IIPR - Innovative Industrial Properties: A Fat Cannabis Powered 9.5% Yield

2023-04-02 03:51:21 ET

Summary

• IIPR is paying out a 9.5% dividend yield, a record high on the back of share price weakness.
• The REIT recently reported rent issues with some operators but the dividend likely remains safe in the near term with a payout ratio of 85% for its fiscal 2022 fourth quarter.
• Common shares are trading near their 52-week lows but still at a premium to tangible book value.
• This current depressed stock price could prove to be an opportunity to accumulate shares if tenant issues are sorted out.

Innovative Industrial Properties ( IIPR ) last declared a quarterly cash dividend of $1.80 per share , in line with its prior payout for a 9.5% forward yield. The payouts have been on an unsatiable upward rise since IIPR went public in 2016. The REIT's three-year dividend compound annual growth rate stands at 35.6% with the payouts up by a staggering 55% CAGR over the last five years. However, recent stock price weakness has meant the yield has swelled to an unfamiliar level and now hovers just below a double-digit yield with interest rate angst working to wholesale reduce the valuation of REITs.

The current yield has understandably seen bears, which form a 10.35% short interest, raise concerns that the payouts are unsustainable. This is against an industry still operating in a legal grey area with statewide cannabis legalization running against cannabis remaining illegal under federal US law. IIPR's tenants are formed from both public and private cannabis companies with the REIT helping the industry to meet its capital needs through sale-leaseback transactions.

IIPR lease terms to state-licensed cannabis operators are extremely attractive with 15 to 20-year initial triple-net lease terms aggregated with annual escalations. The REIT held 110 properties across 19 states, 8.3 million rentable square feet and 29 tenants as of the end of its fiscal 2022 fourth quarter. These had a weighted average lease length of 15.3 years. However, there have been some issues. IIPR recently updated the market that three tenants, Parallel, Skymint, and Vertical were in default. The concerned properties from the three operators formed 6.3% of IIPR's invested capital.

Operator Issues And Tangible Book Value

IIPR collected 92% of base rent and property management fees as of the 18th of January, down from 94% for the fourth quarter of 2022 and 97% for the full year. The REIT is now in an unfortunate position where it's leaning on security deposits in lieu of rent to support its collections with these issues posing a material risk to the dividend payouts. The importance of getting the defaults stabilized is of critical importance with the stock likely to continue to see weakness as investors price in not just the prospect of zero dividend growth but the specter of a cut. IIPR runs the risk of becoming a battleground income stock like Medical Properties Trust ( MPW ) where near-perpetual issues with tenants reflect itself as forever angst around the payouts and a falling stock price.

To be clear here, IIPR's historic premium to its tangible book value ("TBV") has melted on the back of the tenant issues and broader concerns around a still rising Fed funds rate. However, this gap to TBV has been shortening in recent quarters. IIPR's TBV for its fourth quarter was $1.94 billion, essentially flat from the prior third quarter but up from $1.59 billion in the year-ago comp. With TBV per share at $69.28, IIPR's common shares at $75.99 are currently trading at a nearly 10% premium to TBV.

I think the pandemic-era premium is in the rearview mirror and IIPR will likely find it difficult to trade at its previous multiple against current tenant issues. Critically, the outlook for the legal cannabis industry in 2023 sees a dearth of liquidity from elevated interest rates reverberating across MSOs. Publicly listed MSOs have been unable to tap their stock for equity offerings as aggressively as they previously have with continued unprofitability being widespread across the space.

IIPR also still trades on a premium to TBV and this could invert into a discount in the event that defaults shoot up to push an already falling collected rent down even lower. Hence, the preferred Series A shares ( IIPR.PA ) which currently pay an 8.86% yield on cost present a partial hedge against possible future disruption. IIPR's balance sheet is well positioned with debt comprising just 12% of total gross assets.

Funds From Operation

The REIT faced a quarterly fixed cash interest expense of $4.5 million for its fourth quarter, flat sequentially from the third quarter and down from $6.2 million in the year-ago comp. There are also no debt maturities in three years until May 2026.

IIPR recorded dual beats for its fourth quarter with revenue of $70.46 million growth of 19.5% over the year-ago quarter and a beat by $1.48 million on consensus estimates. FFO per share was $2.12, a beat on a consensus of $1.89 and a 14.5% increase from $1.85 in the year-ago comp. Hence, the quarterly payout formed 85% of IIPR's adjusted fourth quarter FFO. Using cash flow from operations of $55.4 million against $50.5 million in commons dividends paid still provides a buffer for the payouts.

I don't think we will see a near-term dividend raise as the REIT moves to protect TBV and work through its tenant issues. The core risk here is that tenant issues persist. Indeed, during the earnings call for the fourth quarter, IIPR's management highlighted broader macroeconomic headwinds from inflation to a lack of funding that will face the MSOs that form 85% of their portfolio in 2023. The long case has been somewhat derisked with the company now trading at a price to FFO of 9x , a roughly 40% negative difference to its peer group median. This is a hold until there is more clarity on the direction of rent collection in the coming quarters.

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