Market Commentary: 1 Sky High Dividend Yield Stock with 61.9% Upside
Innovative Industrial Properties (IIPR), doesn’t cultivate cannabis but instead leases real estate to cannabis companies, enabling them to grow their operations.
In essence, IIPR is a cannabis real estate investment trust (REIT), and it was the first and is the largest cannabis-focused REIT to go public. It’s also got a sky high dividend yield of 9.51% and massive upside opportunity, so is it time to buy?
Unusual Cannabis Play Offers Unique Potential
Most investors keen on the cannabis industry usually consider the growers or the sellers. Very few pay attention to the backbone of the industry: the real estate, which is where Innovative Industrial Properties comes in.
With its unique business model, the company has been able to capitalize on the burgeoning cannabis industry without exposing itself to the legal ambiguities surrounding cannabis production and sale.
The business model involves purchasing industrial and greenhouse buildings and often enhancing them to meet the specific requirements of cannabis growers. It then leases the property back to these companies under long-term contracts. Think of IIPR as the landlords of the cannabis world.
The strategy has proven to be a win-win whereby cannabis companies get the capital to expand their operations while IIPR enjoys steady, reliable income from the leases.
As of the most recent fiscal year, the company owned 108 properties with the average length of the lease contracts spanning around 16.7 years, which suggests long-term revenue stability.
In the most recent quarter, the company’s revenue grew by 8.4% to $76.5 million, continuing a stretch of 20 quarters of year-over-year revenue growth. So is it a safe bet?
Safe Harbor in a Volatile Industry
With legislative waves and market trends causing significant volatility, cannabis stocks are frequently risky bets but IIPR’s real estate-focused business model grants it a sturdy economic moat, making it a less risky play in the cannabis world.
And the company’s properties are tailored for cannabis growing, which makes tenant turnover less likely. For example, IIPR enjoys a 99.1% occupancy rate, demonstrating the high demand for its specialized properties.
On the financial side, the company reported a 92.5% gross margin, reflecting the strength and uniqueness of its business model in the cannabis space.
It’s also paying a sky high dividend right now of over 9%, though it must be noted that this is not without risk because the payout ratio, which we would usually like to see below 50%, has eclipsed 125%.
Federal Regulations and Tenant Default
A notable concern for IIPR revolves around the federal legality of cannabis. While cannabis remains federally illegal in the United States, 18 states have fully legalized it, and 37 states have medical cannabis laws as of September 2023.
This trend suggests a gradual easing of federal regulations, which would be beneficial for IIPR and its tenants. Additionally, IIPR diversifies its risks by having tenants from various states, thus not over-relying on the legal framework of a single jurisdiction. And it can’t be over-emphasized that IIPR is not directly involved in cannabis cultivation, so the risk is somewhat mitigated.
Tenant default is another concern, but the high occupancy rate and long-term leases provide a safety net, so what’s the takeaway?
Buy, Hold, or Sell?
Innovative Industrial Properties is a cannabis stock without being a cannabis stock—a landlord in a high-growth, high-risk industry. With stable revenues, high occupancy rates, and dividends to boot, IIPR appears to be well-positioned for long-term growth.
By our calculations it has over 61% upside to fair value based on a discounted cash flow forecast analysis, which together with a near 10% yield makes for a compelling investment play.
The bottom line is for investors looking to enter the cannabis industry without the associated risks of cultivation and selling, IIPR offers a compelling option.
