Trulieve: The Most Attractive Investment In The Cannabis Industry Read it at this link to see the graphics: Summary Investors are underestimating the Florida medical-use cannabis market's tremendous growth, which is reason alone to buy the stock. This, along with expansion into new states and potential recreational-use legalization before 2022, makes Trulieve's growth profile as attractive as expensive peers. With sustainable competitive moats, a best-in-class balance sheet, and a strong management team, Trulieve is a high-quality business that is rare in a speculative industry. Trading at a steep discount to peers, Trulieve should outperform other cannabis MSOs in the coming years. Thesis Overview I believe that Trulieve (OTCQX:TCNNF) will outperform peers for three key reasons: FL's rapid medical cannabis market growth, Trulieve's successful expansion into new states, and its best-in-class balance sheet. Additionally, its steep undervaluation versus other US cannabis companies will drive a high return on investment for TCNNF stock. Introduction The U.S. cannabis market is one of the hottest industries, and for good reason. U.S. retail marijuana sales are estimated to have grown by 40% in 2020 and are projected to continue expanding at a 18+% CAGR through 2024. Currently at ~$19 bn in sales, the market is projected to be $37 bn by 2024, more than doubling. This is driven by a variety of factors, including increased state legalization of marijuana for medical use (currently approved in 33 states) and recreational use (approved in 11 states), expanded medical applications due to the increasing amount of scientific literature supporting the substance's benefits, and changing sentiment around the substance by physicians and patients. According to the National Institute of Health, cannabis has been used in medical treatment for more than 3,000 years for pain relief, digestive issues, and psychological disorders. Today, the growing prevalence of chronic pain, opioid use, mental disorders, and cancer paired with clinical evidence showing the substance's ability to reduce chronic pain, improve mental health (depression, epilepsy, PTSD, anxiety, bipolar disorder, Alzheimer's, Parkinson's), and reduce the growth of cancer will continue to drive growth in the adoption of medical-use cannabis in the coming years.
Jan. 13, 2021 3:51 PM ET
By Shak Arunachalam
And although it may seem that left-leaning European countries (and their progressive citizens) offer the biggest market opportunity, the legalization of medical marijuana in several European countries also comes with strict rules for cultivation and sale of the substance, limiting the supply and slowing the industry's growth. Currently, North America accounts for 88% of global marijuana sales, and the U.S. accounts for ~80% (driven by population size, age, and wealth). This market leading share is projected to continue as the U.S. is estimated to account for 73% of the global market in 2024. So in my opinion, the American operators offer superior growth profiles when compared to Aphria, Tilray, and other non-U.S. operators.
Source: Grandview Research, "Legal Marijuana Market Size, Share & Trends Analysis Report"
I could go on about the drivers for the industry, including state's recession-induced pressure to increase tax revenue and create jobs, but it is obvious that this industry is one primed for booming growth. Investors should take note and position themselves to reap the rewards of its growth, but at a reasonable valuation, of course.
I believe that Trulieve, a Florida-focused, vertically integrated multi-state operator (or "MSO"), is the most attractive investment in the space. The business is seeing eye-popping growth and has an incredibly strong balance sheet but is being unfairly discounted due to its regional focus on the Florida market.
Business Overview
I'll begin with a brief business background. Trulieve is a vertically-integrated "seed-to-sale" operation focused in Florida (~51% marketshare in the state) that grows, harvests, packages, and sells cannabis. Trulieve boasts over 500+ SKUs (product types) and its widespread dispensary network and large delivery fleet provides important, much-needed access to thousands of patients throughout the state. It operates 73 stores nationwide (FL, CA, CT, PA), 69 of which are in Florida. Its first mover advantage in Florida creates sustainable competitive advantages and has driven strong financial performance (58% annualized 2020 revenue growth, industry-leading margins, and multi-year profitability). Although focused on FL, it has made acquisitions and organic build-outs to enter new states (CA, CT, PA, MA, WV).
