It was roughly one year ago that pot euphoria peaked. By the end of the first quarter of 2019, the Horizons Marijuana Life Sciences ETF was up more than 50% on a year-to-date basis, and over a dozen popular pot stocks had advanced at least 70%. With high-margin derivatives (edibles, infused beverages, vapes, concentrates, and topicals) expected to be launched in Canada and numerous U.S. states angling for recreational legalization, it looked as if nothing could stop marijuana's momentum.
Yet, one year later, "green" is something that the cannabis industry has not delivered for investors. In fact, if you thought the performance of oil stocks was bad, take a gander at some of the one-year returns for pot stocks, many of which have lost 50% to 95% of their value.
But there is hope on the horizon as this industry shakeout moves to eliminate weaker companies. No matter how dismal the news gets surrounding the coronavirus, the cannabis industry still has the potential to grow worldwide sales to $50 billion (or more) on an annual basis by 2030. This suggests that opportunistic investors who (pardon the pun) weed through a sea of bad companies to find the real standouts could make a fortune.
Here's why Innovative Industrial Properties stock has struggled of late
Before diving into the laundry list of reasons to buy Innovative Industrial Properties, I typically like to run through the reasons why a company in question has seen its valuation decline of late.
The first and most obvious reason that IIP, as the company is more commonly known, has seen its share price fade significantly in recent weeks is the spread of COVID-19. The coronavirus has disrupted cannabis supply chains, halted trade shows where new product can be displayed, and put a serious crimp in the pocketbooks of marijuana companies operating in popular tourist destinations. In other words, the baby has been thrown out with the bathwater, and anything cannabis related has been assumed to be hurt by COVID-19.
More specific to IIP, it's a cannabis real estate investment trust (REIT). It's therefore reliant on its tenants to continue paying rental income in order to generate a profit. With economic activity in numerous industries slowing dramatically due to the coronavirus pandemic, there may be some outlying concern about the ongoing ability of the company's tenants to continue paying rent.
Another reason investors may have been a bit skeptical of Innovative Industrial Properties is the cash crunch that's affected much of the North American pot industry. With banks and credit unions mostly unwilling to offer basic banking services in the U.S. due to the drug's scheduling at the federal level, there's the concern that rental demand for cannabis cultivation and processing sites may diminish.
To build on this point, IIP's method of raising cash is almost entirely confined to selling its common stock. While effective, issuing stock proves dilutive to existing shareholders, which is something marijuana stock investors have unfortunately become accustomed to.
These are the presumed risks investors take on with Innovative Industrial Properties. Now, here is the laundry list of reasons why it's time to buy.
Let's count the reasons you'll want to own Innovative Industrial Properties
To begin with, the United States is the centerpiece of the global cannabis industry. Although the expectation is that more countries will allow marijuana to be sold for recreational and/or medical purposes, virtually all projections have the U.S. generating the most annual sales of any country. Presumably, this puts IIP in excellent position to take advantage of this upswing in sales growth and consumer demand.
Second, I think it's important to point out that Innovative Industrial Properties has minimal direct exposure to the coronavirus. While it is always possible that its tenants could struggle to pay rent, this is a company that owns 53 properties in 15 states. It's financially and geographically well diversified, which means it's unlikely to face serious repercussions from COVID-19.
A third reason to buy IIP (to build on the previous point): the company's long lease periods and healthy return on invested capital. As of this past weekend, IIP's 53 properties had a weighted-average lease length of 15.9 years and an average return on invested capital of 13.2%. In simpler terms, the company should be able to net a complete return on its invested capital in 5 1/2 years, with everything else being gravy. Plus, as a REIT, the company's ongoing expenses (aside from acquiring new assets) are relatively minimal.
Fourth, don't overlook the role Innovative Industrial Properties is playing with sale-leaseback agreements. Since U.S. multistate operators (MSOs) are struggling to gain access to nondilutive forms of financing, IIP has been purchasing cultivation and processing assets with cash, then leasing these assets right back to the MSOs in question. This provides MSOs with the capital they need, while at the same time bolstering IIP's tenant portfolio. As long as the U.S. keeps marijuana's Schedule I classification unchanged, Innovative Industrial Properties will hold this competitive advantage.
Fifth and finally, Innovative Industrial Properties is the only pure-play pot stock that pays a dividend. And it's not just your average dividend. Since REITs are required to return a substantive portion of their earnings as a dividend in exchange for special tax treatment, current investors are going to net about a 5% annual yield. That's more than double the yield investors will net from the benchmark S&P 500.
On the surface, the marijuana industry may look like a mess. But there's no doubt that Innovative Industrial Properties belongs in your portfolio.