We have been looking at defining scope of risk if/when federal legalization takes place, which would likely bring interstate commerce, or if Florida removed the vertical mandate themselves. And Florida, under present management, does not look to be removing it for medical. Would they change their stance if adult use came to pass? Who knows.
Investors should understand the risk and then evaluate how that risk impacts their portfolio. Then IF things change in the future… TheCannalysts will have done our job in making you aware of the implications.
In this piece we look at the ramifications for Trulieve if FLA lost mandated verticality. The dismantling of vertical mandate would also impact others with operations in Florida, but none so much as Trulieve. The Florida risk exposure to Trulieve is probably their biggest chink in their armor.
Should they take advantage of their situation in Florida and open more retail outlets? The opening of additional locations organically is a lot less costly than acquiring licenses in other states. But with +300 open dispensaries the metrics are considerably different than in markets with less saturation. The payback time on the investment is likely the driver, but we are not provided with that level of information.
Florida is the largest medical only market, and they mandate full verticality. No wholesale. Florida has had several lawsuits that have been struck down attempting to break the vertical only model. Verticality could be impacted by federal regulations, or by Florida changing rules themselves. The latter probably would not happen without a change in state government or might be contemplated if Florida allowed adult use.
In any open market, or even limited license markets like Illinois, no store is stocking 100% of its own products and not carrying others’ products. That would be retail suicide. In Illinois, and other markets that allow wholesale, it is common that a Cresco store will have Verano and Cura products on their shelves.
It is easy enough for Trulieve to stock other manufacturers’ product on their shelves. But what happens to their margins if that happens, and do they have enough product to direct through a wholesale channel to accomplish the same GM$ metric as in a full vertical?
Let us take a look. We are going to start with a scenario where TRUL maintains 30% of their shelf space in their stores.
Scenario #1: 30-70 Trulieve to Other Split in Trulieve stores.
Column A: Trulieve last Q. I rounded down to $190 from $194 million. For ease of analysis and given TRUL does not provide any segmentation of sales by state, I have assumed $190 million was generated from Florida. It is likely less, but by the time this event was to occur TRUL would likely have more revenue in FLA than $190 million.
Column B: I assumed TRUL would maintain 30% of their shelf space and sales for their own products in their own stores. This could be a touch high, so I will run a 20% scenario below.
Just because TRUL is not moving 100% of their own product in their stores does not mean that revenue would fall away, as they would supplement their product sales with products purchased from others. We gave them this full benefit and balanced Revenue in B to Actual by adding $133 million in other manufacturers’ products sales through their store.
But selling other manufacturers’ product in their stores does not carry the same Gross Margin as fully vertical TRUL. So, we applied a 50% retail margin to other manufacturers’ products.
The result… TRUL GM generated through their stores drops from $133 million to $106 million or -20%
Column C: Trulieve would be able to redirect their sales previously through their stores to wholesale to competitors stores, as they would have surplus product now available. So, in this column we assumed a 35% GM on wholesale revenue and plugged the wholesale revenue with a figure that would aggregate to Gross Margin in Actual at $133 million. (NOTE: Stacking a 50% retail margin and 35% wholesale margin is likely high, but I did not want to play around with too many variables. Feel free to do so in your models.) The plug wholesale revenue ended up being $76 million. Which with +200 stores in FLA not owned by TRUL would work out to $380k per quarter per non TRUL store. Certainly, doable.
But we wanted to see how much CoGS were left over from Actual to fuel wholesale revenue in order to ensure they had enough CoGS to drive that sales level.
Thus, we took CoGS from A at $57 million and subtracted CoGS from a 30-70 TRUL-Others scenario of $17 million for their own product in their own stores. They are left with $40 million in CoGS to service wholesale revenue. We divide this CoGS figure by our assumed 65% wholesale CoGS and we get a $61 million in possible Maximum Wholesale Revenue that could be generated by that level of CoGS.
So, it would appear that TRUL would not have the capacity (assuming they maxed out sales in March 31, 2021) to generate $76 million in wholesale revenue.
Column D: We use the maximum amount of Maximum Wholesale Revenue from CoGS from Column C as our upside Wholesale Revenue. We apply the 35% GM for wholesale and we get maximum Revenue of $252 million and GM$ decline of $5 million to $128 million.
In column C and D, as we are adding a large wholesale function… there will be accompanying SGA expenses that we are not contemplating in this model. The operation or Retail store fronts would remain the same under all the scenarios and these expenses would remain unchanged.
So, what does this tell us?
It tells us if TRUL, or any other operator in FLA, were to open its shelves to Others products their net GM$’s would decrease. BUT they would obviously have wholesale opportunities presented as a result.
The effort to maintain the Actual GM$’s increases with the demise of verticality. They could likely increase cultivation output to drive wholesale… but again mor effort to maintain status quo GM$. And then there is the SGA that goes with the wholesale channel.
Note what happens to GM% as we layer in these additional non vertical functions. It decreases to the CURA and CL present range in C and D to 50-51%.
Removing verticality would likely be good for Trulieve opportunity to sell more product at others stores, but it would not be generated at the same margin. It could generate more absolute GM$’s, but the base case is a limiting factor. Plus, Trulieve presently has under 2 Q’s of inventory on hand to satisfy their own stores. They would likely have to build out their capacity and inventory by more than what was achieved in revenue last Q.
Scenario #2: 20-80 Trulieve to Other Split in Trulieve stores.
As we said above, maintain a 30% market share might be high. This scenario is run at 20-80 mix.
OK… same approach as above, so we will skip straight to conclusions.
They would have to sell more of Others product in their stores, this results in B drop GM$ to $103 million or -$30 million from Actual, as less margin value from their own products is generated.
In order to maintain $133 GM$ they would need C wholesale revenue of $87 million at 35% GM. However, as they have more unabsorbed CoGS this can now be used to maximize wholesale in D at only $70 million, which would then produce a GM of $127 million versus $133 million presently.
GM% across these scenarios weakens from Scenario 1 as TRUL losses more higher margin vertical sales.
As you can see by reviewing the above the ability to sell 100% of your own product in your own stores has a significant advantage. As MSO’s are largely a patchwork quilt of various individual states, exposure to a preferable state regime today can erode GM$ and % overtime and investors should keep that in mind as regulations change.
A lot of investors wonder why TRUL does not have the market capitalization of CURA or GTII despite superior operational metrics. The exposure to Florida being greater than CURA and GTII is likely a factor.
NOTE: The above does not take into consideration any interstate commerce or the impact that collection of excise on first sale and interstate would being to Revenue, Gross Margin and the ability of FLA production to compete with any imports from the other states.
The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author does not have a position in CURA, TRUL or CL and will not start one in the next five days.