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If I Could Only Buy 1 Stock, This Would Be It

By Will Healy - Updated Feb 26, 2021 at 3:29PM

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The case for Innovative Industrial Properties.

Innovative Industrial Properties (IIPR -5.82%) has become an unusual but lucrative stock. The San Diego-based real estate investment trust (REIT) directly benefits from the growth of the marijuana business despite its status as a real estate company. As a result, the company profits from massive revenue increases as well as business and legal tailwinds that make it a stock worth owning.

Innovative Industrial and its legal environment

Innovative Industrial leases agricultural property and greenhouses set up to meet the needs of cannabis producers, and collects rental revenue from them. As a REIT, it pays stockholders a dividend on its profits.

Moreover, it has positioned itself to benefit from an improving legal environment. Since New Jersey just legalized marijuana for recreational use, Innovative Industrial now holds more potential for expansion in that state. Additionally, hemp became fully legal with the 2018 Farm Bill. Hemp's similarities to marijuana mean that Innovative Industrial could operate properties in all 50 states if it chose.

Worker standing by grow lights while using a laptop instead of a greenhouse.

Image source: Getty Images

Moreover, late last year, the U.S. House of Representatives voted to remove cannabis from the list of scheduled substances by a wide margin. This could mean either a loosening or, possibly, complete removal of legal restrictions in the foreseeable future. Although President Biden had opposed legalization in the past, his campaign showed support for medical marijuana and leaving recreational use laws up to the states. Little wonder that Grand View Research estimates a compound annual growth rate (CAGR) for the cannabis industry of 18% through 2027.

Innovative Industrial's business

To this end, Innovative Industrial has positioned itself advantageously. As a REIT (and not a producer), the federal government's Schedule I restrictions -- which forbid producers from obtaining bank loans -- do not apply. Instead, Innovative Industrial buys a producer's property, thus giving that grower capital. It then leases the property back to the former owner, collecting revenue as a landlord. This program has helped the company build a portfolio of 48 properties in 17 states.

Admittedly, not much would stop other REITs from entering this business. Also, some industry observers question whether the company would thrive or dive after full legalization. Legal status means that some producers would turn to banks rather than selling a property to Innovative Industrial. Such a development would concern shareholders. Nonetheless, producers not in the financial shape to attract loans would likely still turn to Innovative Industrial. The company could also buy property and seek tenants, bolstered by the industry's 18% CAGR.

Nonetheless, the REIT benefits from little competition for now. Power REIT competes with Innovative Industrial, though cannabis-related properties make up about $19 million of its $40 million gross book value. In comparison, Innovative Industrial holds just over $1 billion in real estate assets geared toward cannabis production.

Surging company financials

Its investments in new properties and improvements on current holdings have paid off: Tenants have leased 100% of its properties. Overall, the company netted six additional clients and earned added business from numerous others last year.

This growth helped revenue rise by 162% from fiscal 2019 to $117 million. Net income spiked by 191% to just over $64 million during that time as the increase in expenses lagged the rise in revenue. Moreover, adjusted funds from operations income, which adds back non-cash charges such as depreciation to income, surged 180% over the same period to just under $98 million.

During the year, the yearly dividend payout rose by 58% to $4.47 per share. The company hiked its payout every quarter during 2020, with the last quarterly dividend coming in at $1.24 per share, a yield of 2.4%.

Investors have taken notice of the company's growth. Its stock has surged by approximately 70% over the last 12 months.

IIPR Chart

IIPR data by YCharts

The company's valuation could present investors with a value opportunity. Investors sold off the stock on news that diluted earnings per share increased by only 13% in the fourth quarter. Since the number of diluted shares outstanding more than doubled during 2020, the increase in diluted earnings per share came in well below the percentage growth of overall earnings. Innovative Industrial had traded at a 70 P/E ratio before the latest earnings announcement, but the recent plunge has taken that multiple below 60. 

Innovative Industrial has reinvested the funds generated from all those stock sales, devoting more than $254 million since October to either acquire or improve 13 properties. Such expenditures help to bolster its top and the bottom lines, both now and in future quarters. For this reason, investors may want to treat this sell-off as an opportunity to acquire shares at a lower price.

The state of Innovative Industrial

Innovative Industrial has placed itself in an opportune position in its industry. By providing real estate for cannabis cultivation, it can profit directly from the marijuana boom and generate continually higher returns for the foreseeable future. Moreover, as a REIT, the company faces less regulatory scrutiny than its clients. As long as cannabis remains a growth industry, investors should expect Innovative Industrial's shareholder and dividend returns to continue growing like a weed.

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Stocks Mentioned

Innovative Industrial Properties Stock Quote
Innovative Industrial Properties
$128.11 (-5.82%) $-7.92
Power REIT Stock Quote
Power REIT
$21.10 (-4.05%) $0.89

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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