Returns for cannabis tickers over the next few months are set to be heavily defined by the actions of an increasingly dovish Fed about to declare victory over its fight against inflation. This interest rate and inflation dynamic has for more than a year defined the capital markets and set in place a sustained flight of capital rendered skittish from sectors deemed to be too high risk or companies still in their loss-making phase. Trulieve Cannabis (OTCQX:TCNNF) is the third largest US multi-state operator by revenue behind Green Thumb Industries (OTCQX:GTBIF) and Curaleaf (OTCPK:CURLF). However, both its peers have a market cap that's more than 2x Trulieve's despite the gap in revenue being around 21%. Trulieve is unprofitable but operates in a sector being forecasted to grow to $71 billion in sales without US federal legalization. This will come on the back of statewide legalization with Ohio being the most recent state to legalize adult-use cannabis.
Trulieve trades over the counter due to the cannabis being classified as a Schedule I drug. This has heavily limited its investor base to mostly retail investors and traders with institutional ownership placed at just 0.08%. The late summer recommendation that cannabis be reclassified from a Schedule I to a Schedule III drug from the US Department of Health and Human Services to the Drug Enforcement Administration combined with a bipartisan bill to federally legalize marijuana called The States Reform Act ("SRA") form legislative catalysts for 2024.
The DEA will likely push through with cannabis reclassification but the SRA holds a low possibility of being approved in an election year. Further, with 68% of Trulieve's brick-and-mortar retail locations in Florida, the outcome of the Smart and Safe Florida ballot initiative, which seeks to legalize recreational marijuana for adults 21 years old and older across the Sunshine State forms a more material near-term catalyst. The Florida Supreme Court is expected the rule on the initiative by April 2024 which means it may appear on the ballot in Florida as an initiated constitutional amendment on November 5, 2024.
Growth, Cost Control, And Margins
Closing the valuation gap to its close peers and enhancing its liquidity stack now form the most pressing needs for Trulieve. Trulieve recorded fiscal 2023 third-quarter revenue of $275 million, down by nearly 7% over its year-ago comp but a beat by $5.76 million on consensus estimates. The seasonal decline in Florida and Arizona sales was partially offset by Maryland where the launch of adult-use sales drove a 235% increase in traffic at the company's three dispensaries. Third-quarter revenue was down by 2.3% versus the second quarter. Critically, the company exercised strong cost control with gross margins seeing gains to contribute to healthy free cash flow generation during the quarter.
Sales and marketing expenses at $59.4 million in the third quarter dipped by $15 million from its year-ago period with general and administrative expenses falling by 8.4% year-over-year. Third-quarter GAAP gross margin of 52% drove gross profit of $143 million and was up 170 basis points over the second quarter but fell from 57% in the year-ago period. This meant a net loss of $25.4 million, down materially from a net loss of $114.5 million in the year-ago period.
A New Leaf In 2024?
The reclassification to Schedule III would be material by eliminating the 280E tax burden which prevents businesses from deducting normal business expenses from gross income that's been tagged as being associated with the "trafficking" of a Schedule I substance. According to Bernstein, it would also fundamentally mean cannabis being viewed more as a medical product instead of a consumer packaged goods to somewhat limit the downstream addressable market for MSOs. The treatment of tax drove what was a positive free cash flow of roughly $87 million during the third quarter.
Trulieve elected not to pay cash taxes during the third quarter and has filed a $143 million tax refund claim. The company is essentially following through with filing its taxes as a customary US taxpayer to eliminate the tax liabilities that arise from 280E. Trulieve will keep this lower-burden tax payment regime in place as they await a response from the IRS on their refund claim. Taxes deferred during the third quarter and the upcoming fourth quarter will come due in February 2024. The company's cash position at the end of the third quarter stood at around $192 million, up $40 million from the second quarter. 2024 could see a return of retail investor risk capital if the Fed mirrors expectations to cut rates in the second half of next year. I'll remain on the sidelines but Trulieve is a hold.
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