“The person that turns over the most rocks wins the game. And that’s always been my philosophy.” – Peter Lynch
In a market where it has become harder and harder to find equities with attractive risk/reward profiles, NewLake Capital Partners (OTCQX:NLCP) stands out to me as an asymmetric opportunity. I have always been a competitive person and to be perfectly honest, I hate losing more than I like winning. It’s just the way I’m wired. If a renowned investor like Peter Lynch, the former Fidelity Magellan fund manager, says that you can win by turning over the most rocks and looking at the most interesting companies, then I guess I’m going to be turning over rocks for a long time.
I think discerning small-cap investors are in for a fantastic decade. There is so much passive money in the market today that is driven by computers, formulas, and automatic purchases. We have this self-perpetuating cycle with passive investing and low interest rates that have driven market valuations to absurd heights. Trees, as well as companies, don’t grow to the sky, but big tech is viewed as safe-haven trade on Wall Street right now.
If you ask me, the market we have today is an active investor’s paradise. So, while many investors have their investing on autopilot by just buying ETFs, I have been doing the exact opposite. In the last couple of months, I sold off most (not all) of my big tech positions and have been looking for small-caps and contrarian opportunities that I expect to outperform by a wide margin over the next 5 to 10 years. NLCP is one of those small-cap opportunities.
Over the last couple of years, I have watched plenty of IPOs and SPACs go public. This is followed by the speculation-driven boom and subsequent crash back to reality for most of them. Prudent investors can avoid most of these landmines simply by doing five or ten minutes of research before buying the latest hot stock. However, NLCP is a recent IPO that I have been buying lately and I am planning to continue to add to the position in the coming months.
As has small-cap cannabis REIT, NLCP is focused primarily on cultivation facilities in the Northeastern quadrant of the US. They have advantages with the cap rates for properties in the cannabis industry, generating unlevered yields well over 12%, while most other types of real estate have cap rates below 5%. With their recent IPO, NLCP has plenty of dry powder and has a balance sheet that essentially has no liabilities.
With a weighted average lease term just under 15 years and rent escalators typically around 2-3%, NLCP should print money with their double-digit property yields. I think investors buying shares today can expect a good combination of share price appreciation and dividend growth over the next 5 years. Later I will draw connections between NLCP and Innovative Industrial Properties (IIPR), the older, larger, and more entrenched cannabis REIT, to illustrate the future potential of NLCP.
NLCP makes money by acquiring cultivation facilities and dispensaries and leasing them to cannabis operators. This includes large MSOs (multi-state operators) as well as smaller companies. NLCP is more concentrated in the Northeastern part of the US, but that leaves them plenty of room to expand into the rest of the country.
With 27 properties at the end of 2021 Q3, NLCP is just getting started in my opinion. They have no leverage (just over $10M in other liabilities), and after the recent IPO, they have $167.8M in cash on their balance sheet ready to deploy over the next couple of years. While NLCP has 10 cultivation facilities and 17 dispensaries, the cultivation facilities make up nearly 90% of the portfolio due to the larger size.
One thing that investors should be aware of is NLCP’s tenant concentration. The top 5 tenants are large cannabis operators that make up 21 of NLCP’s 27 properties and 90% of the rental revenue. I think that the tenant concentration will come down significantly in 2022 as NLCP acquires new properties and continues to expand.
Most REITs use a mix of equity and debt to fuel expansion and acquisitions. NLCP currently has no debt on the balance sheet but is still able to obtain larger yields than most REITs simply due to the property type.
Shares outstanding more than doubled when compared to 2020, but that is to be expected with the recent IPO. They redeemed the outstanding preferred stock earlier in 2021, but I expect NLCP to continue to use equity to fund the majority of acquisitions moving forward. With double-digit yields, a weighted average lease term just under 15 years, and rent escalators typically around 2-3%, I think NLCP could provide explosive growth from the current market cap of $575M.
We can’t use Fast Graphs yet for NLCP unfortunately, but I wanted to touch on the valuation briefly before comparing NLCP to IIPR. The FFO/share for the first nine months of 2021 was $0.80, so I think we can conservatively expect at least $1.00 (and probably slightly more than $1.00) in FFO/share for 2021. With a current share price of $27.10, that puts shares of NLCP somewhere in the 25-27x price/FFO range. This is a steep discount to IIPR’s 35x multiple, and in my opinion, NLCP is set up for more explosive growth than IIPR. These are essentially back of the napkin calculations on NLCP, so they won’t be perfect, but I think they are fairly conservative. I think investors buying now with a long-term time horizon will be richly rewarded as NLCP is poised to grow rapidly in the coming years.
IIPR & the Dividend
Innovative Industrial Properties is the larger, more established REIT focusing on cannabis real estate. Since going public at the end of 2016, shares of IIPR have grown from ~$17 to just over $220 after a recent pullback. The quarterly dividend has grown from $0.15 to $1.50. For a link to my recent article on IIPR, click here. The article also covers some of the regulatory nuances that could affect the cannabis industry in the coming years.
I included this chart simply so investors could see what IIPR has been able to provide for long-term shareholders. I have owned IIPR for a year and a half, I have no intention of selling, and I will continue to reinvest dividends. I don’t make this comparison to IIPR as a prediction that NLCP will provide similar returns, but they operate in the same real estate sector with the same cap rate and yield advantages, and they both have the same extended growth runway ahead of them.
Will NLCP have a yield on cost over 30% in five years? Maybe, maybe not. I certainly wouldn’t be complaining, but I am expecting double-digit dividend growth for a long time with NLCP. With the most recent quarterly dividend of $0.31 ($1.24 annualized), NLCP would yield 4.6% in 2022 without any further dividend hikes. In my opinion, it is far more likely that NLCP hikes the dividend aggressively in 2022 than paying out the same $0.31 quarterly dividend.
I currently have a half-sized position in NLCP, and I am planning to add to the position after the company releases their annual report in the next couple of months. With property yields over 12%, an average lease term just under 15 years, and 2-3% escalators, I think NLCP could provide absolutely massive returns for shareholders over the next 5 years. Shares are a strong buy under $30 and long-term shareholders could be richly rewarded as NLCP starts to use its dry powder over the next couple of years and beyond. When you consider the valuation, the current yield at 4.6%, and the dividend growth potential, NLCP looks like a no-brainer to me at these prices.