Close comparable businesses include Curaleaf (OTCPK:CURLF), a U.S. cannabis company with the largest retail footprint in the U.S., Green Thumb Industries (OTCQX:GTBIF), a U.S. company operating the fast-growing RISE retail chain, Cresco Labs (OTCQX:CRLBF), an American vertically integrated MSO operating in 9 states, and Planet 13 Holdings (OTCQX:PLNHF), a vertically integrated high-end cannabis operator focused on Nevada and expanding to California. I choose not to compare Trulieve to APHA/TLRY because of the latter's focus on the Canadian/European markets, which has a different growth and margin profile than the U.S. market.
Thesis
In my view, the Florida medical-use market's growth opportunity alone makes Trulieve look cheap. Florida is the second-oldest state and the fourth richest economy; the older and affluent population in the state makes it the second biggest market for medical-use marijuana, with 459k registered patients as of Jan 2021 (a 54% increase from Jan 2020). The large total accessible market, low penetration (~3% of adults with a card), and rapid adoption make Florida primed for big growth in the coming years, and Trulieve, commanding the lion's share in the state, will be the biggest beneficiary. I see it continuing to dominate the Florida market for a few reasons, including its aggressive retail strategy, great marketing, strong brand, higher growing capacity, and patient switching costs; I will discuss these in greater detail in a bit.
It is important to note that medical marijuana was only legalized in Florida in 2017, and expanded uses have just recently been approved (smoking in 2018 & edibles in late 2020), so needless to say, it is a very young market. Despite this, Florida is the second fastest growing market in the country (over 50% patient increases in both 2019 and 2020). A large reason for this growth is the Florida Department of Health's well-organized Office of Medical Marijuana Use (OMMU) program, which addresses the lack of understanding and stigma around cannabis. Through the OMMU, there is a rigorous physician training program and transparent facts and statistics about growers, dispensaries, and licenses, which helps both physicians and patients be confident in using the substance. In fact, physicians have even reported changing their stance on the substance after going through the Health Department's training and seeing its impact on patients. Further, Florida's rule to be a "seed-to-sale" operator to obtain a license further instills confidence in patients as to the safety and quality of the medicine. Below is my top-down Florida sales model for Trulieve.
Source: Model created by the author using data from U.S. Census Bureau, OMMU, and New Frontier Data
While taking conservative estimates and modeling decreasing growth in active cannabis cards, revenue per patient, and market share, I still anticipate Trulieve posting incredible growth figures that will allow it to top analyst estimates (bottom line of the above model). I have taken a more granular top-down approach and believe my estimates are more accurate.
An important note is that the above model does not factor in legalization of recreational-use cannabis; I believe that this a highly likely scenario, however. There is a high potential for an adult-use ballot in Florida's 2022 elections, and federal legalization of adult-use cannabis is also on the table (although unlikely to happen before 2022). Florida has the third-largest tourist market in the U.S., grossing $112 bn in tourism revenue in 2018, and introduction of the recreational-use market, usually multiple times the size of the medical-use market, would lead to an explosion in revenue growth for all operators in the state. Recreational-use will be an enormous catalyst for the stock, although it is uncertain what the timeline looks like.
Furthermore, I believe that Trulieve's Florida-first strategy is highly effective. In my view, this is such a nascent industry that demand abounds wherever you look, and with limited capital, companies cannot choose to expand in every state; it is not a question of expanding in Florida and another state, rather Florida or another state. Especially in the cannabis industry where each state has vastly different regulations (obtaining a license, growing and harvesting rules, sales regulations) and customer bases (medical- vs. recreational-use), focusing on one state, establishing a dominant brand, and maintaining leadership is more conducive to maintaining high returns on capital than spreading thin and expanding in several states, which is what most cannabis companies choose to do.
Still, Trulieve complements its Florida-first strategy with expansion into other states, both organically and inorganically. Trulieve's strong game plan for entry into new states adds more ways to win. Already, the company is in 5 states outside of Florida: CA, CT, PA, MA, and WV. Most of this expansion is inorganic (acquisitions followed by rebranding and remodeling locations), and in my view, its acquisition strategy is strong. In 2020, it acquired both Solevo Wellness and Pure Penn at just a 4.5x EBITDA valuation (Trulieve is valued at ~19x EBITDA).
