Newlake Capital Partners Inc (NLPC) is a publicly-traded cannabis REIT that trades OTC. It was founded in 2019 and IPO'd on August 20th, 2021. As of this writing, the share price is $22.85.
I was initially intrigued to research the stock because it is part of the OTCQX, has good disclosure, a 5.78% dividend yield, and its story initially made sense to me.
Cannabis companies have limited access to capital in the United States because cannabis is federally illegal. So they can't have the normal banking relationships that other industries of that size would have. Growing and distributing cannabis requires capital-intensive real estate. So a cannabis company can sell their real estate to NLCP through a sale-leaseback and the cannabis company gets to free up capital and get a long-term lease in the real estate that they once owned.
NLCP is run by seemingly impressive management and now gets to own cultivation and retail properties in the cannabis industry with long-term tenants through triple net leases. Seems like a win-win.
NLCP owns 29 properties in 11 states. They choose to work in limited license jurisdictions where they believe there is less competition - leading to a better business environment for NLCP and their tenants. All of their properties are 100% leased. They have a 12.5% average weighted revenue yield on the capital they have invested.
It struck me as interesting that NLCP has $460 million in assets and almost no debt. Usually, REITs are fairly levered. I don't know if this is because they also have difficulty accessing bank debt to lever the balance sheet because they are associated with cannabis. Or, if it is because they are a recently public company that is flush with cash and they plan on levering the balance sheet in the future.
Here are the things that don't make sense to me.
1. NLCP's bull thesis is that the cannabis industry is rapidly growing and will inevitably become federally legal. By owning NLCP you can take part in the cannabis industry's growth and inevitable profitability.
The issue that I see with this is that if the industry grows and becomes federally legal - the cannabis companies will have more and more access to low-cost capital. They may still decide to do sale-leasebacks but they will have more options and at better prices and terms.
NLCP is focused on continued growth and acquisition of new properties. So if the cannabis industry does as well as they are expecting - then they will face more competition from other lenders and will be getting worse and worse deals with future sale-leaseback transactions.
Also, NLCP is a REIT and has to pay out 90% of its taxable income in the form of dividends. So they can't fund their future acquisitions with retained earnings. They say they will do so by issuing equity or debt. So far they have done it with the issuance of equity.
So by owning NLCP you are theoretically going to get diluted over time with potentially worse and worse deals.
2. The price is not cheap. I was intrigued when I saw NLCP because I saw that the share price was down about 24% from the IPO and was at a 5.78% dividend yield. I thought there might be some value there.
Turns out that NLCP is trading at 1.1 times book value. But 27.6% of NLCPs assets are in cash that will be deployed.
Because only 60% of their assets are invested in real estate, and the balance sheet is not levered -the return on equity is only 4%.
And the PE is currently 34.5.
Yet they pay a 5.78% dividend yield. Earnings for 2021 were $0.65 per share diluted but in just the last 3 quarters they paid out $0.76 per share.
So they are paying out more in dividends than they are actually earning. Which is fine because they are flush with cash right now. But it doesn't really make the dividend yield all that attractive once you learn this.
To be fair - as NLCP invests the excess cash that they have, their revenue, earnings, and return on equity will go up. But it still would not juice earnings to an enticing amount.
Conclusion
Overall the stock does not seem cheap to me. There will be significant dilution in the future in order to fund business growth. Yet their strategy doesn't make total sense to me. If the cannabis industry becomes legalized and takes off - they aren't going to get any extra rent payments. At best they get yearly inflation increases and all of their tenants pay on time.
But with that will come increased competition to give funding to these cannabis companies. So if cannabis does well in the US it will become harder and harder for NLCP to strike good deals on these sale-leaseback transactions. NLCP has direct competition with other publicly traded companies right now - most notably is IIPR which has a market cap of $4.3 Billion.
I am not saying I am right, but this does not seem to be a worthy investment to me. What could prove me wrong and change my mind is if cannabis stays illegal for longer than expected. Management turns out to be spectacular and continues to make incredibly smart decisions regarding future transactions and how to fund them. Management then levers the balance sheet to get a quality ROE. And the stock grows and grows, gains in popularity, and eventually gets up-listed and trades at a premium price.
But that isn't something I am willing to bet on.
Cheers,
Calum