Trulieve (OTCQX:TCNNF), the number one cannabis operator in Florida, recently announced a secondary offering worth up to $87.4 million. Based on the stock’s 5% selloff on the news, as well as commentary on related articles, it appears that the investor base felt uneasy regarding such dilution. As a shareholder myself, I feel otherwise: this equity offering gives TCNNF a much-needed infusion of cash. The stronger balance sheet gives it financial flexibility as well as a significant reason for multiple expansion. I rate shares a strong buy for long-term investors.

Dilution: A Long-Term Investment

TCNNF announced that it had entered an agreement with Canaccord Genuity to sell 4.1 million shares for C$24.50 each, as well as an over-allotment option for an additional 615 thousand shares. This works out to a potential total of approximately $87.4 million (unless otherwise noted, all currency figures are in US dollars). The market didn’t seem to like the news, as the stock dipped around 5% for the day:

(Google Finance)

On the surface, the reaction looks justified. If TCNNF is issuing shares, that implies that it thinks its stock is overvalued, right? Further, this increases shares outstanding, which reduces existing shareholders’ ownership of underlying earnings, right?

While both statements are somewhat true, focusing on these statements solely would miss the overall picture. Yes, shares outstanding will grow by nearly 4%. In return, however, TCNNF gets a revitalized balance sheet image. TCNNF ended the last quarter with $150 million in cash versus $130 million in debt. At first glance, it might seem like TCNNF did not need additional cash at all. TCNNF’s debt, however, typically have yields in the double digits. TCNNF’s most recent debt offering had a yield of 9.75%. As a shareholder, such a high cost of capital frightens me. I would be particularly troubled to see TCNNF continue to issue debt at double-digit yields, even if doing so would be more accretive to its bottom line than issuing shares. Why is it risky? Let’s say that TCNNF keeps growing its presence by issuing ~10% yielding debt. If the growth pans out, then the investments likely would yield far more than 10%. But what if TCNNF is unable to prove profitability in new markets? Profits might never materialize, but the interest expense accrued from funding the growth would remain a thorn in the side.

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After this equity raise, TCNNF would have more net cash on its balance sheet, giving it the ability to reduce its cost of capital over time. I expect TCNNF to try to refinance its high yielding debt at lower interest rates, which might be possible given that its balance sheet is now much stronger. This equity offering has dramatically reduced balance sheet risk in the event of a downturn in the cannabis sector. TCNNF now has enough net cash to afford 4 years of interest expenses even if TCNNF is unable to generate free cash flow.

That leads to the next benefit: multiple expansion. It seems that companies with net cash balance sheets tend to trade at premium multiples and that cannot be more true in the cannabis sector. Canadian peer Canopy Growth (CGC) trades around 17 times sales versus approximately 5 times the price to sales for TCNNF. Unlike CGC, TCNNF is cash flow positive, suggesting that CGC’s premium multiple is not due to superior financial performance but instead perhaps due to its listing on US major exchanges as well as the significant net cash on its balance sheet. TCNNF won’t be able to solve the former issue until cannabis is decriminalized on the federal level, but it has made a large step toward addressing the latter. Prior to the equity offering, any positive attributes regarding TCNNF’s strong profitability metrics and scale in Florida could be counteracted by its large debt load. Now, TCNNF has a strong net cash balance sheet that looks more like CGC’s balance sheet than it did yesterday.

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TCNNF’s stronger balance sheet may be the key to paving the path for multiple expansion, which would make the company be able to issue even more equity to fund external investments. That point is key.

The current competitive landscape is one defined by aggressive market share expansion and consolidation – if TCNNF can rely on its stock as cheap currency, then this would place it at an advantage to peers that wouldn’t have the same luxury and would have to instead rely on double-digit cost of capital.

Conclusion

It is a mistake to punish TCNNF for issuing stock at this juncture. The increased cash on its balance sheet helps to reduce financial risk which, in turn, may help TCNNF lower its cost of capital. While this piece specifically focuses on the equity offering, I note in passing that when backing out 280E taxes, TCNNF earns an annualized $81 million in net income, suggesting that shares trade at 30 times “legalized” earnings (280E taxes would go away once cannabis is decriminalized federally). Even after the strong stock performance this year, shares remain deeply undervalued compared to its growth potential in the medical marijuana space, not to mention the immense upside once adult-use cannabis is legalized in Florida (and nationally). I rate shares a strong buy.

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Disclosure: I am/we are long TCNNF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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