Trulieve’s Bold Tax Strategy: A Game Changer In The U.S. Cannabis Sector

Trulieve Cannabis Corp. (OTCQX:TCNNF) [CSE:TRUL] presents a fantastic opportunity for investors interested in the U.S. cannabis sector. Its high-quality and consistent leadership, sound business strategy, and a genius tax plan can yield great results for years to come. This position aligns with Seeking Alpha’s Quant Rating of “Buy”.

Introduction

Trulieve is a vertically integrated cannabis company and multi-state operator, which primarily operates in Florida, Arizona, Georgia, Pennsylvania, and West Virginia with market leading position. Below outlines their operation footprint:

Here is why I believe that Trulieve presents a fantastic opportunity to invest in the U.S. cannabis sector with an attractive valuation.

Sound Growth Strategy

Trulieve excels on execution in key states and expands organically rather than growing quickly and entering into various states blindly. They took the time to integrate a major acquisition (Harvest Health) completed in 2021 helping bring its presence to the North Eastern market through Pennsylvania and the South Western market through Arizona while strengthening its market leadership in Florida. It doesn’t always strive to be the first to enter into a market (for example rushing to New York, California or New Jersey). Its focus in 5 key states cover very strategically important geographical locations in the U.S. For example, while they are dominating in the South Eastern market through Florida, they organically expanded into the neighboring state, Georgia. Rather than building its brand presence from scratch, Trulieve always have a consumer base from Georgia that comes to Florida to purchase Trulieve products. This strategy is very sound in my opinion when operating in the extremely regulated and segmented U.S. cannabis market.

Consistent and High-Quality Leadership

Kim Rivers has been Trulieve’s CEO since inception in 2014. In the volatile cannabis industry, it is very rare to find a CEO with such a long tenure, especially considering how far she has grown Trulieve, too. It is no small feat to grow a business from 1 license in Florida to a multi-billion dollar company across the U.S. In addition, she has shown investors that she can grow a business organically and swiftly dominating the Florida market while she can identify key acquisition target and integrate large businesses. The acquisition of Harvest Health in 2021 was the largest in the U.S. cannabis sector supporting Trulieve to enter the South Western and North Eastern market with strong existing market leadership rather than starting from scratch like what they did in Florida.

Profitability

• Trulieve reported an adjusted EBITDA of $78 million in Q3 2023 with the quarterly revenue of $275 million;
• Gross profit for the quarter was $142 million surpassing its peer, Green Thumb Industries, which reported $133 million in gross profit;
• Cash flow from operations was $93 million in Q3 2023, largely thanks to not making the estimated income taxes payments in addition to strong profit generation.

It is extremely rare if not impossible to have a U.S. cannabis business that can be profitable in 23 consecutive quarters including Q3 2023. Trulieve somehow has managed to do it, especially considering the challenges with banking, taxes and fierce competition. U.S. cannabis businesses don’t have access to the traditional banking services such as allowing patients/consumers pay products through credit card. As such, Trulieve along with its peers faces much higher fees on banking services than the other industries. In addition, 280E tax code, which calculates income taxes on gross profit rather than net profit, usually puts the effective income tax rates for U.S. cannabis businesses north of 70% compared to just about 25% for other industries.

Tax Strategy

This is the key point I would like to bring to fellow investors’ attention.

In October 2023, Trulieve filed an income tax refund claim by amending previously filed income tax returns with the IRS for 2019, 2020, and 2021 fiscal year ends. The total income tax refund claimed was whopping $143 million dollars. At the same time, Trulieve stopped making the estimated income tax payments to the IRS starting Q3 2023. To put it in perspective, Trulieve remits approximately $40 million estimated income taxes payments every quarter or $160 million on an annual basis. Rather than making the estimated tax payments, in December 2023 Trulieve made early redemption of $57 million of the 2026 private placement notes as well as $130 million 2024 private placement notes that are due in June 2024, expecting to save about $20 million in interest payments. The 2024 private placement notes bear 13.4% interest rate while the 2026 private placement notes bear 8.5% interest rate. Although it is far from a guarantee that Trulieve will receive the $143 million refund claimed from the IRS, this move is very smart in several ways.

