IIPR - Innovative Industrial: Leading Cannabis REIT On The Verge Of A Turnaround

2023-09-26 12:30:00 ET

Summary

• Innovative Industrial Properties investors saw a surge in early September as buyers rushed in, anticipating a favorable outcome for the risk reclassification of marijuana.
• However, that surge proved unsustainable, as business model risks for cannabis companies persist. Furthermore, the Fed's higher-for-longer positioning could impede a near-term upward inflection.
• Despite that, IIPR has bottomed out in April 2023, and the worst is likely over. The market has not reflected its best-in-class growth and profitability grades.
• Therefore, high-conviction investors looking to capitalize on IIPR's nascent recovery should consider taking advantage of its recent pullback from its September highs.
• I argue why IIPR's valuation dislocation is a fantastic opportunity for investors to buy more.

Innovative Industrial Properties ( IIPR ) investors have seen a brief respite earlier in September, but the upward recovery has stalled. As a reminder, Bulls rushed in as cannabis stocks staged a sharp surge into a bull trap in early September, as they reacted positively to the potential risk reclassification of cannabis into a lower-risk category. As such, it reportedly could lead to improvement in their underlying cash flow projections due to lower taxes, which attracted buying fervor.

However, the surge was unsustainable, as these companies still need to prove their business model. Furthermore, it's highly uncertain when the Drug Enforcement Agency will complete its review, rescheduling marijuana from Schedule I to Schedule III. As such, profit-taking and increased short bets likely occurred as pot stocks surged, as seen in the price action (to be discussed later). Such a risk-off maneuver is astute, allowing dip buyers to take some risks off the table.

As the leading industrial REIT focusing on regulated cannabis players, Innovative Industrial Properties also benefited from the recent recovery. Despite that, IIPR has significantly underperformed the S&P 500 ( SPX ) ( SPY ) since I upgraded it in December 2022.

Despite that, I gleaned that IIPR has decisively bottomed in April 2023. IIPR sellers battered the stock further as market operators probably anticipated a bruising collapse in funding conditions, leading to a significant credit crunch. However, the liquidity crunch from the banking crisis didn't materialize. Moreover, while the Fed could remain higher for longer, the 10Y Treasury yield has already reacted, breaking above highs last seen in October 2022.

As such, it's arguable that the market has already anticipated significant headwinds against Innovative Industrial Properties' cannabis tenants. Notwithstanding its triple-net lease terms, IIPR remains exposed to rent collection headwinds. However, in its second quarter or FQ2 earnings release , the company updated that rent collection for its operating portfolio was 97%. While it faced challenges with Parallel, I assessed that IIPR's cash flow remains robust, supporting its distribution to its holders.

In addition, Seeking Alpha's Quant Factor assigned best-in-class profitability "A" and growth "A+" grades for IIPR. However, its "A" valuation grade suggests the market reflected significant pessimism on its growth profile, anticipating a widespread default on its rent collection, which hasn't materialized.

While the higher-for-longer Fed could impede a near-term upward valuation re-rating, high-conviction investors should capitalize on its valuation dislocation before the rest of the momentum buyers return.

As seen above, IIPR has bottomed out in its 2-Day chart, recovering its short-term uptrend bias decisively. Bearish prognosticators might call the recovery a "bear market rally." While that remains possible, as IIPR's medium-term bias remains bearish, I believe the early signs are favorable.

As such, I assessed that IIPR remains early in its uptrend recovery, suggesting investors must be prepared for volatility, as bearish operators could load up on their short positions.

I believe IIPR's September highs ($90 level) likely saw these short-sellers reloading as it was at a critical resistance level, leading to a sharp decline through this week.

However, the selling momentum has waned, with IIPR likely attracting dip buyers and possible early profit-taking by short-sellers as IIPR re-tested its short-term moving average.

As such, the nascent uptrend recovery thesis remains intact, supported by Seeking Alpha Quant's "B" momentum grade.

Rating: Maintain Buy.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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