysts said that the layoffs: “reveal a situation more challenging than previously contemplated. Compressed margins, lower Quebec market share (and a less attractive Quebec contract), management credibility issues, and a capital raise all serve as reasons to believe that both operations and sentiment could worsen from here.”
Hexo had previously been a darling to cannabis investors because of its joint venture with Molson Coors Canada (TAP), which offers a solid distribution network and consumer packaged goods background.
And when compared to its industry peers, Hexo has a relatively healthy balance sheet with C$230 million in net cash. The company also has a contract with the Quebec province, which was supposed to provide a boon for years to come.
But last June Hexo management indicated that it would be short-sighted to enforce the Quebec contract for near-term gains — and this is where things begin to get sticky for the CIBC analysts.
“Whether or not this is the right move is debatable, but without the contract, HEXO is relatively undifferentiated versus peers, in our view,” said the analysts.
“Today’s announcement of job cuts indicates to us that the company has not been able to capture meaningful share outside its home province, and we do not believe investors will wait until Quebec’s lack of retail footprint has been addressed.”
Hexo’s new debentures also raise concern
Further fueling the analysts’ concern was Hexo’s announcement Wednesday that it would postpone its Q4 earnings release until October 28, 2019, and will issue convertible debentures worth C$70 million ($53.5 million) in a private placement.
The CIBC analysts wrote that Hexo’s decision to postpone earnings was “curiously timed,” and creates another question mark. But Hexo says that with the new financing the company needs extra time to finalize its financial results for Q4 and the fiscal year-end.
Hexo signed subscription agreements with a group of investors including company CEO/Co-founder Sebastien St-Louis, as well as other board members.
“The confidence in HEXO Corp that this $70 million private placement demonstrates is a testament to the value the Company is expected to bring to shareholders,” said St-Louis.
“We remain focused on garnering significant market share, driving growth and in shaping this company into a mature, resilient and valued leader in our industry.”
The debentures carry an 8% annual interest rate, are payable quarterly and will mature in three years from the date of issuance. After one year, the debentures will have the option to convert into common shares at the price of $3.16 per share.
“It is important to note the one-year anti-dilution feature in this arrangement, meaning that the financing does not dilute current shareowners’ ownership of the company in the short term,” St-Louis said.
Hexo reserves the option to repay all debentures with unpaid interest within one year from issuance. The company says it plans to use the funding for general corporate purposes.
HEXO shares were trading at $2.37 per share on Monday morning, down $0.01 (-0.42%). Year-to-date, HEXO has declined -30.90%, versus a 23.03% rise in the benchmark S&P 500 index during the same period.
About the Author: Eric Bowler
Eric is an accomplished journalist providing in-depth insights for more than two decades, with a special focus on the cannabis industry. Learn more about Eric’s background, along with links to his most recent articles. More...
