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3 Top Pot Stocks to Watch in September

Motley Fool - Thu Sep 7, 2023

Cannabis stocks rallied last week after the U.S. Department of Health and Human Services (HHS) confirmed that it recommended that the Drug Enforcement Administration (DEA) lower the federal classification of cannabis from a Schedule I drug to Schedule III.

By the government's definition, Schedule I is the classification for drugs that are deemed to have no currently accepted medical use and are also highly susceptible to being abused -- drugs such as heroin and fentanyl. The proposed move would recategorize cannabis into the group that includes Tylenol with codeine, ketamine, and testosterone -- drugs that are viewed to have medical uses and only a low to moderate potential for causing addiction.

That would open the door to marijuana being decriminalized at a federal level, which would be huge for cannabis companies. Just one example of the change's impact relates to the U.S. tax code. The code currently prevents cannabis companies from deducting typical business expenses because they are connected to the sale of a Schedule I or Schedule II controlled substance. Placing marijuana on the Schedule III list would mean those deductions would be allowed. That change alone would help many more cannabis companies reach profitability.

However, there's no guarantee the DEA will follow the HHS recommendation. Even if it does, the path to federal decriminalization could still take years.

Still, this ray of hope reignited interest in cannabis stocks. Three that are worth watching are Innovative Industrial Properties(NYSE: IIPR), NewLake Capital Partners(OTC: NLCP), and Green Thumb Industries(OTC: GTBIF), and that's even if federal decriminalization doesn't happen soon. All three companies are profitable and growing revenue, which is more than can be said for many in the industry. Here's why these three pot stocks are buys in September.

1. Innovative delivers a healthy dividend

Innovative Industrial Properties is the largest cannabis real estate investment trust (REIT). It owns 108 properties (five of which are still being developed) across 19 states, which it leases to cannabis businesses (largely cultivators) using triple net leases.

Innovative has increased its dividend by 1,100% since it first began paying one in 2017. The stock's price is up more than 27% in the last three months, but its yield remains an inviting 8.2%. The company raised its quarterly dividend by 2.8% this year to $1.80, but its adjusted funds from operations (AFFO) payout ratio of 80% leaves room for more increases.

In the second quarter, revenue rose 8% year over year to $76.5 million, and net income was $40.9 million, up from $39.8 million in the same period a year ago. More importantly, it grew funds from operations (FFO) and AFFO, both of which are considered better metrics of profitability for a REIT than net income. FFO per share was reported as $2.04, up 3.5% year over year, and AFFO per share was $2.26, compared to $2.15 in the prior year period. Since 2017, the company's AFFO has grown at a compound annual rate of 151%.

There are a few concerns for Innovative. Two of its smaller tenants, Holistic Industries and Temescal Wellness, struggled to pay their rents last quarter, and their security deposits were used toward that end. However, the company maintains strong, consistent cash flows, with the average lease length remaining on its properties being 14.9 years. It also, for a REIT, has a low level of debt, with 12% debt to total gross assets.

2. NewLake Capital Partners shows surprising growth

NewLake is a smaller cannabis REIT with less tenant diversity, owning 32 properties across 12 states leased to 13 operators with a net average remaining lease term of 14.5 years. However, NewLake offers more potential for growth than Innovative. Its AFFO climbed by 344% over the past three years, and at its current share price, it has a higher-yielding dividend.

Late in 2022, the company boosted its quarterly payouts by 5%, effective this year, to $0.39, which gives the stock a yield of around 10.8%. The AFFO payout ratio is 84.7%, which leaves room for another potential dividend increase next year.

Over the past three months, the stock has climbed by more than 15% as the company had a strong second-quarter report and boosted its annual guidance.

For Q2, NewLake reported revenue of $22.8 million, up 10.2% year over year, and net income of $11.7 million compared to $8.8 million in the same period last year. FFO rose by 31.3% to $19 million, and AFFO was $19.8 million compared to $17.2 million in the same period a year ago.

In other signs of strength, the company bought back 56,372 shares of its stock in the quarter, and management upgraded guidance to say it expected full-year AFFO of between $39.8 million to $40.8 million -- 4.1% higher at the midpoint than its AFFO in 2022.

3. Green Thumb's fiscal responsibility pays off

Green Thumb is the only major multi-state operator that has consistently turned a profit this year. Its stock is up more than 27% over the past three months. The company focuses on limited-license states and operates 85 Rise dispensaries across 14 markets.

In the second quarter, Green Thumb reported revenue of $252 million, down 1% year over year, but up 1.5% over the first quarter. The company reported net income of $13.4 million, or $0.05 in earnings per share (EPS), down from $24.4 million and EPS of $0.10 in the same period last year, but an improvement over its $9.1 million in net income and $0.04 in EPS in the first quarter of 2023.

The company's quarterly report also didn't reflect any boost it might get from the legalization of adult recreational-use sales in Maryland, where the company has four dispensaries. That change in Maryland came on July 1, the beginning of the third quarter. In the first month of adult-use sales, the state reported $87.4 million in overall cannabis sales.

The key for Green Thumb is that most of its growth has been organic rather than through acquisitions. The company has seen rapid annual revenue growth, with its top line rising from $7 million in 2016 to $1 billion in 2022.

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Jim Halley has positions in Innovative Industrial Properties and NewLake Capital Partners. The Motley Fool has positions in and recommends Green Thumb Industries and Innovative Industrial Properties. The Motley Fool has a disclosure policy.

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