REFI - Chicago Atlantic Real Estate Finance: Cannabis Lender With A 13.4% Yield

2023-05-04 12:37:45 ET

Summary

• Chicago Atlantic operates in the nascent space for providing debt capital to legal US cannabis companies.
• The mortgage REIT is paying out a 13.4% dividend yield that's fully covered by distributable earnings.
• The payout is set to be maintained at $0.47 per quarter through 2023 as the mREIT trades at a narrow discount to its tangible book value.

Chicago Atlantic Real Estate Finance ( REFI ) last declared a quarterly cash dividend of $0.47 per share , in line with its prior payment and for a 13.4% forward yield. The mortgage REIT is a commercial real estate lender and has built its loan portfolio from real estate credit investments, primarily in the cannabis space. This is from properties in all parts of the cannabis value chain, with the mREIT having $351.4 million in loan commitments across 22 portfolio companies as of the end of its fiscal 2022 fourth quarter.

The large yield is set against an industry that is set to grow to reach $71 billion in sales by 2030. Bulls have a lot going for them here, but the specter of an industry starved of liquidity in the short term and fast consolidating on the back of ramping bankruptcies presents some headwinds to Chicago Atlantic's loan portfolio and its ability to maintain its dividends.

The regular quarterly payouts have been maintained at their current level since it was raised by 17.5% in the Spring of 2022. There was also a special dividend of $0.29 paid out last year to meet its REIT taxable income distribution requirements. Further, during its fourth-quarter earnings call , Chicago Atlantic flat-out stated that the dividend should be safe for this year. The mREIT intends to keep its distributions stable at $0.47 every quarter, with at least 90% of distributable earnings paid out. There could also be another special dividend at the end of 2023 if the REIT undershoots its taxable income threshold. Hence, is this a buy? It depends.

Distributable Earnings Against An Industry Facing Headwinds

Public cannabis companies are currently amidst an implosion sparked by a dearth of cash following more than a year-long decline in equity values. Pandemic-era retail-driven mania has fully given way to fears around a liquidity crunch, and cannabis equity REITs are already feeling the pressure. Innovative Industrial Properties ( IIPR ), the largest cannabis REIT, is faced with rising tenant rent defaults which have placed its payouts at risk.

Chicago Atlantic reported fiscal 2022 fourth-quarter net interest income of $14.76 million , this represented growth of 14.2% over the year-ago comp and also beat by $1.3 million on consensus estimates. This was driven by total drawn loan commitments of $336.3 million, with a weighted average yield to maturity of 19.7%. The externally managed mREIT saw its prime rate move up by 125 basis points to 7.50% from 6.25% on the back of the increases to the Fed funds rate. Chicago Atlantic also originated $5.9 million of new loans during the fourth quarter and amended yield terms on some of its loans to increase the floating rate portion of its portfolio to around 83%.

Distributable earnings were $10 million, around $0.57 per share, and down by 1.7% versus the year-ago comp. The dividend paid out formed 82.45% of distributable EPS. This is versus a 90% payout ratio sported by close peer AFC Gamma ( AFCG ). A payout ratio just over 80% is also a level where it could take on some portfolio defaults and still be maintained.

A Somewhat Nascent Industry With A Mixed Future

Legal US cannabis sales remain illegal at a federal level as the current liquidity crisis forces through a consolidation of the sector. On a broader level, the next year for the industry will be critical as cash runways near their end against compressed valuations from near-distressed stock prices. I like that Chicago Atlantic has taken the steps to diversify its loan portfolio, with no singular loan accounting for more than 11% of the whole portfolio.

The mREIT is currently also trading 4.5% under its tangible book value ("TBV") of $264 million , or $14.86 per share, as of the end of the fourth quarter. This compares to a discount to TBV of 27% for competitor AFC Gamma. Hence, there is less of a margin of safety with Chicago Atlantic. Further, in the long-term actual legalization would open the door to financing from more mainstream lenders. This would bring competition that would likely drive down the yield to maturity Chicago Atlantic currently enjoys on its portfolio.

I'm bullish on the dividend yield, but there could be a risk that the discount to TBV widens in the quarters ahead as interest rates remain high to keep overall liquidity flowing into the sector constrained. Chicago Atlantic only went public in 2021 and has done great work to build a shareholder accretive dividend payout history and a shareholder base that has helped maintain its valuation against the broader market volatility. I'm still neutral on taking a position in cannabis companies, but this could be a buy following their fiscal 2023 first-quarter earnings later in May.

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