Innovative Industrial Properties (IIPR) focuses on the acquisition, ownership, and management of industrial properties. It includes properties leased to experienced, state-licensed operators for regulated medical-use cannabis facilities.
The firm intends to acquire properties through sale-leaseback transactions and third-party purchases. It enters into triple-net leases, which are agreements where the tenants pay the property taxes, building insurance, and building maintenance.
This structure allows IIPR to reduce its operating costs and keep maintenance capital expenditures to a minimum. Given that IIPR focuses on leasing to cannabis companies, a niche area of the REIT industry with little competition, it is able to negotiate favorable contracts.
This has allowed the company to see very fast growth in the past, which is likely to continue going forward. As a result, we are bullish on the stock.
Why Did IIPR Stock Drop Recently?
IIPR was already down year-to-date along with most other stocks. However, it tumbled further in the past week after the company was targeted by short-seller Blue Orca Capital, a firm known for its activist style of investing.
Blue Orca has claimed that IIPR’s top two tenants are fraudulent and at risk of defaulting on their rent payments. It labeled IIPR’s largest tenant a Ponzi scheme that is facing lawsuits from investors. Furthermore, Blue Orca claims that IIPR’s second-largest tenant was being sued by its co-founder in 2021 for selling cannabis to the black market.
In addition, Blue Orca also claims that IIPR has overpaid for its properties, thus, their values are overstated. As a result, the company wouldn’t be able to recover all of its losses should tenants default.
However, before investors run to push the sell button, it’s worth mentioning that almost the exact same argument was made in April 2020 when the stock was trading around $70.
Short-seller Grizzly Research claimed that properties were overvalued, many tenants were likely to be insolvent, and that 38%-49% of IIPR’s income was either lost or at risk of being lost.
Fast forward a couple of years, and you’ll notice that at a current price of around $160, the short seller report provided a good buying opportunity. Indeed, IIPR’s management actually referenced the 2020 report in order to brush off the current one.
Therefore, investors shouldn’t really put too much weight on Blue Orca’s accusations since it stands to benefit from a declining share price while mirroring a previous report that had no real merit.
Growth Catalysts
IIPR provides financing to cannabis companies by buying properties from them and then leasing the properties back. Given that cannabis is not federally legal yet in the U.S., not many institutions are willing to finance these companies. As a result, IIPR is one of the few players in this niche of real estate.
In addition, the cannabis industry in North America is projected to reach $38.2 billion by 2028, which represents a compound annual growth rate of 16.6% from 2022 to 2028. Thus, this provides strong industry tailwinds to help fuel growth.
However, the most important catalyst for IIPR is that it’s a safer way of playing the relatively new cannabis industry. This is because instead of trying to pick which cannabis producer ends up being the winner, investors are simply betting that they’ll pay their rents.
An investor’s odds of picking a stock that will 10x in share price out of the many cannabis companies is much lower than the odds of them paying IIPR each month. As a result, the more the industry grows, the more successful the companies will be, and the less likely they are to default on their payments.
Risks
Although IIPR is less risky compared to other cannabis stocks, it doesn’t mean it’s not without risks. It’s possible that there are cannabis companies that are sketchy operators. The impact that this may have on IIPR is that they may be forced to discontinue operations if they are discovered to be breaking the law. In such a situation, rent payments can’t be collected.
Furthermore, it may not be as easy to replace tenants should the company lose some. This is because there are many hurdles to acquiring a license to operate, which limits the number of companies allowed to participate.
Also, these properties are specialized for cannabis, and it could be expensive to convert them for other commercial use.
Valuation
To value Innovative Industrial Properties, we will use the H-Model, which is similar to a three-stage dividend discount model. The H-Model assumes that growth will decelerate linearly over a specified period of time.
We believe this is a reasonable assumption as companies gradually slow down as they mature. The formula is as follows:
Stock Value = (CF(1+tg))/(r-tg) + (CFH(hg-tg))/(r-tg)
Where:
CF = dividend per share
tg = terminal growth rate
hg = high growth rate
r = discount rate
H = half-life of the forecast period
For the high growth rate, we will use the expected growth over the next 12 months. In the past 12 months, the dividend per share was $6.15. Analyst expectations for each of the next four quarters are as follows:
- June 2022: $1.75
- September 2022: $1.825
- December 2022: $1.825
- March 2023: $2.03
This equates to a total of $7.43 per share, which is 20.8% higher than in the last 12 months. Therefore, for Innovative Industrial Properties, we used the following assumptions:
CF = $6.15 per share
tg = 2.99% (using the 30-year U.S. Treasury yield)
hg = 20.8%
r = 9.5%
H = five years (we are assuming it will take 10 years to reach terminal growth)
As a result, we estimate that the fair value of Innovative Industrial Properties is approximately $181.42 under current market conditions.
Of course, it is also possible that IIPR will grow above its terminal growth rate for longer than 10 years. If you are an investor that believes this to be the case, then the company is worth even more than our estimate of $181.42 per share.
Wall Street’s Take
Turning to Wall Street, Innovative Industrial Properties has a Strong Buy consensus rating, based on four Buys, one Hold, and zero Sells assigned in the past three months. The average Innovative Industrial Properties price target of $251.80 implies 52.1% upside potential.
Final Thoughts
IIPR has been the target of short-sellers before that claimed similar issues as Blue Orca has. Nevertheless, the company has continued to grow and proven to be much more resilient than some may think.
Moreover, the company’s dividends are still expected to grow fast enough to suggest that IIPR is undervalued. As a result, we are bullish on the stock.
Discover new investment ideas with data you can trust.
Read full Disclaimer & Disclosure
