Innovative Industrial Properties (IIPR -3.68%), a real estate investment trust (REIT) servicing the regulated cannabis industry, had notable gains in Q2 2022. Meanwhile, in early spring it raised funds via a common stock sale, which helped it keep down its debt while continuing to grow the company. But, it's already spent a portion of that, has a large debt due in 2026, just had a default on a lease obligation, and then there's that ever-present regulatory lag at the state and federal level. All that leaves investors with the same question, will IIP's latest investments pay off during tough economic times?
The top and bottom lines rose in Q2
IIP's total revenue grew to $70.5 million, up 9.3% sequentially and 44% year-over-year thanks to the acquisition and leasing of new properties, combined with rent increases. The company has 110 properties around the country and 80% of those are attributable to multi-state operators (MSOs). Net income rose sequentially by 98% to $40.2 million with a net profit margin of 57%, a notable number as this is the money left over after IIP paid its bills. One thing it did with those funds on July 15 was its stockholders, who'd invested by June 30, a dividend of $1.75 a share, or $7.00 for a yearly dividend rate.
Lastly, it said in its recent investor call it had 12% debt to total gross assets, with approximately $2.5 billion in total gross assets, representing a total annual fixed cash interest obligation of approximately $16.7 million. Lucky for IIP most of the $300 million debt -- with the exception of $6.5 million in senior exchangeable notes -- isn't due until 2026.
Falling cash prompted the company to raise money
IIP's cash was steadily on the decline throughout 2021, dropping from $156 million in Q2 2021 to just over $43 million, a 72% drop, by the end of the year and leaving it little choice but to borrow more or sell stock to replenish its bank vaults. On April 5 as the stock was trading at $205 a share, the company initiated an underwritten stock offering of roughly 1.5 million shares at $190 a piece, raising roughly $330.9 million of aggregate net proceeds. Not too shabby a haul for only a 7% stock dilution.
Since April, the stock value has fallen 55% -- some of that is contributable to a major tenant default -- to just over $91 a share the day of this writing, surely investors were not pleased. IIP says they will use the money to invest in specialized industrial properties used in the cannabis industry and for corporate expenses, a promise it's already made good on, leaving it with only $45 million in the bank at the end of Q2 2022.
It quickly invested the money but will that work?
With its stock sale behind it, Innovative Industrial Properties wasted no time and bought four new facilities in Arizona (adult use and medical), Maryland (small medical with an adult use initiative on the November ballot), Massachusetts (medical and adult use), and Texas (very limited medical). Throwing in five lease adjustments to fund facility improvements in Illinois, Michigan, New York, and Pennsylvania (all medical and adult use, except Pennsylvania, which is medical only and two or more years out from adult use), the new investments and facility improvements represent a $239.4 million investment for the company.
These investments can help IIP create new relationships and strengthen ties with large companies like Curaleaf (CURLF -2.56%), Green Thumb Industries (GTBIF 0.78%), PharmaCann, and Sozo Health. This is good news for the company. Unfortunately, not all news was good last quarter for IIP.
One of its leaseholders, Kings Garden, defaulted on its $2.2 million a month rent and management fees on its six properties for the month of July. But if the issue extends for a year that could result in a loss of over $26 million. This scenario is still playing out as Kings Garden and IIP work on a possible new agreement. The company said the default would represent 8% of total revenue and 7.4% of capital investments, management further explains the most risk any one of its leaseholders exposes the company to is 14%, trying to reassure investors it's protected from the fallout from another potential-tenant default.
IIP financials appear to be in good shape going into the rest of 2022, and with its new partners made up of some of the largest MSOs in the country like Green Thumb and Curaleaf it's prepared to leverage those new contracts to start paying down its 2026 debt and increasing its cash in the bank. However, IIP may still be vulnerable if more leaseholders, 90% of whom are production/processing facilities and cost the most to manage, default on their obligations. And with the cannabis industry coming down off its 2020 high, federal adult use policy change potentially stalled, states like Pennsylvania and Maryland dragging their feet toward adult use, and just the general uncertainty associated with cannabis production, future defaults are plausible.
IIP's cash in the bank is a metric to watch for the next two quarters because a continued slide may signal it needs to raise more money. Despite the issues with a client default, IIP's relatively lower valuation and its relationship with some major MSOs could make it a buy for investors who believe the new investments will shape out and don't mind a little volatility in their portfolio as the ongoing economic issues unfold. But for everyone else, the jury's still out.
