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Oct. 15, 2019, 7:42 a.m. EDT

Hexo stock dives after downgrade, dragging cannabis sector lower

Aurora Cannabis slides 7% after MKM lowers its stock price target

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By Ciara Linnane, MarketWatch


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Cannabis stocks have taken a beating in the past week amid concerns about a lack of profit.

Hexo Corp. shares took another bath on Monday, after Seaport Global downgraded the stock along with market leader Canopy Growth, in a note that advises investors to switch out of Canadian cannabis stocks and into U.S. multistate operators.

Hexo stock /zigman2/quotes/206508254/composite HEXO -5.29%   /zigman2/quotes/200008967/delayed CA:HEXO -5.62%  fell 6.8% in light volume on the Columbus Day holiday, bringing its one-month losses to 44%. The stock fell sharply last week after the company issued a revenue warning for its fiscal fourth quarter and pulled its fiscal 2020 outlook. The news served as a reminder that the Canadian sector is not yet creating any profit thanks to a still powerful black market and the slow rollout of stores, sending stocks lower across the board.

Seaport downgraded Hexo and Canopy Growth /zigman2/quotes/200603886/composite CGC -3.22% /zigman2/quotes/202205609/delayed CA:WEED -3.20%  to neutral from buy and maintained Aurora Cannabis /zigman2/quotes/210559470/composite ACB -17.02% /zigman2/quotes/203734337/delayed CA:ACB -18.04%  and Tilray /zigman2/quotes/209129655/composite TLRY +0.61%  as neutral, leaving Aphria Inc. /zigman2/quotes/207425803/composite APHA -3.63%   /zigman2/quotes/205566616/delayed CA:APHA -3.09%  as the only buy-rated stock among the Canadian cannabis stocks in its coverage. Analysts Brett M. Hundley and Luke Perda said they have placed their model, rating and price target for Green Organic Dutchman /zigman2/quotes/204266798/delayed TGODF -14.15%   /zigman2/quotes/206870535/delayed CA:TGOD -15.66%  on review, pending news on its efforts to raise fresh financing.

“As for the U.S. multistate operator group, we see a completely different set of circumstances in place, and we would broadly recommend that investors rotate away from Canada and toward the U.S., the analysts wrote in a note to clients. “We do not think that recent vape headlines will materially cut into forward MSO financials, and we see a number of opportunities for public MSOs on the horizon.”

See: ‘Don’t smoke the Kool-Aid,’ analyst says in sober note on the cannabis sector

The analysts said they are disappointed with Hexo’s development of its hub-and-spoke model “and we wonder if the latter is even possible for marijuana, specifically, any more.” They were further disappointed by the departure of Chief Financial Officer Michael Monahan, who quit on Oct. 4, to seek a better work/life balance.

In Canopy’s case, the analysts said they no longer expect the company to receive incremental equity warrant funding from Constellation Brands /zigman2/quotes/207737284/composite STZ -1.76% , the brewer of Corona beer that is Canopy’s biggest single shareholder following a $4 billion investment last year.

“ This added cash assumption had been a core tenet of our buy rating under our valuation analysis,” the wrote.

Canopy stock was down 3.6%.

Aurora Cannabis shares fell 2.3%, as Seaport tweaked estimates and MKM lowered its stock price target to C$C$3.50 ($2.65) from C$5.00.

“The company has said that it is tracking toward Ebitda profitability, but we expect the landscape to get much tougher, ahead,” wrote the Seaport analysts. “ACB is in the process of fleshing out an expensive asset base in Canada and Denmark, against markets that are anticipated to open slowly. Now more than ever, we believe that Canadian LPs need to maintain a low cost structure while also maintaining appropriate capital/cash reserves.”

MKM analyst Bill Kirk reiterated his sell rating on the stock citing softer prices for cannabis, a widening gap between the price of legal pot and black market product and fewer-than-expected new store openings in Quebec and Ontario.

“Aurora warned on its September 12th earnings call that July and August had slowed, and including Hexo Corp’s commentary and pace of new stores, we have no evidence that September and early October were any better,” Kirk wrote in a note to clients.

See also: Cannabis stocks pare early gains as profit doubts persist a day after major selloff

The analyst lowered his first-quarter fiscal 2020 sales estimate to C$98 million from a previous C$117 million, below the C$105 million consensus. “We believe profitability for cultivators will generally get worse before getting better,” he wrote. “Pricing is already decreasing and supply availability will continue to grow/improve.”

See now: Mitch McConnell meets with pot execs in California, pitched need for cannabis banking reform

Click to Play

Why the future of Canada's cannabis industry is not smoking products

After Canada became the second nation in the world to legalize recreational marijuana, the cannabis industry is betting on edibles and beverages to drive future growth.

In other news on the sector, the two Ukrainian businessmen tied to President Donald Trump’s personal lawyer, former New York City Mayor Rudi Giuliani, who were arrested last week and charged with federal campaign finance violations, have also been indicted in a U.S. cannabis corruption scheme, according to news site Leafly.

The pair, Lev Parnas and Igor Fruman along with another Soviet-born U.S. citizen Andrey Kukushkin, were charged with working on behalf of a foreign national to try to elect two Nevada candidates to gain favor in getting recreational licenses.

CannTrust shares /zigman2/quotes/201332942/composite CTST -1.71%   /zigman2/quotes/206800806/delayed CA:TRST -1.71%  reversed early losses to trade up 15.7%, after the company said it is taking steps to regain its licenses after they were suspended in a scandal involving illegal grow rooms. As part of those measures, the company said it would destroy C$12 million of biological assets and about $65 million worth of inventory that was not authorized by its licence. The material to be destroyed includes product that was returned by patients, distributors and retailers.

Aphria was down 9.6%, Aleafia /zigman2/quotes/203485112/delayed ALEAF +2.79%   /zigman2/quotes/200214885/delayed CA:ALEF +2.86%  was down 2.5%, /zigman2/quotes/209289540/lastsale OGI -7.29%  was up 3% and KushCo /zigman2/quotes/209165034/delayed KSHB -3.73%  was down 3.5%. Zenabis /zigman2/quotes/208790252/delayed ZBISF +15.81%  was down 4.6% and Akerna /zigman2/quotes/202667634/composite KERN +56.30%  was down 3.6%.

The ETFMG Alternative Harvest ETF /zigman2/quotes/204332491/composite MJ -2.27%  was down 2%, while the Horizons Marijuana Life Sciences ETF /zigman2/quotes/208856346/delayed CA:HMMJ -3.04%  was not yet trading.

The S&P 500 /zigman2/quotes/210599714/realtime SPX +0.95%  and Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.80%   were flat.

Cannabis Watch: Read all of MarketWatch’s coverage of cannabis companies

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Ciara Linnane is MarketWatch's investing- and corporate-news editor. She is based in New York.

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