Shares of Canadian marijuana giant Canopy Growth (TSX:WEED) have significantly increased in recent trading sessions. Investors were optimistic over news that the U.S. might decriminalize weed at the federal level.
Even if weed consumption is decriminalized south of the border, Canopy Growth and its fundamentally weak peers will have to wait for cannabis to be legalized at the federal level in the U.S.
The U.S. is the largest cannabis market in the world. However, Canadian marijuana producers will not be able to enter the U.S. market until country-wide legalization is announced, which may take several years.
Due to its negative profit margins and high cash-burn rates, Canopy Growth will have to raise equity capital within the next two years, diluting existing shareholder wealth significantly. A weak balance sheet coupled with tepid top-line growth is a recipe for disaster for long-term shareholders.
But investors that want to gain exposure to the cannabis sector can consider investing in Innovative Industrial Properties (NYSE:IIPR), which also pays you a tasty dividend yield of 8.1%.
Is IIPR stock a buy?
IIPR is the largest U.S.-based marijuana-focused real estate investment trust (REIT). Valued at a market cap of US$2.5 billion, IIPR stock trades 69% below all-time highs, increasing its dividend yield significantly.
Its tenant list includes the largest multi-state operators in the U.S., such as Green Thumb, Curaleaf, and Trulieve Cannabis. While all of the REIT’s properties are located in the U.S., it has a presence in most of the 23 states where cannabis is legalized for recreational and medical use.
Around 91% of its properties are weighted towards pure industrial facilities, while retail accounts for just 3% of its portfolio. The rest includes a hybrid of industrial and retail properties. IIPR ended the June quarter with 103 operational properties, with five more under development. The occupancy rates stand at 99.9%, with a weighted average remaining lease term of 14.9 years.
IIPR operates via a sale-leaseback model where it acquires properties from cannabis producers and leases them back to the seller, who is now a tenant.
Due to the steady expansion of properties, IIPR has increased revenue from just US$15 million in 2018 to US$276 million in 2022. Its net income has surged from less than US$7 million to US$153 million in this period.
IIPR needs to pay at least 90% of its net income to shareholders via dividends to maintain its status as a REIT. Due to its widening profit margins, the company’s dividend yield has tripled in the last four years to US$7.20 per share.
What is the target price for IIPR stock?
Priced at 15.6 times forward earnings, IIPR is quite cheap and trades at a discount of 22.7% to consensus price target estimates. After accounting for dividends, total returns may be closer to 31% in the next 12 months.
However, investors should note that the performance of IIPR is directly related to its tenant base, which consists of licensed cannabis producers. The cannabis sector is a low-margin one, and the ongoing sluggishness continues to act as a headwind for IIPR’s clients.
For instance, IIPR experienced three rent defaults last year. It was forced to amend two leases with two other tenants to avoid defaults and used a portion of a tenant’s security deposit as rent payments.
