2023-07-20 11:24:01 ET
Summary
- AFC Gamma had to reduce its most recent dividend by 14.3% from the prior payout.
- This was on the back of a 98% payout ratio against fiscal 2023 first quarter distributable earnings per share. The ticker currently offers a 14.5% annualized forward dividend yield.
- A decline in commitments following a more conservative approach to originations has reduced the risk of impairments, but has placed future dividends under some uncertainty.
AFC Gamma ( AFCG ) has had to navigate ten consecutive interest rate hikes until the June FOMC meeting, a highly discombobulated cannabis industry arguably amidst its own recession, and the rising specter of widespread cannabis bankruptcies as difficult capital market conditions restrict the overall flow of liquidity coming into the industry. The cannabis mortgage REIT last declared a quarterly cash dividend of $0.48 per share , a 14.3% decline from its prior payment for a 14.5% forward annualized yield. This is AFC's first dividend cut and was sparked by a payout ratio that had become unsustainable. Indeed, distributable earnings of $11.6 million , around $0.57 per share, for its last reported fiscal 2023 first quarter formed a 98.2% payout ratio against the prior dividend payout of $0.56 per share.
Whilst AFC did an incredible job with consecutive dividend hikes from when it started trading on the Nasdaq in the spring of 2021, the mREIT now faces a more uncertain future. Bears, who form the 6.27% short interest, are expecting further dividend cuts even after the rightsizing of the quarterly payout. Bulls are flagging the current marked discount to book value and a still double-digit inflation-beating yield that is better covered by distributable earnings. Hence, is AFC a buy? It depends. The ticker fundamentally forms a safer way to play the cannabis industry and is currently sporting total returns of just under negative 2% over the last year against a US cannabis-focused ETF from AdvisorShares ( MSOS ) which is down by 53% over the same time frame.
Operations Reflect A Conservative Deployment Of Capital
AFC reported an interest income of $18.5 million for its first quarter, down by around $135,000 from its year-ago comp to drive a net interest income of $16.83 million. This was a 0.61% year-over-year decline and a miss of $1.48 million on consensus estimates. AFC is a commercial real estate lender focused on state-licensed cannabis operators. The mREIT's loan portfolio had an outstanding principal balance of $404 million as of the end of its first quarter with commitments at $415 million.
AFC is targeting annual gross yields in the range of 12% to 20% for its loan portfolio which currently has an estimated weighted average yield to maturity of 21%. These loans are also broadly backed by real estate collateral and licenses to state law-compliant cannabis operators. There was no growth recorded for the first quarter with higher general and administrative expenses driving net income to decline by around $140,000 over its year-ago comp to $10 million. However, the mREIT actually saw interest expenses essentially stay flat year-over-year even against a Fed funds rate that was hiked to its highest level in over a decade.
This stability has been driven by a lowly leveraged balance sheet that held a total debt of $87.6 million with a trailing 12-month total debt-to-capital ratio that was less than half of its peer group median at 20% . The mREIT was able to raise $100 million at a 5.75% fixed rate in the fourth quarter of 2021 from senior notes due in 2027. AFC also has an untapped $60 million senior secured revolving credit facility. This was with cash and equivalents of $80.6 million as of the end of the first quarter. The lack of growth, despite a $700,000 provision for credit losses, was driven by management's more conservative approach to originations in the current macroeconomic backdrop and against the headwinds being faced by US MSOs. They're right, it makes little sense to maintain underwriting momentum against an industry currently facing material financing uncertainty.
Trading Below Tangible Book Value
AFC was clear during its first-quarter earnings call that they're threading extremely conservatively. They've raised the bar on new originations and have sought additional equity from borrowers whilst maintaining cash on their balance sheet to potentially capitalize on opportunities as they arise. The mREIT's current commitments have been in decline since a peak in the third quarter of 2022 with 13 loans currently held on its balance sheet. The mREIT has also had to downgrade a large loan which if impaired could form an earnings hit of as much as $0.24 per share .
In my view, AFC's greatest headwind is just how concentrated its portfolio is. The mREIT has essentially funded just 13 loans with some of these to the same company. Whilst this undoubtedly means a focus on quality, it radically ramps up concentration risk and heightens the impact of a potential failure of any one borrower. I like that AFC's management team is aligned with public shareholders with their 20% equity stake in the common shares but book value is likely set to realize some near-term disruption.
This was as AFC's tangible book value of $337.8 million, around $16.49 per share fell from $17.04 per share in the year-ago quarter. The mREIT is now trading at a roughly 20% discount to book value. This renders the ticker a hold even as continued uncertainty clouds the outlook for dividends and book value expansion.
For further details see:
AFC Gamma: There Could Be Another Dividend Cut From This Cannabis Lender