The market is currently questioning the viability of Innovative Industrial Properties’ (NYSE:IIPR) 8.9% dividend yield, as evident by the stock’s never-ending decline from its November 2021 highs. The company has lost more than two-thirds of its value since, with investors appearing increasingly confident that the stock is heading for a dividend cut.
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That said, the company continues to post tremendous growth and profitability. While there are valid risks attached to Innovative Industrial Properties’ investment case, and the dividend is by no means invincible, I don’t think that it is going to get a cut anytime soon. If anything, the stock could be subject to wonderful upside potential ahead. Accordingly, I am bullish on the stock.
Profitable Growth Persists Despite Tenant Headwinds
Innovative Industrial Properties has a fantastic track record of profitable growth, which has persisted well up to the company’s most recent results, despite investors’ growing bearish sentiment.
Following the company’s FY-2022 results, its five-year compound annual revenue growth rate (CAGR) now stands at 112%. This growth has been driven by Innovative Industrial’s acquisition spree and strong lease signings. Also, while growth has slowed down recently, with revenues rising by “only” 20% to $70.5 million in Q4, this is a stunning result for the industry. Most industrial REITs barely grew their revenues in Q4, let alone post such a tremendous top-line rise.
However, the reason I am impressed with Innovative Industrial Properties’ performance is not just that the company can rapidly grow its rental revenues but that it does so in a way that is accretive to profitability from a per-share point of view. Growth by itself can be “easily” achieved. How? Issue a bunch of shares and use the funds to buy more properties, instantly showing revenue growth.
The tricky part is to make sure that these acquisitions are accretive on a per-share basis, which means that the cost of issuing those extra shares is lower than the incremental benefit received for each additional share.
Innovative Industrial Properties’ management has exhibited exceptional expertise in precisely this aspect. Their extended track record of acquisition has proven surprisingly fruitful, and last year’s results further solidified this trend.
To illustrate what I am describing here, Innovative Industrial’s adjusted funds from operations per share (AFFO/share, a cash-flow metric used by REITs) in 2017, 2018, 2019, 2020, 2021, and 2022 came in at $0.67, $1.34, $3.27, $5.01, $6.66, and $8.45, respectively. Still, the takeaway to highlight here is that last year’s $8.45 AFFO/share implies adequate coverage of the company’s $7.20 annual dividend per share.
Having said that, it’s natural to ponder upon the basis of the stock’s negative outlook and why it’s being priced for a dividend cut.
Innovative Industrial Properties Has Some Tenant Issues
Innovative Industrial Properties’ bear case is primarily based on the company’s tenant issues. The context here is that cannabis producers (i.e., all of the company’s tenants) have a very hard time turning profitable. The reason for this is that cannabis is essentially a commodity, and like any other “farming” product, it’s next to impossible for players in the space to generate significant profits.
While developing a brand can boost sales to some extent, it’s difficult to charge a premium over other competitors, particularly when legitimate players are also competing with the black market. Evidently, some of the company’s tenants have been struggling to keep up with their rent payments.
In Q3, for instance, the company did not collect contractual rents adding up to $5.7 million from two tenants whose financial conditions had deteriorated. The company did manage to withhold $2.6 million from the two tenants’ deposits, somewhat offsetting the blow, but overall, that wasn’t great news.
Then, in Q4, the company collected 94% of rent due to a few of its tenants going out of business, suggesting that the situation among cannabis producers may be gradually worsening. If this were to become a trend, Innovative Industrial Properties could really struggle to maintain its dividend — especially with rising interest rates set to impact the profitability of all REITs in the coming years.
Is IIPR Stock a Buy, According to Analysts?
As far as Wall Street’s view on the stock goes, Innovative Industrial Properties has a Strong Buy consensus rating based on five Buys and one Hold assigned in the past three months. At $138.80, the average Innovative Industrial Properties stock forecast suggests 71.65% upside potential.
The Takeaway
The bear case of Innovative Industrial Properties is not totally groundless. We have already seen the company’s tenant condition deteriorate in two sequential quarters. Simultaneously, however, IIPR’s momentum remains incredibly strong. Even with the tenant issues experienced in Q3 and Q4, the company managed to grow its AFFO/share by a superb 26.9% during Fiscal 2022.
With the 8.9% yielding dividend remaining well-covered and shares trading at just under 10 times AFFO/share, it appears that Innovative Industrial Properties offers a substantial margin of safety along with significant upside potential.
The bulk of the downside from tenant issues seems to have already been priced in, and unless the company’s tenant base suddenly collapses (which seems far-fetched), I don’t see the company’s hefty yield getting cut anytime soon.
