TCNNF - Trulieve Cannabis: Government May Finally Come To The Rescue

2023-09-01 03:26:51 ET

Summary

• Trulieve Cannabis stock soared 62% following the potential rescheduling of cannabis from a Schedule 1 controlled substance to a Schedule 3 drug.
• If cannabis is reclassified, Trulieve and other MSOs could potentially drop the 280E taxes and uplist to U.S. stock exchanges.
• Trulieve Cannabis could see a surge in free cash flow levels, greatly enhancing its capital position.
• TCNNF stock is cheap at only 3x the current adjusted EBITDA.

As with most cannabis stocks, Trulieve Cannabis ( OTCQX:TCNNF ) was struggling heading into the end of August. The cannabis multi-state operator ((MSO)), mostly focused on Florida, faced tough business conditions due to the competitive threats in their main medical cannabis market but the stock soared 62% following the potential for the re-scheduling of cannabis. My i nvestment thesis remains Bullish on the stock, even after the big rally the last 2 days.

Schedule 3 Reclassification

The legal landscape for cannabis remains complex. The cannabis stocks all soared the last couple of days after the news came out on August 30 that the Health and Human Services sent a letter to the US Drug Enforcement Administration recommending cannabis be reclassified from a Schedule 1 controlled substance to a Schedule 3 drug.

Cannabis would no longer be illegal in the U.S. allowing the MSOs to potentially drop the 280E taxes and uplist to U.S. stock exchanges. The DEA is expected to recommend a move towards the end of the year or by early 2024 with no indication the government agency wouldn't follow the recommendation of the HHS working with the FDA.

As in the past, investors are cautious because the U.S. government has made a lot of proclamations of wanting to reclassify cannabis or approve cannabis at the Federal level or even approve the Safe Banking act to remove restrictions from banking limits. None of the federal level government actions have occurred with cannabis just being approved at the state level in various forms from medical to recreational while even some state approvals have come with restrictions preventing the MSOs to effectively enter the market.

With cannabis no longer being a Schedule 1 controlled substance, the 280E federal tax restrictions would no longer exist. The MSOs would no longer pay taxes on gross profits leading to effective tax rates in the 70% range compared to an effective tax rate of around 21%.

According to Viridian Capital Advisors, all of the big MSOs would see huge boosts to free cash flows. Trulieve Cannabis and Curaleaf ( OTCPK:CURLF ) would be left with the largest free cash flow levels, greatly enhancing their capital positions going forward.

According to Viridian, Trulieve Cannabis would see the free cash flow levels surge to nearly $150 million for a stock with a market cap only topping $1 billion after the big 2-day rally. The sector has long focused on adjusted EBITDA due to the removal of taxes and better focus on cash flows.

The MSO reported Q2'23 adjusted EBITDA of $79 million for a 28% margin, though the number plunged from $111 million last Q2 for a 35% margin. For the 1H, Trulieve actually produced $98 million in operating cash flows excluding the tax payments with a goal to improve cash flows in the 2H.

The company only spent $11 million on capex in Q2 and the company expects to cut capex by 50% from the 2022 levels of $165 million. Trulieve reported a $34 million income tax provision in Q2 due to the $142 million in gross profits for a company technically reporting a GAAP loss in Q2.

Trulieve actually forecasts $100 million in operating cash flows for the year, after paying the 280E taxes. The MSO will even report positive FCF with capex of ~$80 million this year while the tax provisions have been around $35 million per quarter amounting to $140 million for 2023.

The company plans to be FCF positive despite making 5 quarterly tax payments this year.

Still Cheap

The cannabis stocks were so beaten down that Trulieve is still cheap despite rallying 62% in the last 2 days. Based on the Q2 adjusted EBITDA level, the company is producing about $316 million in annual EBITDA.

Trulieve guided to Q3 revenues down from Q2 levels, but a lot of the revenue decrease is due to exiting some operations in California and other states. The MSO has the potential to boost EBITDA in the 2H and has already guided to higher cash flows.

The market cap jumped back over $1 billion on the rally back above $5.50. The stock only trades at 3x current EBITDA levels.

Trulieve has $647 million in debt with net debt at $487 million. In addition, the MSO has differed tax liabilities of $212 million with an unknown outcome of what taxes would still be due on a shift of cannabis to Schedule 3 in late 2023 or early 2024.

As with past rallies on suspected cannabis regulation changes, the DEA rescheduling cannabis isn't guaranteed. The election of a Democrat president in 2021 was supposed to usher in new federal regulations, and the MSO stocks have been crushed due to the lack of any regulatory progress.

Takeaway

The key investor takeaway is that Trulieve Cannabis has more upside from a DEA move to shift cannabis to Schedule 3. The major risk here is that federal regulators have been very slow to actually make changes and the ramifications of cannabis as a Schedule 3 drug is completely known considering typical FDA regulations of such drugs.

The stock is still cheap at 3x EBITDA targets, but Trulieve will be very volatile towards year end with the unknown outcome here.

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