The worst case scenario is that the IRS denied the claim and Trulieve needs to make income tax payments for 2023 and 2024 together with some interests. However, even this scenario has significant benefits:

1. being at the forefront of the fight with the IRS to remove the 280E punitive taxes on the cannabis sector puts Trulieve further on the map to be noticed and respected by fellow cannabis businesses, patients and consumers driving business opportunities to Trulieve. The more IRS fights against Trulieve, the more Trulieve can assemble alliance and support from fellow cannabis business and advocate groups to join the fight. Every dollar of legal expenses that Trulieve pays becomes sort of a marketing and business development expense increasing Trulieve’s brand equity.
2. even if there is only a slight chance that the IRS will grant this income tax refund, Trulieve is able to capture that by filing the amended income tax returns. Otherwise, if Trulieve doesn’t file these amended tax returns, the previously filed tax returns become statutory barred from amendment, which means that Trulieve can never file such claim in the future. Other U.S. cannabis businesses won’t be able to access this refund if they don’t file the amended tax returns within the statutory period even if 280E tax code is overturned for the cannabis sector. In addition, Trulieve with the acquisition of Harvest Health in 2021 generated significantly higher revenue and profit in 2019, 2020, and 2021 compared to previous years.
3. Even if Trulieve has to pay interest to the IRS on unpaid taxes for 2023, the interest rate with IRS is far better than the interest rate on the private placement notes. The IRS interest rate on unpaid taxes is determined quarterly based on the Federal short-term rate plus 3%. For the quarter beginning on January 1, 2024, the IRS interest rate for owed but not fully paid taxes is only 8%, compared to 13.4% on the 2024 private placement notes or 8.5% on the 2026 private placement notes. What’s better is that it is widely expected that the Federal Reserve will cut interest rate by at least 100 basis points by the end of 2024 with further cuts expected. Essentially, Trulieve managed to switch the private placement notes with a fixed interest rate that are very high with an IRS debt that bears a variable interest rate with expectation to decline. Usually, for this type of swap agreement, there is a large fee. However, Trulieve managed to do this for free with added benefits.

The best case scenario will be that in addition to the benefits above Trulieve can receive $143 million refund plus interest income (5.5%, better than investing in U.S. Treasury Bonds) from the IRS for 2019, 2020, 2021. Then, Trulieve will claim the income tax refund from 2022 and 2023 for another $200 million approximately adding a total of $350 million cash to its balance sheet. To keep in mind, Trulieve’s current market capitalization is only $1.2 billion in USD.

This is a fantastic tax and business strategy demonstrating Trulieve management team’s ability and business acumen.

Recently in January 2024, Federal health authorities who recommended the DEA to reschedule cannabis also concurred with one of marijuana advocates’ core arguments: Compared to other widely available and abused substances – namely, alcohol – cannabis is safer, if not harmless.

This development will help Trulieve move closer to the best case scenario.

Valuation

Trulieve’s current market capitalization is $1.2 billion while its peer, Green Thumb Industries (which generated slightly lower gross profit), is at $3.03 billion.

At the current run rate, Trulieve’s expected to generate cash of $360 million from operations and $500 million gross profit in the next year, putting the current valuation at only 3 times of cash flow or 2 times gross profit. It is extremely hard to find a company that is growing at this fast pace with this type of valuation.

In addition, if Trulieve actually wins the battle with the IRS, that is another $350 million cash added to its balance sheet.

Risk Factors

Despite the strong case above for Trulieve, there are risk factors to consider.

Conducting businesses in the U.S. cannabis sector is extremely difficult from a credit perspective. While Trulieve is performing well, its customers may not. Trulieve’s provision for credit losses increased significantly to $3 million as of September 30, 2023 from $2 million as of December 31, 2022. This amount should be monitored on whether Trulieve has been exposed to a higher significant credit risk with its customers.

Although Trulieve’s tax strategy may yield those benefits above, it is far from certain that the Federal Reserve will indeed cut the interest rate in 2024. If the Federal Reserve changes course to instead increase the rate in 2024 or 2025, that can put a significant strain to Trulieve’s resources if Trulieve ends up losing the battle with the IRS.

In addition, Trulieve’s tax strategy may also be copied by its competitors diluting the marketing impact that this strategy can potentially yield for Trulieve.

Conclusion

Trulieve represents a compelling investment opportunity in the U.S. cannabis sector, as a result of its robust business strategy, effective leadership under CEO Kim Rivers, and an innovative tax plan that could significantly bolster its financial position. With a strong financial performance Q3 2023, and the successful integration of Harvest Health boosting its presence in key markets, Trulieve is well-positioned for sustained profitability. However, investors should remain alert of the risks inherent in the dynamic cannabis industry, regulatory uncertainties and competitive pressures.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.