One of the most frustrating trades of 2021 was in U.S. cannabis stocks. After riding a wave of enthusiasm early in the year on the back of a Democratic electoral victory and hopes for federal legalization, Congress became bogged down in other priorities. While there is bipartisan support for cannabis reform, some lawmakers want to go further than others who want only incremental measures. So of course, nothing got done.
Cannabis stocks sank in response. But amid lower stock prices, could now be the time to hop on the U.S. cannabis train? One of the best and most profitable U.S. multistate operators is Trulieve Cannabis (TCNNF -2.70%), which was up more than 60% by January and February in 2021, before falling with the sector to finish the year down 17.7%.
After the fall, shares are basically back where they were shortly after the 2020 election. So does this mark a bottom? And where will Trulieve go in 2022?
Closing a big deal in October
The big event for Trulieve was closing its massive $2.1 billion acquisition of Harvest Health and Recreation on Oct. 1. Before the deal, Trulieve had pursued a somewhat unusual strategy of concentrating its efforts to dominate a single state: Florida. Trulieve ended up with more than 50% market share in that huge state as a result, with Florida's limited licenses and vertically integrated structure affording it industry-leading margins.
Some may think that the huge acquisition of Harvest is a departure from that strategy, but it's really an expansion. Although the acquisition gives Trulieve a combined footprint across 11 states, the bulk of Trulieve's "new" footprint is now in three regional hubs of Florida, Pennsylvania, and Arizona.
On its recent third-quarter conference call, CEO Kim Rivers said the company will concentrate its investments in these three limited-license states, converting Harvest stores to Trulieve stores and becoming a branded retail giant, as opposed to following a lower-margin wholesale strategy.
So Trulieve is still employing its strategy of concentration in high-margin opportunities, not spreading itself thin across too many states as other large MSOs have done.
Reasons Trulieve could skyrocket
Cannabis stocks have tended to trade almost entirely based on the prospects for federal legislation, so any movement on that front could cause Trulieve and all pot stocks to soar. However, even absent federal legislation, more state-level movement could also be a catalyst. An adult-use legalization bill has been proposed in Pennsylvania, which is medical-only right now. If that passes, investors would probably view it positively, since adult use should lead to increased volumes. Florida is medical-only now as well, but it will probably go adult-use sometime around 2024. That would be a big deal for Trulieve, but it's probably further off.
Then there are always earnings catalysts. Trulieve actually closed the Harvest acquisition ahead of plan, and its integration is going well. Management noted that when Truleive upgraded Harvest stores in Florida, volumes increased about 35%. There are some concerns about competitive pressures and pricing concerns, so better-than expected revenue and profits could also be catalysts. Trulieve will report its first full quarter post-acquisition in March, which could lead to either positive or negative surprises.
Since the industry is under pressure, Trulieve may also be able to pick up smaller cannabis companies or individual stores at good prices in 2022, given its scale, high relative margins, and a solid balance sheet that has more cash than debt.
Why Trulieve could sink
Of course, those competitive pressures and aggressive price discounts from competitors could weigh on Trulieve, even if Trulieve is perhaps the best-equipped MSO to handle it. In addition, if there is some sort of definitive killing of federal legislation on any front, even banking reform, it could hurt sentiment for cannabis stocks in general. If Republicans take over the House of Representatives and Senate, it would probably be bad for cannabis stocks. While many Republicans are open to legalization, a large number aren't, and a Republican-controlled Congress would make federal legislation less likely.
In addition, if the Federal Reserve raises interest rates more than expected, it could also hurt cannabis stocks and Trulieve. While many U.S. cannabis companies make healthy EBITDA margins, they don't make much in the way of GAAP net income. And when you factor in capital expenditures to grow, many are cash flow negative. Higher interest rates tend to hurt companies with profits further out into the future, so the interest rate risk is there as well in 2022.
What's more likely?
Given that Trulieve's stock has come all the way back down to where it was around the time of the 2020 election, I don't think there is too much downside here. That's especially true since Trulieve is among the most profitable and cash-rich U.S. cannabis stocks.
But if cannabis stocks do have a bad year, Trulieve could be in a good position to pick up other cannabis assets on the cheap. That lower risk profile in a somewhat risky sector is why Trulieve remains my largest cannabis position. And of course, if Trulieve executes well and gets a bit of good luck on the regulatory front, so much the better.