The Last Fairly Valued Marijuana Stock?

HEXO Corp. (TSX:HEXO) may be fairly valued when compared to other marijuana stocks and adjusted for growth prospects.

| More on:

The Horizons Medical Marijuana Life Sciences exchange-traded fund (ETF) holds a basket of more than four-dozen marijuana stocks and has climbed by more than 50% year to date. This is after the most stellar year for pot stocks on record.

In anticipation of the October 17th legalization of recreational marijuana sales across Canada, pot stocks shot up to historic highs. Canopy, the clear leader in this space, is up 100% over the same period and is now valued at a forward price-to-sales ratio of 62.5, assuming quarterly revenues cross $60 million after legalization.

Other marijuana stocks are similarly richly valued, usually trading around 100 times annual sales or more. That’s the underlying reason for their inherent volatility. Every piece of good news is met with jubilation, while every piece of bad news butchers stock prices. Finding undervalued stocks in this industry is nearly impossible, but there are a handful of fairly valued ones that seem to fly under the radar.

By my estimate, HEXO (TSX:HEXO) is one of those rare, fairly valued gems. HEXO isn’t cheap by any traditional measure, but when you account for its partnerships, provincial supply agreements, and production capacity, you can start to see why the company is worth its current market value.

The biggest factor underpinning HEXO’s value is the company’s joint venture with Molson Coors. Molson Coors Canada is North America’s oldest brewer and Canada’s second-largest brewer by volume. In 2017, the brewer produced one in every three beers sold across the nation.

The joint venture is separate from the parent companies and is structured as a startup. The startup will spend the rest of the year trying to create a cannabis-infused beverage. If successful, this new consumer brand will benefit from Molson Coors’s vast distribution network and branding prowess.

Meanwhile, HEXO is still the premier cannabis producer in Quebec. In April 2018, HEXO signed a five-year agreement with the province to supply 200,000 kilograms of marijuana. That means 40% of the company’s near-term production capacity is already sold under this agreement.

While the joint venture with Molson Coors creates an attractive opportunity for future growth, the provincial supply agreement in Quebec creates revenue and cash flow visibility for the next five years.

Assuming HEXO can keep production at or beyond 100,000 kilograms a year and sell it at the average selling price in Quebec — $7.30 per gram — annual sales could hover around $730 million in 2019 and beyond. Meanwhile, HEXO’s market capitalization is $1.5 billion, which implies a forward price-to-sales ratio of just two.

If you account for the growth potential of the beverage startup, the potential for international expansion, and the possible federal-level legalization of weed in America over the next five or more years, HEXO starts to look rather attractive.

Bottom line

Compared to its larger rivals and adjusted for the growth opportunity of the Molson Coors joint venture, I believe two times annual earnings is a fair price for HEXO. The provincial supply agreement with Quebec’s government is another factor that supports HEXO’s intrinsic value. Investors in this space may want to take a closer look.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Vishesh Raisinghani has no position in the companies mentioned. The Motley Fool owns shares of Molson Coors Brewing.

More on Investing

Man data analyze
Tech Stocks

3 Reasons Celestica Stock Is a Screaming Buy Now

These three reasons make Celestica stock a screaming buy for long-term investors.

Read more »

profit rises over time
Dividend Stocks

These 2 Dow Stocks Are Set to Soar in 2025 and Beyond

Two Dow Jones stocks are screaming buys but Canadians must hold them in an RRSP or RRIF to avoid paying…

Read more »

TFSA (Tax free savings account) acronym on wooden cubes on the background of stacks of coins
Dividend Stocks

How to Use Your TFSA to Earn Ultimate Passive Income

If you have a TFSA, then you have the key to creating ultimate passive income. All you need is a…

Read more »

Confused person shrugging
Dividend Stocks

Better Buy: Fortis Stock or Hydro One Stock?

Let's do a compare and contrast of these two top utilities stocks right now, shall we?

Read more »

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Dividend Stocks

Boost Your Passive Income: 2 Canadian High-Yielders at a Bargain

Nutrien (TSX:NTR) stock and another play that appear like fantastic dividend bargains in mid-November.

Read more »

Super sized rock trucks take a load of platinum rich rock into the crusher.
Metals and Mining Stocks

Invest $7,000 in This Dividend Stock for $672 in Passive Income

High yield can be an essential requirement when you need to start even a modestly sized passive income with a…

Read more »

telehealth stocks
Tech Stocks

Well Health Stock: Buy, Sell, or Hold?

Another record-breaking quarter and strong demand sets the stage for continued momentum for Well Health stock.

Read more »

3 colorful arrows racing straight up on a black background.
Dividend Stocks

TSX Stocks Soaring Higher With No Signs of Slowing

Three TSX stocks continue to beat the market and could soar higher in an improving investment landscape.

Read more »