The cannabis industry will experience enormous growth over the next few years. Any investor can see this and massive valuations have been assigned to unproven companies such as Canopy Growth Corp (CGC) and Tilray (TLRY). These stocks flaunt enormous valuations which come along with significant risk as much of the companies’ future growth may already be priced into the stock. However, these stocks are yet to even prove if they can generate profit. I instead have a far more reliable investment that still takes advantage of the future expected growth of the cannabis industry, Innovative Industrial Properties (IIPR). This REIT has the safety net of a strong dividend while still being the potential benefactor of the booming cannabis industry. Innovative Industrial Properties acquires, owns, and manages specialized industrial properties which they lease to state-licensed operators for their cannabis facilities.
IIPR purchases properties and makes the proper improvements in order to make them conducive to the growth of cannabis. They then lease these properties to the operators on a triple-net basis so they are not responsible for fees that come along with structural repairs, maintenance, taxes, and insurance.
Upon first glance at IIPR’s FY2018 10K, I was impressed with the company’s ability to generate a significant amount of cash from rentals while enduring quite low levels of property expenses. Given their extremely low debt-equity ratio I figured they could take even greater advantage of these impressive gross margins by increasing their leverage and selling bonds. Innovative Industrial Properties has a business model that is proven to work and it is quite visible through its terrific growth throughout 2018. However, I saw this company as one that had far more potential if it increased its leverage. The intervention of an investment bank to sell bonds and increase the current cash on hand would allow IIPR to increase capital expenditure on more properties and improvements that would in turn lead to greater rental income.
I then looked at IIPR’s most recent 10Q and this is exactly what they did. In February of this year IIPR issued $143.75 million of 3.75% Exchangeable Senior Notes due in 2024. With the new cash on hand they purchased $7.4 million worth of new real estate and invested $6.8 million in improving their current infrastructure. This investment led to a 250% growth in rental revenue and a 385% increase in net income. Not only is the company able to increase their rental revenue due to the growth in properties but they are also becoming more efficient in generating profit due to them benefiting from economies of scale. They now have a debt/equity ratio of a little over 50% which I believe is a much better leverage ratio than the severely under-leveraged debt/equity ratio of just 6% that they were operating at before. IIPR is not done investing in growth yet. Following Q1 the company still has $59 million in cash that can be put towards more properties. As the number of properties increases rental revenue will increase and net income will increase at an even faster rate due to the increased efficiency in generating profit.
As shareholder value continues to grow moving forward the debt/equity ratio will decrease from it’s current level of 50% once again. At this point IIPR will be due to sell more bonds and go thru another period of high growth.
As great as this company is, I am not buying at the current market price of $84. When looking at the chart I see a line of support at around the $80 mark. Given the currently high P/E ratio of 62 I would like to see this stock break through support and take a quick tumble before buying as I don’t like buying stocks at such a high multiple to earnings. However, If the price breaks through support I will be buying because I believe Innovative Industrial Properties has a business model with attractive downside protection due to its reliable rental revenue and high upside as it may grow alongside the high-flying cannabis industry.