Finding Value in Cannabis Bonds: Are Trulieve's Secured Notes Actionable?
Assessing Credit Risk in a "Budding" Landscape
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In this week’s post, I will initiate coverage of US cannabis high yield issuers. This is not a sector I’ve followed closely in the past; however, it appears to be a sector ripe for mispricing given institutional ownership constraints. Based on a current subscriber recommendation, I’ll first take a look at Trulieve to see if there’s anything actionable in the capital structure. To the extent there is sufficient interest, I’ll review other issuers in the sector. Drop me a line with your thoughts!
Situation Overview:
Trulieve Cannabis Corp. (“Trulieve” or “TRUL”) is one of the largest vertically-integrated cannabis companies in the US, operating 196 retail dispensaries with >$1 billion in sales and $350 million in Adj. EBITDA. The company, classified as a Multi-State Operator (MSO), operates across 9 states (primarily in Florida where it holds >30% market share), managing cultivation, manufacturing, distribution, and retail operations. Founded in 2015 by CEO Kim Rivers, the company went public in September 2018, listing on the Canadian Securities Exchange (CNX:TRUL / OTCQX:TCNNF) after completing a reverse-merger.
Geographic Diversification Through M&A
In 2021, Trulieve made a significant move to diversify its operations beyond Florida by acquiring Harvest Health & Recreation in a $2.1 billion all-stock deal. This acquisition expanded Trulieve’s presence in important markets such as Arizona, Pennsylvania, and Maryland, while also adding talent and experience in wholesale operations. To help finance the acquisition and retire certain Harvest Health & Recreation debt, TRUL privately placed $350 million of 8.0% Senior Secured Notes due 2026.
Sector Wide Market Challenges
Despite its strong market position and growth initiatives, Trulieve (along with many others in the sector) encountered significant headwinds in recent years including intense competition and weak macroeconomic conditions. The influx of new competitors eroded Trulieve’s market share, and economic headwinds like inflation and labor shortages eroded the company’s margins. The company also experienced decelerating patient growth attributed to the reversal of COVID-related trends, which previously saw a boost from increased at-home activity and stimulus dollars.
As a sector, the cannabis industry has been dealing with oversupply and overexpansion, which correspondingly resulted in Trulieve selling off excess inventory at lower prices, impacting gross margins. The company also exited certain unprofitable markets, resulting in its first annual revenue decline in 2023. On the regulatory front, the sector continues to face uncertainty regarding federal legalization and the resulting limited access to traditional financing. You can read more about the sector’s challenges here.
Bond Price Reaction
TRUL’s bonds began trading in distressed territory in 2023, with its 2026 Secured Notes reaching a low of 68.5 cents in September 2023 as investors weighed erosion in profitability against near-term debt maturities. However, this low bond price proved to be a solid buying opportunity as the company quickly used excess cash to repurchase its debt at a discount, buying $57 million face value at a 17% discount. Shortly thereafter, in November 2023, Trulieve announced its intention to redeem all of its outstanding ($130 million) 9.75% Senior Secured Notes due 2024.
After reaching its 2023 lows, the cannabis industry has seen a resurgence on the backs of anticipation that the DEA could reclassify cannabis as a controlled substance. This potential change could alleviate the sector’s hefty tax burden and may also prompt Congress to pass the SAFER Banking Act, allowing banks and credit unions to work with the legal cannabis industry.
Current State of Affairs
Despite the regulatory overhangs, Trulieve has been working on improving its margins by reducing excess inventory, ramping up a new cultivation facility for lower production costs, optimizing product mix, and implementing strategic pricing adjustments. These business decisions appear to have had a positive effect, as the company reported strong performance in 1Q’24, with a return to topline growth and gross margins improving to 58% (vs. 50% at the lows). The company also maintained its guidance for over $225 million in operating cash flow for the year.
In the next section, I’ll review the company’s capital structure, financials, and key considerations, as well as provide my views on whether the company’s bonds still look interesting at current levels despite the recent run-up.
Disclosure: The information provided is for informational purposes only and should not be considered as investment advice. Any investment decisions made based on the information provided are at your own risk. It is essential to conduct your own research and consult a qualified financial advisor before making any investment decisions. Investing involves risks, and past performance is not indicative of future results. By using this information, you acknowledge that you are responsible for your own decisions and release me from any liability. Seek professional advice tailored to your financial situation and objectives.