Despite the recent sell-off driven by a delay in marijuana reforms, 2021 has been a very fruitful year for the cannabis industry, in part because the ramp-up of state legalization boosted marijuana sales. As new states open their doors to sales, the new year should be even better.
One company that should benefit is real estate investment trust (REIT) Innovative Industrial Properties (IIPR 2.21%). Innovative Industrial allows investors an indirect entry into the sector without having to bear much of the volatility of the industry. The company provides real estate capital to cannabis companies in the U.S. and in return earns rental income. Thanks to this business model, it has been performing outstandingly well for the past few years, and its recent Q3 results are proof of why it is a must-buy and hold for the long term.
A unique business model linked to an evolving industry is its big advantage
Cannabis is illegal federally under the Controlled Substances Act. This makes it harder for cannabis companies to procure capital to set up larger production facilities. Innovative acquires these properties and then leases them to the cannabis companies in a sale-leaseback system. Rental income, the only source of income for the company, has proven to be more than enough for it to thrive. It has grown its total revenue from $6.4 million in 2017 to $117 million in 2020, an increase of 1,728%.
Acquisitions have been a driving factor of Innovative's drastic growth in revenue and profits. Between July 1 and Nov. 3, 2021, Innovative made five acquisitions. Its tenants include popular cannabis players Curaleaf Holdings, Green Thumb Industries, Cresco Labs, and Trulieve Cannabis. These domestic cannabis growers are expanding aggressively, and therefore are bringing in more business for Innovative. Its wise business model has allowed Innovative to now own 76 properties (100% of its properties are leased out) in 19 states totaling 7.5 million square feet of space.
The company's weighted-average lease term is 16.7 years, implying that it will keep generating revenue for many years to come. This is good news for investors who worry that U.S. cannabis federal legalization will put a dent in Innovative's growth.
Outstanding performance, quarter after quarter
In its recent quarter ended Sept. 30, total revenue surged 57% year over year to $54 million, while profit grew to $30 million from $19 million in the year-ago period.
Management stated that acquisition and leasing of new properties and an amendment to existing ones resulted in improved allowances, which drove the awesome Q3 performance. Analysts expect 2022 total revenue to grow to $281 million, a 140% jump from 2020 levels.
A cherry on top
Innovative is not only a growth stock but is also an income stock. It has been consistently paying dividends since its initial public offering (IPO) in 2016. Its dividend yield of 2.3% is not sky-high, but still above the S&P 500's average of 1.3%.
However, the most important thing to consider when choosing a dividend stock is not the yield but its consistency in dividend payments. Innovative not only is consistent in its dividends but also increases its dividends regularly -- a sign of a stable, growing company. Its consistent growing adjusted funds from operations (AFFO) is proof of that. AFFO is a measure of earnings left to be paid as dividends for a REIT (similar to net earnings for a non-REIT). In Q3, AFFO grew 61% year over year to $45 million.
As a REIT, Innovative is also legally bound to pay 90% of its taxable income to shareholders as dividends. Thanks to its surging AFFO, the company made a 28% year-over-year quarterly dividend hike to $1.50 per share as third-quarter dividends. This hike is also its 12th dividend increase since its IPO.
As the medical cannabis industry expands, so will cannabis companies' requirements for properties. Innovative can continue to help with this. With a stable balance sheet, the company is more than ready to acquire more properties. It ended Q3 with cash, cash equivalents, and short-term investments of $682 million and no secured debt.
A safe pick in a sea of dangerous options
Not growing cannabis itself keeps Innovative safe from the ups and downs of the sector. Some investors are still skeptical about investing in this stock because they believe Innovative's growth will be challenged after federal legalization of marijuana (if it happens), as cannabis companies will have fewer barriers to procuring capital.
However, if the drug becomes legal nationally, the industry will expand to great heights. There will be many smaller companies who might not be able to procure capital easily and could still use Innovative's help. As long as state legalization keeps ramping up in 2022 and the years to come, so will expansion plans for cannabis companies, allowing Innovative to grow drastically. All of that makes the company a must-buy for 2022.