Hydropothecary, also known as HEXO on the TSX, is part 2 of our 4 part series on our top Cannabis picks.
Hydropothecary, based in Gatineau Quebec, is possibly the safest long term bet in the cannabis space, at least as of right now. With a market cap around 800 million, its considered a mid cap, but what separates it is it’s massive Quebec supply deal, as well as its move towards innovation.
As it stands right now, HEXO has 20,000kg of cannabis committed for this coming year, which then increases the following year to 35 000 kgs, and then to 49 500 kgs in the third year. The estimated amount, as we know is to allocate and not a sale quite yet, but as said by CEO Jean Sebastien St. Louis, the SAQ (in charge of cannabis sales), in Quebec is being conservative with their purchases. The SAQ is not counting out good old Bob down the street and the black market from stealing market share in there estimates, meaning this is a threshold that is likely to hit. With HEXO being the largest cannabis company based in Quebec, it shows the degree of protectionism for Quebec businesses, meaning it’s likely to continue even after the 5 year contract is up. Other supply deals include their Elixir supply deal in BC, and we wouldn’t be surprised to see one from ontario as well for a diversity of products, although not to many right away.
Next is there work towards innovation. Hydropothecary prides itself on its many variety of products, especially their Elixirs, which it has won various awards for. Going into the future they seem to have a focus on R&D in the product side that should help them as the market eventually shifts from raw cannabis to value added products. On top of their quality products, because of their greenhouse design and cheap quebec conditions including power, they will be one of the lowest cost per gram producers out there. Their innovation is evident to why they received the JV with Molson Coors today, which even we didn’t foresee when we wrote this article yesterday, but could be huge for them. the stock is up a lot, as this validates Hydropothecary and gives them backing and research help to develop a potentially disruptive product in this growing market place which is cannabis infused drinks.
Although many positives, a few negatives include a concentration risk in heavy overall sales to just Quebec, as well as little international expansion planned. This will be a shortfall with a looming oversupply, and takes away avenues of growth.
For the napkin math lovers, here what we know based off what was said in the announcement conference call. 20 000 kgs × 5 cogs(Cost of Goods Sold) average, would yield 100 million in revenue , and when that balloons to 49 500 kg in year 3,, it would make approximately 250 million revenue, lets call it closer to 200 with cost per gram likely to be weaker with more supply online. They are confident with there value added products that they still will have a fairly high wholesale price. If they were to make 75 million profit off of the 49 500 kgs to Quebec alone, they would be trading at a fairly cheap around 11x earnings as of right now. This is without counting other markets and medical, just strictly Quebec numbers alone.
With this almost guaranteed revenue, and stronghold on Quebec, and with this unforeseen deal today as well, it shows just how Hydropothecary has the makings of a great long term cannabis investment.