All five acquisitions Trulieve has made were already high-quality businesses at time of purchase. Its acquisitions have added large, state-of-the-art cultivation facilities to meet increased supply demand, added dispensary operations that have outperformed peers, and added wholesale retail operations (selling cannabis to other retailers). For example, through just one acquisition in 2020, Trulieve gained a 10% market share in CT. It is also organically expanding in West Virginia. Pair this with Trulieve's successful operating history in Florida and its management team and board's past experience (CEO Rivers and board member Healy have backgrounds in M&A and most board officers and board members have long histories in cannabis and agriculture), I am confident that Trulieve's top-tier brand will successfully cross state borders. Adding this revenue growth to my above Florida projections for 2021/2022, I can see the company posting well over 50% revenue growth.
Third, I believe that Trulieve's sustainable competitive moat paired with its seasoned and well-incentivized management team will help it maintain market share and continue to drive high growth in the long-term. Let me start with Trulieve's competitive advantages. As I see it, there are a few sources of a competitive moat, some of which are sustainable.
One, Trulieve has one of the highest growing capacities in the state, which is critical since Florida requires operators to be vertically integrated to obtain a license, and also has a strong distribution system to accompany it (in-store and delivery), dramatically reducing order times for consumers which is critical for patients' timely access to medicine. While Trulieve has nearly 2 mm square feet of cultivation capacity in FL, close competitor Curaleaf has 1.6 mm nationally and other MSOs are not as involved in cultivation at all and opt to purchase supply from third-party growers, since many states do not require operators to be vertically integrated. Over the last two years, this expanded capacity and superior distribution system has allowed Trulieve to lower prices and capture a big market share. While some consumers have had to wait as long as 2-3 months for medicine, Trulieve was able to deliver medicine in 5 days in 2019 and now in Jan 2021, delivery is ~2-3 days (state-wide delivery) and in-store pickup is same-day. As of Dec 2020, Trulieve accounts for 47% of all medical marijuana sold in the state (down from 50% in Dec 2019) and 56% of the smokable marijuana (up from 48%).
Although its large cultivation capacity is critical in becoming a first-mover, reaching patients first, and operating at far superior margins (while peers pay growers high prices for cannabis supply, Trulieve cultivates its own supply), in the medium-term I don't view the higher growing capacity as a sustainable competitive advantage. As the market matures and more MSOs target Florida, competitors will build out growing and distribution capacity. In my view, increasing growing capacity and expanding distribution has diminishing marginal returns. At present, Trulieve's supply is much closer to meeting demand than rivals, but the delta between it and competitors should eventually close.
However, this first-move advantage is still a game-changer, as there are critical patient switching costs that Trulieve can now leverage. Like with any medicine, patient trust is key; being a first-mover has allowed Trulieve to compile a large patient database, build customer relationships, and win loyalty. With cannabis specifically, there are several ways of consuming the THC (edibles, oils, smoking), countless strains, varying concentrations, and different edible varieties (gels, cookies, brownies, butter, drinks, etc.) each of which digest and react slightly differently; a gel from Curaleaf behaves differently than a gel from Trulieve. This is where patient relationships are critical; as consumers have a pre-existing relationship with Trulieve's associates and familiarity with Trulieve's product varieties (and how their body reacts to them), they are more likely to be repeat customers rather than trying a competitor. This is evidenced by Trulieve's 79% customer retention rate.
Last, Trulieve's brand and retail strategy are second-to-none in Florida, which has been powered by its strong brand marketing and store design. Trulieve has built its well-recognized brand by partnering with premier national brands (Bhang, Love's Oven, Blue River), working with trusted local brands (Sunshine Cannabis, Black Tuna, Bellamy Brothers), and focusing on its large and growing line of high quality private label products (500+ product types with varying concentration ratios and new strains). Further, Trulieve's superior growing capacity gives it a first-mover advantage, which allows it to reach customers first, build trust (critical for new medical products), and drive stickiness (79% customer retention rate); for example, Trulieve was the first dispensary to sell edibles following its approval in late 2020.
