Cannabis REIT Innovative Industrial Properties (NYSE:IIPR) is currently offering an attractive 8.2% dividend yield, sparking doubts about the sustainability of its payouts. These concerns have lingered for the past couple of years, reaching a peak in April when the stock’s yield exceeded 11%. While there are risks, I remain optimistic about IIPR’s dividend, which should remain well-covered. Plus, another dividend hike is likely on the way, which should bolster investor interest in the stock. Therefore, I am bullish on IIPR.
Evaluating the Sustainability of IIPR’s 8.2%-Yielding Dividend
To assess the sustainability of IIPR’s 8.2%-yielding dividend, let’s begin by analyzing the extent to which the underlying payouts are secure. Thus far, IIPR has put up a robust dividend growth streak given its short trading history, spanning six consecutive years. In fact, given that the company has traditionally increased its dividend in September, the question that comes to mind is whether IIPR will be able to afford another hike sometime around this month. Its year-to-date financial performance suggests this is likely.
In its most recent Q2 results, Innovative Industrial Properties showcased both excellent operating results and an improving balance sheet. The company posted revenue growth of 8%, setting a new milestone at $76.5 million. What truly stands out, however, is its remarkable ability to boost AFFO per share. This is despite grappling with escalated expenses and a higher share count due to stock issuances for acquisitions. These challenges were adeptly countered by the revenue upswing and deleveraging.
Specifically, Innovative Industrial Properties reported a commendable 5.1% year-over-year growth rate in AFFO per share, which reached $2.26. In my view, the company’s AFFO-per-share growth deserves special recognition. In an economic landscape characterized by rising interest rates, the majority of REITs struggle to sustain, let alone expand, their profitability. Yet, IIPR managed to grow, pay down debt, and improve its dividend coverage.
Regarding dividend coverage, for Fiscal 2023, Wall Street expects the company to achieve AFFO/share of roughly $8.18. This implies a year-over-year growth rate of about 5.2% and a payout ratio of 88% at today’s annualized dividend rate of $7.20. The payout ratio may seem too high for IIPR to pursue another dividend hike here. However, before we jump to conclusions, let’s look at IIPR’s payout ratios in past years by dividing each year’s AFFO/share by the respective dividend per share. Here are all the payout ratios:
- 2017: 82%
- 2018: 90%
- 2019: 87%
- 2020: 89%
- 2021: 86%
- 2022: 84%
As you can see, the company continued to increase its dividend in each and every one of these years, even though the payout ratio often exceeded this year’s projected rate of 88%. As long as the company is able to post bottom-line growth, I feel confident that IIPR will continue to grow its dividend. It only makes sense to keep the streak intact if the company can afford to do so — especially with regard to maintaining investor confidence in the stock.
What is the Greatest Threat to IIPR’s Dividend?
On the one hand, the company continues its profitable growth trajectory and even bolsters its dividend coverage, as discussed earlier. However, certain investors remain worried about the potential risk that its tenant base’s quality (or rather, the lack thereof, in this instance) may pose to the dividend.
The Context Regarding IIPR’s Tenants
To provide context regarding IIPR’s tenants, the cannabis industry presents distinctive challenges for producers, rendering the pursuit of profitability an arduous journey. Basically, cannabis is a commodity resembling other agricultural products. Thus, achieving substantial profits becomes an extremely hard endeavor for players within this niche yet massive industry.
Some producers have tried to differentiate themselves by cultivating a brand (no pun intended) that may indeed bolster sales to some extent. Still, it’s very hard to command premium prices in an intensely competitive landscape. Further, legitimate businesses compete against the illicit market players, further compressing their profitability prospects. Consequently, some of IIPR’s tenants have historically encountered difficulties in fulfilling their rent obligations. Here is a short history of this theme:
- In Q3 2022, two tenants facing financial challenges failed to meet their rent obligations, resulting in $5.7 million in unpaid rent. This was partially mitigated by withholding $2.6 million from their deposits, though the situation was far from ideal.
- In Q4 2022, the company saw a decline in rent collection, receiving only 94% of the expected rent. This was primarily attributed to a few tenants going out of business, indicating a possible weakening trend in the cannabis producer segment.
- In Q1 2023, however, the company’s rent collection rate made a strong recovery, reaching 98%. The remaining 2% represents the outstanding amounts from tenants who had defaulted in Q4 2022, specifically Parallel and Green Peak.
- In the most recent quarter, Q2 2023, there were some noticeable challenges in rent collection. Specifically, there was an outstanding rent balance of about $2.1 million for the quarter, primarily stemming from the previous default by tenant SH Parent. However, it’s important to note that overall rent collection is still robust, reaching an impressive 97%.
While concerns about the company’s tenant base are a perpetual consideration in the REIT’s sub-industry (cannabis), the current situation does not appear to be as alarming as some may perceive. To date, the majority of rents continue to be paid punctually and in full.
Is IIPR a Good Stock to Buy Now?
Regarding Wall Street’s view on the stock, Innovative Industrial Properties has a Hold consensus rating based on one Buy and three Holds assigned in the past three months. At $129.50, the average Innovative Industrial Properties stock price target implies 47.63% upside potential.
The Takeaway
In conclusion, Innovative Industrial Properties presents a compelling high-yield investment case backed by a solid track record of AFFO and dividend growth. The company’s ability to navigate challenges and maintain robust dividend coverage is evident in its most recent results, which were rather impressive, in my view.
While some concerns linger about tenant quality in the cannabis industry, IIPR’s recent performance indicates that the firm remains resilient. With the potential for another dividend hike soon and the high yield offering a margin of safety, I remain optimistic about IIPR stock.
