Innovative Industrial Properties Inc Is The Best Value Opportunity (NYSE:IIPR)

We believe in the long-term viability and prosperity of the American cannabis industry. It is of enormous value for local and state economies. Cannabis stocks and the companies that service the industry have the best value for potential ROI over the long term. Innovative Industrial Properties, Inc. (NYSE:IIPR) is, in our opinion, the Best Value Investment at this time.

Profile

Innovative Industrial Properties, Inc. is a real estate investment trust (REIT). It has $2.4B in assets and a $2.06B market cap. The company caters to regulated cannabis businesses. 91% of the properties are industrial, 6% are a mix of industrial and retail, and 3% are retail types.

A company statement explains:

Innovative Industrial Properties acquires freestanding industrial and retail properties leased to state-licensed cannabis operators under long-term, absolute net lease agreements. Under our sale-leaseback program, we focus on well-capitalized companies that have successfully gone through the rigorous state licensing process and have been granted a license in the state where the property is located. We act as a source of capital to these state-licensed operators by acquiring and leasing back their real estate across all product types: cultivation, processing, distribution, and retail. These transactions allow for the opportunity to redeploy the proceeds into core operations, yielding a higher return than they would otherwise get from owning real estate.

The general public and institutions own about 98% of the shares. Individual insiders own 1.5%. Corporate insiders and hedge funds do not make many trades of the stock. Hedge funds increased their ownership of shares by ~10% over the last quarter. 3 of the top 7 largest corporate shareholders bought additional shares while 2 of the 7 sold over the last year.

As of June, ’23, the company’s total property portfolio comprised 108 properties across 19 states. It has ~ 8.9M rentable square feet and 1.6M of rentable square feet under development or redevelopment. 5 of the properties will comprise 715,000 rentable square feet at completion; they are in some of the fastest-growing states for cannabis sales. 6 more states are expected to legalize marijuana for recreational use by 2030.

Two Industries

Innovative Industrial Properties operates in two challenging industries. Innovative’s share price is subject to vagaries in the real estate and cannabis industries though its own business model is highly predictable.

Banks and traditional lending institutions shun cannabis operators because cannabis is a federally classified illegal drug. States license cannabis dispensaries for medical and recreational sales to collect Cannabis Taxes and provide alternative medical and recreational substances to the public. Established brokerage houses do not trade cannabis stocks and credit card companies refuse to do business with these operators. Yet, legal cannabis sales are growing from $26.1B in ’22 and are forecast to top +$44B in sales by 2027.

Upsides to REITs include they distribute their earnings in the form of dividends. Innovative’s payout ratio is 88.6% to 91%. The dividend yield is 9.8%. REITs are tax efficient because untaxed earnings pass through in dividends. That is very attractive to retail value investors.

Senior management is experienced. The biggest challenge is growth and ensuring rental yields remain adequate. Innovative has been up to the challenges for nearly a decade, as the Strong Buy Quant Rating and Factor Grades suggest:

Risks

2023 has not been a stellar year for shares of REITs. The real estate environment is challenged by inflation which affects real estate valuations. Innovative does not borrow much money; if necessary, at some point, the task might be challenging since banks are doing fewer transactions and tightening credit for commercial real estate loans. When challenges arise in real estate markets and the cannabis industry, the ripple effect challenges Innovative’s stock price.

The SPDR Dow Jones REIT ETF (RWR), for example, is down over 5% YTD and -10.36% for the last 5 years. Innovative stock is -23.7% YTD and -22% over the last year. Concomitantly, cannabis stocks lost tremendous value over the last 5 years. Forbes points out that even in the last two years, the shares of cannabis stocks are worth a tenth their value of two years ago. These pressures plus the forecasts for lower revenue and earnings over the next 12 to 16 months contribute to short interest topping 8% at this time.

Increasing competition is always a threat if not a risk in every industry, especially in one that is flourishing. Buildcentral.com reported last year about 10 new cannabis production facilities planned for construction valued at $3.5M to $100M each. Owners/developers appear to all be competitors with Innovative Industrial Properties.

