IIPR - Innovative Industrial REIT Prevails Over Bears As Cannabis No Longer A Clear Sell

2023-08-07 05:35:29 ET

Summary

• Innovative Industrial just declared a quarterly cash dividend of $1.80 per share, maintaining a distribution that has been questioned by bears.
• This formed an 80% payout ratio against fiscal 2023 second quarter adjusted funds from operations.
• A fortress balance sheet heavy on equity and with a significant cash position has materially improved the REIT's investment pitch.

Innovative Industrial Properties ( IIPR ) has been staging a tepid recovery from its lows as market risk appetite returns on the back of positive inflation figures being overlayed with an economy that by most metrics is still chugging along indifferent to interest rates being hiked to their highest level in 22 years. The cannabis-focused REIT has shed a significant level of its prior premium to a tangible book value ("TBV") that has remained steadfast against the broader volatility of the US cannabis industry. The pandemic years were aberrations with this premium to TBV more than tripling from its pre-pandemic averages. So in many ways, the roughly 74% pullback of the common shares from all-time highs has simply been a return to a mean that was heavily distorted by the pandemic. The preferreds ( IIPR.PA ) have also pulled back from highs above par.

IIPR recently declared a quarterly cash dividend of $1.80 per share , in line with its prior payment and for a 9.2% annualized forward dividend yield. The income is the prize and IIPR has defended the quarterly distribution at its current level even though the raises have come to an end. Critically, the rally has skipped the MSOs that IIPR depends on for its revenue. This threatens to deepen a liquidity crisis that throws up material near-term uncertainty around the extent to which IIPR will be able to maintain the dividend at its current level.

Revenue Beat Drives Renewed Optimism

IIPR brought in fiscal 2023 second-quarter revenue of $76.46 million , an 8.4% increase over its year-ago comp and a beat by $2.94 million on consensus estimates and came on the back of rental revenue which grew by $5.9 million over its year-ago figure. Rent collection during the quarter was also relatively robust at 97%, this included $1.5 million of security deposits from three properties, two of which in California and Michigan were related to multi-state operator Holistic Industries. $2.1 million in rent was not collected during the second quarter due to the default of MSO Parallel at a property in Pennsylvania. Further, Parallel intends to fully exit the Pennsylvania adult-use cannabis market.

Parallel forms a top 10 tenant and accounts for 832,000 rentable square feet spread across 3 leases as of the end of IIPR's second quarter. Whilst IIPR flagged that they're in discussion with other parties about taking on the Pennsylvania lease, this move by Parallel will place some pressure on underlying funds from operations. The REIT did execute a new lease during the quarter on a still-in-development property in California that it took back from its prior tenant Kings Garden. Critically, this forms the unassailable hedge IIPR's shorts, who make up the 8% short interest, have to climb.

Disruptions to rent are not perpetual and bearish arguments on a dividend cut are highly dependent on rent disruptions being aggregated in a short time frame. IIPR targets 100% triple-net leases and holds a 108-property portfolio with a 14.9-year weighted average lease length as of the end of its second quarter. This was spread across 8.1 million rentable square feet across 19 states and was leased to 30 tenants.

Fortress Balance Sheet Reduces Risk

Triple net leases have the benefit of no recurring capital expenditure during the lease term with all property expenses including taxes paid by the tenant. IIPR recorded adjusted funds from operations of $64 million , around $2.26 per share. This adds back non-cash stock-based compensation and non-cash interest expense related to the REIT's unsecured senior notes to FFO. AFFO for the second quarter grew by 12 cents over AFFO of $2.14 in the year-ago comp.

The biggest plus for IIPR's investment pitch is what can only be described as a fortress balance sheet. This describes a company with a low debt level, a strong equity base, high liquidity, and a healthy credit rating. AFFO was boosted during the quarter because interest expenses actually fell year-over-year to $4.47 million despite the marked rise in the Fed funds rate seen since early 2022. The REIT held a gross debt of $304.4 million as of the end of the second quarter.

The bulk of IIPR's capital structure is comprised of common equity and is set against $4.4 million in debt maturities coming due up until the end of 2025. There is also a 5.50% $300 million BBB+ investment grade rated unsecured senior note coming due May 25, 2026. Hence, the REIT has significant fiscal headroom and is flush with cash of $92.6 million as of the end of the second quarter. It's hard to see the pathway for a dividend cut against this balance sheet, AFFO that grew over its year-ago comp, and an 80% payout ratio. The common shares are a buy against this despite 2023 likely set to see more general cannabis industry weakness.

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