GLJ Research's Gordon Johnson told The Fly stocks in the cannabis space are "grossly overvalued"
Shares of Hexo Corp (HEXO) are under pressure after the pot producer reported lower than expected preliminary fourth quarter revenue and pulled its fiscal year 2020 outlook, blaming an uncertain environment and slow store rollouts due to delays in cannabis derivative approvals. Commenting on the news, Stifel analyst W. Andrew Carter said he sees the pre-announcement as "another headline damaging the industry's credibility." Meanwhile, GLJ Research's Gordon Johnson told The Fly that he expects this earnings season to be “draconian” for everyone across the space.
PRELIMINARY RESULTS: Based on preliminary financial information and subject to year-end closing adjustments, Hexo Corp said it expects net revenue for the fourth quarter to be approximately $14.5M-$16.5M and net revenue for the year to be approximately $46.5M-$48.5M. "Fourth quarter revenue is below our expectation and guidance, primarily due to lower than expected product sell through," commented Sebastien St-Louis, CEO and co-founder of Hexo Corp.
The company added that "slower than expected store rollouts, a delay in government approval for cannabis derivative products and early signs of pricing pressure are being felt nationally. The delay in retail store openings in our major markets has meant that the access to a majority of the target customers has been limited. Additionally, regulatory uncertainty across the pan-Canadian system and jurisdictional decisions to limit the availability and types of cannabis derivative products have contributed to an increased level of unpredictability. As a result, Hexo is withdrawing its previously issued financial outlook for fiscal year 2020."
"Withdrawing our outlook for fiscal year 2020 has been a difficult decision," noted St-Louis. "However, given the uncertainties in the marketplace, we have determined that it is the appropriate course of action. We are also placing a greater focus on profitability. We are evaluating our plans and operations to see where we can be even more efficient."
'DAMAGING' FOR INDUSTRY'S CREDIBILITY: Following the news, Stifel's Carter told investors that he sees the pre-announcement as "another headline damaging the industry's credibility." For companies facing "significant financing risk," the analyst believes a real segregation of assets will occur with some simply facing "significant dilution" given onerous financing terms prevailing in the industry, and others simply unable to access capital. Further, Carter argued that the macro environment should continue to be difficult, and the capital positions of Canopy Growth (CGC) and Cronos (CRON) are clear competitive advantages, affording each company the ability to continue executing their business plans while capitalizing on the sector weakness, which he contends "will only intensify from here."
'DRACONIAN' EARNINGS SEASON AHEAD: Bearish on the cannabis sector, GLJ Research's Gordon Johnson told The Fly that he expects this earnings season to be "draconian" for everyone across the space. "I couldn't be any more bearish on a sector. I've never seen anything like this. These stocks are so overvalued, it's ridiculous. We think this earnings season is going to be a significantly negative catalyst for the stocks, because not only sales are going to disappoint, margins are going to be crushed, earnings are going to be negative, but also there are going to be talks about having to buy back product that they previously sold," Johnson explained.
The analyst highlighted Canopy Growth as an example of forced buybacks. "Looking at the last quarter, Canopy Growth was forced to buy back product it had previously sold. If you look at the bylaws of Canadian Providences, they can effectively force Canadian producers to buy back product if they deem that necessary. […] Canopy reported this as an $8M write-down, but you can't understate how important this is… they were forced to buy product they previously sold," Johnson told The Fly.
BEARISH ON TILRAY: From the names under his coverage, GLJ Research's Johnson said he sees 71% downside in Tilray (TLRY) stock through the end of 2020. The analyst pointed out that Privateer owns about 72% of the stock and is planning on exiting its position through the end of 2020. Further, "the CEO of Tilray is a C-level executive at Privateer. This does not benefit the shareholders of Tilray. It's becoming increasingly clear that there is not going to be profitability in this sector and we're about to get a draconian earnings report from the bulk of the people in this space," he contended.
PRICE ACTION: In afternoon trading, shares of Hexo Corp have plunged about 22% to $2.88. Meanwhile, Tilray shares are down nearly 10%, Cronos has fallen about 6% and Canopy has fallen about 9%.