HEXO Corp. (HEXO Stock Quote, Chart: TSX:HEXO) is a cannabis player that few can compete with, says Beacon Securities analyst Russell Stanley.

In a research report to clients today, Stanley initiated coverage of HEXO with a “Buy” rating and a one-year price target of $11.00, implying a return of 33 per cent at the time of publication.

The analyst says the LP’s ramp-up cannot be denied.

“With production capacity set to 4x to 108,000kg+ by December 2018, few can compete with this Company on scale,” Stanley says. “HEXO has also successfully demonstrated product innovation, with its new offerings placing 1st and 3rd for Best New Product at last year’s Canadian Cannabis Awards. We believe that the sales of value-added products now represent approximately 40% of revenue, which positions HEXO amongst the leaders in this space. We view this as an important metric, as product innovation will be key to realizing strong pricing and margins in a market where the commodity-grade dried flower produced by many peers will see significant price pressure. The Company’s joint venture with Molson Coors Brewing Company, and its ‘pole position’ as a supplier to Québec’s recreational market further stand HEXO apart from the pack.”

HEXO Stock Undervalued

In a research report to clients today, Stanley resumed coverage (the analyst had covered HEXO for another firm) with a “Buy” rating and a one-year target price of $11.00, implying a return of 33 per cent at the time of publication.

Stanley thinks HEXO will generate Adjusted EBITDA of negative $11.5-million on revenue of $4.9-million in fiscal 2018. He expects those numbers will improve to EBITDA of positive $15.9-million on a topline of $102.5-million the following year.

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The analyst says he believes a dominant theme in the cannabis space going forward will be shelf space and value added products, both of which are increasingly in HEXO’s wheelhouse.

“To simultaneously outperform peers on both costs and quality is quite a feat, but HEXO has managed to do just that,” he says. “In addition to strong cost performance, the Company has successfully commercialized unique value-added products that should help it realize strong relative pricing and margins. While the Company does not formally disclose its revenue mix, we believe its value-added (i.e. nondried flower) product sales comprise approximately 40% of revenue vs. the weighted average amongst the largest peers of 30%. Moreover, HEXO’s Decarb and Elixir products finished 1st and 3rd for Best New Cannabis Product at Lift & Co.’s Canadian Cannabis Awards in November 2017.

Stanley says the ability to sell is key.

“It is one thing to produce; it is another thing to sell,” he adds. “HEXO has laid the groundwork for outperformance on this front as well. It’s agreement to supply the Québec market positions it as the clear leader in Canada’s 2nd largest province, and contemplates a 32% share of provincial volumes in the first year, with potential revenue of $1B over five years.”