Trulieve also has an aggressive retail strategy, including rapid expansion of stores in Florida (6 stores opened in just Q3 2020) and well-designed physical locations; as per reviews, they are the highest rated operator for product availability and cleanliness. Below is a side-by-side comparison of Trulieve (left) and Curaleaf (right). Although both locations are well-reviewed, Trulieve's locations are more sophisticated and clean (almost look like Apple stores), which is a superior strategy for medical-use customers, who view cannabis as a medicine substituting their prescription drugs. MSOs like Curaleaf borrow the "casual" and "hip" retail layout from its national locations, many of which operate in adult-use (recreational) states; the strategy works well in those states but does not sell as well in medical-use states. Note the poster of the teenage girl puffing smoke under the counter of the Curaleaf store.
Sources: Trulieve and Curaleaf websites
This is an underestimated competitive advantage of Trulieve: in an industry where customer base varies from state to state, an expertise in one state's market goes a long way in devising superior branding and retail strategies.
The data indicates that its retail strategy is effective. As per my calculation, the average Florida patient spends about 1.6k per year on medical cannabis, while Trulieve's average patient spends around 4k annually. In my view, Trulieve's focus on investing in Florida will allow it to sustain its brand and retail competitive advantages via improved marketing and branding in the state (more partnerships, product quality improvements, and increased store build-outs).
Considering these competitive moats in the context of its strong management team, I am confident that Trulieve will be able to maintain its high returns (currently operating at above 20% ROA). I have already mentioned the strong cannabis, agriculture, and M&A backgrounds of the officers and board members, and I will also add that there is 31% total insider ownership in the business and options packages for officers to increase ownership. As I see it, management's incentives are well-aligned with the future of the business.
My third thesis point is its balance sheet strength. Trulieve has the strongest balance sheet in the industry, which is critical for long-term compounding growth in a nascent, speculative industry. Below is a comparison of Trulieve's net debt/EBITDA, interest coverage, and current ratio versus its closest comparables.
Source: Image created by the author with public data from Seeking Alpha
Trulieve has the second lowest net debt to EBITDA ratio behind only Planet 13, the small retail operation with just one location in Nevada (albeit the largest dispensary in the world), the best interest coverage ratio, and the best current ratio in the industry. In my experience, a net debt to EBITDA above 4, interest coverage below 2, or a current ratio below 2 can signal potentially precarious financial futures; Curaleaf and Cresco Labs are in that range.
Finally, I want to discuss Trulieve's multiple disparity in the context of its growth and margins versus peers. At present, the market is heavily discounting Trulieve's growth potential and its valuation multiple due to its focus on Florida. As I have already evidenced, Trulieve's Florida-first strategy is just as growth-conducive as competitors. A focused market strategy is likely better for long-term returns, and Trulieve's growth figures versus competitors evidences that well. Below is a comparison of Trulieve's two-year revenue growth and valuation multiples versus its closest comparable businesses.
Source: Image created by the author with public data from Seeking Alpha
As seen above, despite having very similar two-year growth figures (2019-estimated 2021), TCNNF trades at a huge discount, which I believe is unwarranted. The industry average two-year CAGR is 112% versus Trulieve's 123%. Further, Trulieve trades at a 53% discount on a P/E basis and 58% discount on a EV/EBITDA basis (versus the industry average, including Trulieve).
Below is a comparison of the revenues (in millions of USD), gross margin, operating margin, and income margin of Trulieve and its closest comparables.
Source: Image created by the author with public data from Seeking Alpha
Again, considering the comparable size of revenue and far superior profitability of Trulieve (it is the only profitable cannabis business, and has been since 2017), this drastic valuation discrepancy (both on a P/E and EV/EBITDA basis) makes little sense, and in my view, provides a great buying opportunity.
The market seems to be discounting Trulieve's future growth potential due to its focus on the Florida market, but as I have shown, this Florida-focused strategy should be an effective, maybe even better, approach; as Trulieve continues to post great fundamentals in the coming year, the market should come around to this idea, and the valuation delta should shrink, driving TCNNF's outperformance versus peers.
Valuation and Return Profile
I will keep it simple here. I'll focus on price to earnings, as that is more relevant for equity holders. Share price = P/E x earnings. So, there are two sources of share price appreciation: P/E expansion and earnings growth.