In sum, there are risks possibly causing the share price to stagnate or stumble further from its 52-week high of +$125 per share; it is currently closer to its low of $63.36. Risk factors include persistent inflation, higher interest rates, more credit tightening, falling job incomes dampening purchases of higher-priced regulated marijuana products, and chaos in Congress that forestalls passing the Safe Banking Act. Since the pandemic, demand for regulated cannabis is slowing forcing companies to scale back production and perhaps the need for more real estate.

Management at Innovative Industrial Properties must be watchful of rising debt levels among cannabis companies. The U. S. Bankruptcy Court ruled last month that cannabis companies can possibly file for bankruptcy adding another risk factor to Innovative’s rental income stream.

Finding Value

Innovative Industrial Properties is set to announce its next earnings on November 1, 2023. We expect the EPS in Q3 ’23 to be +$2 compared to $1.92 Y/Y. NASDAQ.com forecasts the annual EPS will be $8.19.

Annual rental revenue sequentially increased between 2021 and TTM from $204.6M to $274.4M to $291.7M. Operating income jumped in those years from $135.4M to $169M to $171.8M. Actual reported EPS numbers have been higher than forecasts in 8 of the last 10 quarters.

A potpourri of other value-adding news is that, at last report, earnings rose 5.15% Y/Y; the company touts a 94% gross profit margin and 54.9% net income margin; ROE was last reported 8.2%. 7 out of 8 analysts writing for Seeking Alpha assess the stock as a Buy and Strong Buy, as do we.

We expect the pace of revenue and earnings growth to slow in FY ’23 and FY ’24 but we do not envision any serious risks that will seriously depress the share price. This relatively young start-up, paying a high yield and safe dividend is set to steadily build revenue and cash from operations for the foreseeable future:

Valuation

The company gets an A Factor Grade for valuation. S A concludes all but 4 valuation metrics of 19 are near to hitting their ceiling. Price-to-book and price-to-cash flow TTM get Bs. Only Price-to-sales and price-to-rental revenue are assessed at D+. Note that SA metrics are compared to the last 4 quarters of the general real estate sector. Other positive metrics include

• The PE is a relatively low 13.2x whereas the NYU Stern School sets the PE for REITs at 118.7, at 34.4 for general and diversified real estate companies, and 91.5 for operations and services.
• Innovative’s PE is comparable to those of its peers.
• The consensus among analysts is the stock is considered a Buy opportunity. The current dip in the share price and the September Cannabis stock gains fade in volatile trading on US Senate bill hopes in cannabis stocks adds to Innovative’s value.
• Innovative is in a predictable business with significant upside potential, in our opinion, over the next 6 to 12 months. The share price can top $100 each. One analyst expects the shares to hit $179 and another $199 each if Congress passes legislation.
• The company has a debt-to-equity ratio of 0.15, suggesting to us management is wisely conservative about borrowing in favor of building shareholder equity.

Takeaway

We have to patiently wait for the federal government’s decriminalization of cannabis. Changes will ripple and can potentially pump up Innovative’s share price. Changes

• will validate the industry,
• stimulate the trend for medical marijuana and cannabis oils,
• grow the number of licensed suppliers to meet the growing demand for safe recreational marijuana,
• spark greater sales through new strategies and greater brand awareness,
• might permit investors to trade public cannabis companies through traditional brokerage houses instead of online,
• will give cannabis business suppliers and service providers access to lower-priced loans
• improve cash management and cash flow by lowering overhead costs,
• allow patrons to use all credit cards for purchases for bigger and more frequent sales.

Seeding and growing cannabis plants requires large swaths of quality real estate. The area has to have plenty of water and light, be free of mold, and have access to electricity, ventilation, and warehouse space. Cannabis grow areas must be secure and guarded 24/7. Innovative Industrial Properties provides these facilities, operations, and services to the expanding industry.

States will continue exercising their rights by building local cannabis businesses. That sustains business for Innovative Industrial Properties. We are on the cusp of federal changes that can inspire sizzling savings and better cash flow from operations and EPS. The current share price dip adds to our view that Innovative Industrial Properties offers investors the best long-term investment value.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Best Value Idea investment competition, which runs through October 25. With cash prizes, this competition — open to all contributors — is one you don’t want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!