IIPR - Innovative Industrial Properties: The Dividend Is Juicy But Growth Outlook Looks Dry

2023-11-22 09:00:00 ET

Summary

• Innovative Industrial Properties recently reported Q3 earnings, beating estimates on FFO and revenue.
• The stock has experienced tenant troubles and has seen a significant decline in price over the past year.
• While the cannabis industry is expected to grow, IIPR's financials are projected to decline slightly in the next year.
• The REIT does have a strong balance sheet with no debt maturities until May 2026.
• Investors who believe in the long-term outlook of IIPR may be getting the stock at a great bargain at the current price.

Introduction

Innovative Industrial Properties (IIPR) is a stock that I have been watching for some time now. They first came onto my radar back in 2020. I instantly became attracted to the high dividend. Back then the price was in the high $100's, roughly around $165 if I remember correctly. I remember watching the stock trend higher and higher to nearly $300. I remember kicking myself saying, I wish I had invested some money into that stock. Well, we all know what has happened since then. So, I can honestly say I'm glad I never opened a position. To be fair the stock has continued to grow its dividend during the turmoil. As the saying goes, "What goes up must come down." I've kept an eye on it since then and in this article, I get into whether IIPR is a good dividend investment for the long term.

Q3 Earnings

IIPR recently reported Q3 earnings at the beginning of the month and delivered a beat on FFO and revenue. FFO of $2.09 beat estimates by $0.04 while revenue of $77.82 million beat by $1.26 million. AFFO also increased slightly this year by 2.5% from $63.4 million in Q1 to $65 million recently. Year-over-year AFFO is up over 8% from $60.1 million.

Here you can see revenue has also shown some slow growth over the same period:

So, some may say "Solid growth year-over-year, so why is the price down?" Fair question. Besides the current macro environment, the stock has been having tenant troubles. Does anyone remember Medical Properties Trust ( MPW ) tenant issues? Usually, the market is good about pricing headwinds into the stock price long before the problems come to fruition, or are considered a huge deal. The stock is down over 30% in the past year.

Here you can see where the stock had a good run from the end of the flash crash in 2020 to the end of 2021. If you had invested your money, then you probably made a good chunk of change. But if you're a buy-and-hold investor like me and held IIPR this whole time, then you're very much in the red. Even with the juicy dividend. The stock has come all the way down to the low $60s and now trades around $79 at the time of writing.

To be fair when the stock was skyrocketing a few years ago that was when cannabis stocks were the new thing. Every couple of years there's a new trend to hop aboard that usually ends up costing investors a lot of money in the long run. EV, cannabis, weight-loss drugs, and now A.I. stocks. The stock market is not a casino and one has to be careful not to get caught up in the hype. That's why I prefer to find conservative dividend stocks that have been around for a while, with solid business models that I assume will be worth more over time.

Tenant Troubles

Innovative Industrial has been dealing with tenant troubles for a while now. Earlier this year, the REIT had tenants Parallel & Green Peak Industries default on properties. They also had affiliates of Medical Investor holdings default on one of their California properties. During the last quarter management stated they had taken back properties from Parallel, Green Peak, and King's Garden.

In regards to Green Peak, IIPR regained possession of two small retail properties leased to the company and expects to regain possession of one more at the end of this month. Management did state they sold Green Peak's assets to a buyer this past October. These troubled tenants caused occupancy rates to drop over the past few quarters.

So, the company continues to deal with tenant defaults and I expect this to continue for the foreseeable future. Especially if rates are to remain higher for longer or if the economy does fall into a recession next year. The REIT has also had a slow year in regard to acquisitions due to the macro environment. And this slow pace is expected to continue. However, management did commit additional funds to complete development at one of their New York properties.

Growth Outlook

Although the cannabis industry is expected to grow in the next few years, IIPR's financials are expected to be dry. Over the next seven years, sales in U.S. current legal cannabis is expected to grow nearly 66% from $35 billion to $58 billion. Potential legal cannabis sales are expected to grow to $71 billion over the same period. But just because the industry is expected to grow, the question is, "Can IIPR capture some of that growth and make it sustainable?"

Below is a look at IIPR's financials over the next year. Revenue, earnings, and cash from operations are all expected to decline slightly from the end of this year until the end of 2024.

So, while I think the industry will continue growing, IIPR is expected to decline slightly. Here we see them compared to the industry and the market:

Juicy Dividend & Strong Balance Sheet

If you feel like I've been harsh on IIPR, there are some things I like about them as well. I try to keep things pretty fair. And give my honest opinion. I was really impressed with the company's well-laddered debt maturities. And it's obvious the dividend is what attracts investors to the stock. Their dividend history is not very long but the growth has been impressive the last 6 years.

They've managed to grow the dividend from $0.15 to the current dividend of $1.80 in a short period. And although that is impressive, the tenant troubles are obvious. Management elected to keep the dividend of $1.80 current instead of raising it like they've done in the past paying $1.80 for the fifth consecutive quarter. Of course, we all enjoy dividend raises every year but sometimes it's not a smart move to keep raising when you're having trouble with tenants paying rent. But collecting a near 10% dividend yield while you wait to see if the company can figure out their tenant headwinds isn't all that bad as long as the dividend is safely covered. And for now, it is. IIPR's 79% AFFO payout ratio is in line with management's targeted range of 75%-85%. So it is safe for now.

Honestly, their balance sheet is what impressed me the most. They have no debt maturities until May 2026. And the $300 million due is manageable. This has an interest rate of 5.50% but I think it's likely they will refinance at a lower rate by then. Additionally, the company further enhanced its liquidity position by obtaining a revolving credit facility worth $30 million for three years. Their credit metrics are amongst the best in the sector with a debt-to-gross assets ratio of less than 12% and a debt service coverage ratio of 16x.

Valuation & Risks

If you believe in the growth outlook for this REIT, then now is a great time to buy into the stock as it is trading well below their 5-year forward P/AFFO average of nearly 20x. Furthermore, they offer a nice upside of over 35% to its price target. If you're a long-term investor and believe in the company, then the current price is a steal right now. But due to macroeconomic factors coupled with the tenant issues they've been dealing with all year, it might not be worth the risk. Analysts currently have the stock a hold and I agree. I'd like to see how management handles their tenant troubles in the coming quarters before I would consider buying. If you've been in the stock for a while, then I would hold here as most investors are in the red already. Unless you want to sell for tax-loss purposes.

If we do enter into a recession there could be more tenant defaults. Or even if the FED decides to hike rates again in December or sometime next year. I do think we are closer to the end of the hike cycle, but I wouldn't totally rule out another one in the near future although many think the FED is done.

Conclusion

I've had my eye on Innovative Industrial Properties for a while but never pulled the trigger. I watched the stock fall from nearly $300 to a 52-week low of $63. A lot of this had to do with the cannabis hype train that caused the stock to soar and become grossly overvalued. The REIT has managed to continue growing AFFO and revenue despite tenant troubles this year which is impressive all things considered. Furthermore, they've maintained a safe payout ratio during their tenant issues and facing macroeconomic headwinds.

IIPR also has a very strong balance sheet with no debt maturing until 2026 and increased the available liquidity during the quarter. If you're a long-term investor who believes in the cannabis industry and thinks the company can capture some of the growth in the future, then the price is right. But as a conservative investor, I'll be watching the stock closely in the coming quarters to see how they deal with their troubled tenants. Because of this, I rate IIPR a hold.

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