I do not anticipate Trulieve's multiple rerating to the peer average, at least not anytime soon; I do think that 5+ year growth figures are dampened by Trulieve's Florida-focused strategy, and I believe the market will hold this belief and discount the multiple accordingly. However, I do believe that the drastic discount that TCNNF is trading at (53% cheaper than peers) will close in the coming year as Trulieve continues to deliver growth on pace with its most expensive peers. Conservatively assuming that in 12 months TCNNF trades at a 35% discount to the current peer average, its multiple should rerate to 44.3x (increase of 38%).
According to six analysts, 2022 EPS is estimated at $1.92 (increase of 54%). As per my Florida revenue model above, I believe that analysts are underestimating the growth potential in the state and anticipate Trulieve topping this EPS estimate. However, I will conservatively use the $1.92 figure.
Together, this translates to a stock price of $85.06, or a 112% increase, in 12 months. Again, these are conservative estimates, as I am assuming that Trulieve will still trade at a steep discount and will just meet analyst estimates.
For those that are worried about the 2020 run that TCNNF had in 2020 (when the stock appreciated by ~180%) and "buying high", my response is simple. The share price appreciation that TCNNF saw in 2020 was a symmetrical reflection of the improved performance of the business. At the start of 2020, TCNNF traded at a 24.5x P/E on forward earnings of $0.46 per share, translating to a share price of $11.28. Twelve months later, TCNNF traded at a 25.3x P/E (increase of 3%) on forward earnings of $1.25 per share (increase of 170%), translating to a stock price of $31.62 (increase of 180%). As you can see, the stock price increase has followed EPS growth nearly 1 to 1.
Since the start of 2021, the multiple has rerated to 32.1x (increase of 27%) on the same forward EPS estimate, in large part because of the results of the Georgia runoff elections, which gave the Democrats control of Congress and increased the likelihood of federally legalizing cannabis by 2022 (likely for medical-use, but potentially for recreational-use as well). Future growth looks rosier, and the multiple has followed. I don't see this run as irrational, and shares still look cheap; at 32x forward earnings (53% discount to peers), I do not see TCNNF at bubble-valuation and do not anticipate a significant correction.
Risks
As always, with any good investment idea, there are notable risks. I will briefly discuss three key investment risks and how to get comfortable with those risks.
First, Trulieve could see unsuccessful expansion into new states, which could weaken ROIC. Even so, I look at the big medical market in Florida along with the strong likelihood of recreational-use legalization in the state, which should multiply the Florida market by many multiples, and view expansion into new states as really just a cherry on top (albeit a big cherry that is being baked into the current valuation).
Second, its Florida concentration could hinder its growth in the long-term, keeping it out-of-favor. I think that this risk is very valid, and I do agree that in a 5+ year timeframe, the Florida-first strategy might hinder its market share in other states and thus revenue growth. But I am not entirely sold on this, as Trulieve does have a well laid out game plan for expansion into new states. Second, even while recognizing this risk and assuming that Trulieve will continue to trade at a steep (35%) discount to peers, it is clear that its dramatic undervaluation and fundamental growth will drive strong returns.
Third, delayed federal legalization and continued limited access to capital markets could open the door to financial distress. There are three ways to get comfortable with this. One, Trulieve is already generating positive cash flow from its operations (so no need for outside cash). Two, operating cash flow is growing rapidly while focusing on Florida (so no need for new state legalizations). Three, it has good access to the Canadian capital markets (~$85 mm in equity and $130 mm debt have been raised in 2019 and 2020).
Conclusion
In short, Trulieve is a highly-attractive business in a fast-growing industry. Although discounted for its Florida-concentrated operations, in my opinion, targeting multiple markets in such a nascent, rapidly expanding industry is not needed. In most states, demand growth will outpace supply expansion in the short-term, so diversifying regional exposure will not lead to substantial improvements in growth.
The FL medical market alone is reason to buy the stock, and factoring in new state expansion and potential recreational legalization, the company's future growth profile looks extremely attractive. With sustainable competitive moats, strong management, and a best-in-class balance sheet, Trulieve is a very high-quality business, which is rare in the cannabis industry.
Pairing this with its dramatic undervaluation, I see tremendous upside for Trulieve, both in 2021 and in the medium-term. I am confident that TCNNF will outperform peers as a multi-year hold.
