HEXO (TSX:HEXO)(NYSE:HEXO) was once one of the hottest stocks in the emerging cannabis industry. In 2016, shares were priced at just $0.50. This May, they topped $10.
The rise was incredible, but the recent cannabis bear market has hit the stock hard. Shares recently touched $2.50 apiece. To be fair, nearly every pot stock has been hit hard. Marijuana ETFs have fallen by more than 50% from their peaks.
Expectations for HEXO were certainly too high this summer, but following the decline, expectations now seem too low.
This fiscal year, analysts expect the company to generate $110 million in sales. Next fiscal year, analysts anticipate $230 million in sales. With a market cap of just $750 million, the stock is a screaming bargain if these projections come true.
And that’s just the next year or two. Over the long term, HEXO is building a differentiated business capable of generating at least $1 billion in sales.
Have to be different
This summer, I’d warned investors about the impending cannabis supply glut. “Take a look at most pot stocks, and you’ll discover one thing: the majority are trying to ramp cannabis production as quickly as possible,” I wrote. Indeed, weak pricing has been a major factor behind the recent market slump.
“The key to success will not be production growth,” I noted, “but differentiation.” Today, most pot companies are focused on proving why they’ll maintain pricing power, even as industry supply ramps. Canopy Growth, for example, is looking to create value-add, cannabis-infused beverages. Green Organic Dutchman Holdings has gone all-in on organic products.
But there are ways to differentiate yourself beyond building branded products. If you dig in, HEXO is building something truly special.
Building a giant
This decade, tech companies have perfected a model for creating multi-billion-dollar businesses: platforming. Microsoft and Shopify are popular examples. Microsoft, with its Windows operating system, and Shopify, with its e-commerce platform, have built products that other companies can build on top of.
Think of all the applications and businesses built on top of each respective platform. Without Microsoft or Shopify, they’d disappear instantly. That’s the power of a platform; it creates a super-sticky revenue model with intense customer retention.
Taking a cue from tech, HEXO is building the first cannabis platform. Instead of selling directly to consumers, the company is focused on building backend infrastructure capable of supporting the needs of other businesses.
Let’s say Coca-Cola wants to create cannabis-infused sodas, but doesn’t want to deal with the regulatory and capital-expense issues related to building its own private cannabis segment. Instead, it can simply partner with HEXO, which can use its existing infrastructure to research, develop, manufacture, package, and distribute Coke-branded cannabis products. It’s as simple as that.
Already, HEXO has attracted top-tier customers like Molson Coors Canada. In 2020, it wants to acquire additional Fortune 500 partners in new verticals like sleep aids, cosmetics, edibles, and more.
This hub and spoke model — with HEXO as the central hub and external partners as the spokes — is new to the cannabis industry, but it’s been proven in other markets. If it gains traction next year, HEXO stock could go gangbusters. That’s because it no longer needs to tap the market opportunity by itself. Instead, it’ll have pre-existing global partners ready to hit the ground running.
What’s more likely to succeed: a cannabis product from an upstart brand, or a cannabis product from a well-known global powerhouse? HEXO is betting on the latter.
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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Microsoft, Shopify, and Shopify. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends HEXO. and HEXO and recommends the following options: long January 2021 $85 calls on Microsoft. Fool contributor Ryan Vanzo has no position in any stocks mentioned.
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