TerrAscend and 280E: Potential Gains in Stock Value

TDR Three Key Takeaways:

1. Section 280E creates a substantial tax burden for TerrAscend.
2. Analysis of TerrAscend reveals significant tax overpayment and stock impact.
3. Potential Section 280E changes could markedly increase cannabis stock values.

We are embarking on an exploration of the potential effects of changes to Section 280E on cannabis companies. Below we will use TerrAscend‘s stock as a case study on how we determine the effect on stock price. To begin, let’s understand what Section 280E is and its implications for cannabis businesses. Section 280E of the U.S. Internal Revenue Code, enacted in 1982, forbids businesses involved in the trafficking of Schedule I or II controlled substances, as per the Controlled Substances Act, from deducting typical business expenses from gross income. Despite the legalization of cannabis in many states for medical or recreational purposes, it remains a Schedule I drug federally. This places cannabis companies, even those operating legally within their states, under the purview of this federal tax code. They face a higher effective tax rate, unable to deduct common expenses like rent, wages, and marketing costs. This unique tax situation considerably affects the financial well-being and profitability of U.S. cannabis companies.

How significant is this impact on companies’ earnings and stock prices? Consider this analogy: if you own a Subway Sandwich franchise and sell a footlong sandwich for $10, incurring expenses of $8, including rent, food, and labor, being taxed 28% on the full $10 rather than the $2 profit would render the business unviable. Section 280E poses a substantial challenge for any company that cannot deduct its expenses.

So, how do we determine its effect on cannabis companies?

Our analysis incorporates factors like Earnings Before Tax (EBT), corporate tax rates, and the S&P 500 earnings multiple to offer a detailed perspective on stock valuation. Here’s how we analyze using TerrAscend as a case study:

1. Earnings Before Tax (EBT) Evaluation: We start by examining TerrAscend’s EBT, considering both standard and unusual items. In cases of disparity, we opt for the higher figure for conservatism. For TerrAscend, this was $5.05M USD over the last year.
2. Corporate Tax Rates in the USA: We also factor in the varying corporate tax rates across the USA, ranging from 23.5% to 32.5%. Our analysis uses a median rate of 28%.
3. Overpayment of Taxes: TerrAscend appears to have overpaid taxes by about $46M USD in the past year, as per our calculations.
4. Stock Earnings Multiple: We then apply the current S&P 500 earnings multiple, which stands at 26.37 times earnings.
5. Per Share Value Calculation: Dividing by the number of outstanding shares, we find an added value of approximately $4.22 USD per share.

Based on the above calculation, TerrAscend’s stock is priced at $1.78 USD. With the potential change in Section 280E, TerrAscend’s stock could be valued at $6.00 USD or $7.86 CAD.

We are initiating comprehensive research coverage on various companies in the cannabis sector, aiming to calculate the valuation effects of Section 280E for these businesses.