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
Interesting write-up, thanks. On your two things that "don't make sense to me". On the first item, I believe that your assumption is correct about the cost of capital eventually coming down. The question is when, how fast, and by how much. With politics always changing, it's hard to forecast when cannabis will be removed as Tier 1 substance. It may be a while before that happens. It may very well stay an individual state by state issue longer than anticipated, which would be a positive. As to how fast, banks move glacially, so that will take time. Finally, even if spreads do eventually come down, that process could take years as the industry evolves. Right now, a 12.5% cap rate is juicy. NLCP has talked about the positives of legalization in their quarterly calls as well.
ReplyDeleteOn the issue or valuation, I'd look to P/AFFO since it's a REIT. Based on that measure, I don't see the same issue, particularly compared to IIPR and considering it's growth rate. On dividends paid, again, look at the AFFO per quarter, and then it correlates to the declared dividend. As they've put capital to work, they've paid out that new income each month... see the dividend growth per quarter. That's also a reason that I think valuations are cheap.
Hope that was of value.
Hey, thank you for the comment! I had not heard of the P/AFFO metric before. That makes sense to add back in the depreciation. But it doesn't make sense to me to add back in the stock based compensation, all though it's not too much.
DeleteYeah I think you are making some good points. If they can use all of the excess cash to get more sale-leaseback transactions at a 12.5% cap rate that would be good. I guess the REIT structure is what gives me pause. They want to grow a lot more, and to continue acquiring more properties. But they have to pay out almost all their income as dividends. So they will have to issue a lot more equity over time. If management kills it, and makes incredible decisions and future deals then the stock will probably do great. Because it has such a short track record I don't feel comfortable on betting that management will make all the right moves going forward. I feel like it all really hinges on their capital allocation decisions. And there just isn't a lot of history to go off of.
I see your point on the fact that it might take a while on cannabis to become fully legalized and that banks will be slow to come in with financing. But I think there will be more competition moving forward, as there already is with companies like IIPR that are larger and have more capital and scale than NLCP.
Cheers!
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