The sharp drop in Innovative Industrial Properties (IIPR 0.01%) offers a great example of investor sentiment in action.
During the pandemic, investors anticipated rapid growth in U.S. pot consumption and exuberantly bid up this profitable cannabis sector real estate investment trust (REIT) to all-time highs. Fast-forward to 2022. While the sector continues to grow, Innovative Industrial's stock is down more than 50% with few takers despite steady profits and an attractive dividend yield.
Cannabis in the U.S.
It's too bad investors aren't taking advantage of the opportunity to buy the dip because Innovative, founded in 2016, fills a lucrative industry niche.
Setting up a state-licensed, commercial-scale indoor growing operation is expensive. A building the size of two football fields, with growing supplies, lights, irrigation, and other necessities of pot cultivation cost around $4 million to $5 million.
Raising capital is even more difficult since cannabis remains illegal under U.S. law, effectively shutting operators out of the federally regulated banking system. A bill called the SAFE Act of 2021 could change that. But while the legislation was approved by the U.S. House of Representatives last year, it's anyone's guess if it ever gets approval in the Senate, or signed by the White House.
That's where Innovative Industrial Properties fits in with its "sale-leaseback" proposition. The REIT buys the pot operator's building, then leases it back to the business. The grower now has capital for growth, while IIPR gets a steady stream of rental income.
A solid company in a growing industry
Consumption of cannabis continues to grow fast. According to market researchers, demand is projected to rise 30% to nearly 1.7 billion kilograms (by volume) this year, and jump another 80% to more than 3 billion kilograms annually by 2025.
This marijuana REIT is riding that wave of consumption. Innovative Industrial started with the buy and leaseback of a single cultivation facility in 2016 and now owns more than 100 cannabis properties. The company averages around 17 to 18 purchases a year (including six deals in the first four months of 2022).
It still has plenty of acquisition targets as well. For example, the company sees Texas as a growth market, with one leaseback arrangement in the state already even though it only allows limited medical use under a 2015 law. With New Mexico and Oklahoma expanding their regulated cannabis programs, the company expects Texas to eventually follow suit.
With all those acquisitions, the company is on track to generate $288 million in revenue this year -- up 40% from year-ago levels. Analysts expect those numbers to rise another 51% to $436 million by 2024.
The financials speak for themselves
What should really make Innovative Industrial Properties so attractive to investors now is the company's profit metrics, relative to the price of the stock.
Most REITs report their earnings as FFO or funds from operations. Basically, FFO is a REIT's net income, with real-estate specific accounting such as depreciation expense, added back in. But we'll stay with earnings per share here, since Innovative reports both numbers. No matter how we slice up the numbers, it still points to an undervalued stock.
After reporting better than expected results of $1.32 a share for the first quarter, analysts raised the company's annual profit estimate to $6.08 a share. That's 33% more than the company made in 2021.
If we divide Innovative Industrial Properties' stock price (around $130 at the time of this writing) by the company's projected profits per share this year, it gives us a price-to-earnings ratio of 21. To give you some perspective, that's the cheapest valuation for IIPR's stock since the bottom of the initial pandemic panic in 2020's first quarter.
Better yet, analysts expect the company's earnings per share to rise by nearly 18% next year, with profits for 2024 forecast to continue increasing, to $7.64 a share.
There's one more kicker that makes Innovative Industrial's stock a good one to consider -- it pays a dividend. Starting in 2017, the company has raised the quarterly payout every year and most recently by 16% to $1.75 a share -- giving the stock a dividend yield of 5.46%.
So if we consider whether Innovative Industrial Properties is still a good buy, the deflated sentiment of many investors might indicate no. But if we look at the numbers, this ancillary marijuana stock is a great buy at a value-laden price.