Regulatory Uncertainty And Tenant Risks Will Undermine Cannabis Portfolios

Key Takeaways

• Slowed legalization momentum and ongoing federal prohibition limit NewLake's growth opportunities, tenant demand, and access to affordable capital, compressing margins.
  
• Tenant financial stress and weak asset demand heighten vacancy risk and earnings volatility amid challenging market conditions and declining industry expansion.
  
• Conservative financial management, longstanding leases, and strategic industry positioning enable resilient income streams and position the company to capitalize on cannabis sector institutionalization.

Catalysts

An internally-managed real estate investment trust (“REIT”) that provides real estate capital to state-licensed cannabis operators through sale-leaseback transactions and third-party purchases and funding for build-to-suit projects.

• The market appears to be pricing in expectations that the gradual state-level legalization momentum will stall or slow, and that a lack of definitive progress on federal reform will materially constrain expansion opportunities and tenant demand, capping NewLake's long-term revenue growth.
  
• Persistent federal-level prohibition and regulatory uncertainty are likely to deter institutional capital, limit NewLake's access to lower-cost funding, and increase capital costs-even as alternative asset inflows slow-leading to compression in net margins and restricting the company's ability to drive accretive growth.
  
• Emerging tenant financial distress, such as the Ayr Wellness default (affecting nearly 6% of annualized base rent), highlights ongoing credit risk due to concentrated exposure to financially vulnerable cannabis operators, which could result in higher portfolio vacancies and reduced rental revenue going forward.
  
• Subdued demand for cultivation property acquisitions and fewer major state conversions, as indicated by management's outlook, imply diminished deal flow and asset base expansion, leading to slower AFFO and earnings growth over the next several years.
  
• Increased risk of oversupply and industry consolidation, coupled with lease repricing pressures and longer re-leasing timelines in challenged markets like Massachusetts, suggest potential for persistently lower occupancy rates, compressed rental rates, and earnings volatility for NewLake's portfolio.

NewLake Capital Partners Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming NewLake Capital Partners's revenue will decrease by 8.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 50.9% today to 46.0% in 3 years time.
• Analysts expect earnings to reach $18.0 million (and earnings per share of $0.84) by about August 2028, down from $26.1 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 23.2x on those 2028 earnings, up from 11.7x today. This future PE is lower than the current PE for the US Industrial REITs industry at 25.7x.
• Analysts expect the number of shares outstanding to grow by 0.21% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.45%, as per the Simply Wall St company report.

NewLake Capital Partners Future Earnings Per Share Growth

Risks

• Continued state-level legalization and expansion of medical/adult-use cannabis programs (such as recent moves in Texas, Delaware, Kentucky, Minnesota, and ongoing Pennsylvania debates) support long-term tenant demand and potential portfolio growth, aiding sustained rental revenues and supporting future earnings.
  
• The company maintains a very conservative balance sheet (1.6% debt to total assets, no near-term maturities, strong liquidity) which provides stability, flexibility for opportunistic growth, and protection of net margins even amidst temporary tenant distress.
  
• Annual rent escalators and long-term leases (with a weighted average lease term of around 13 years) provide predictable, growing cash flows, supporting both consistent earnings and the ability to maintain or grow dividend distributions over time.
  
• NewLake's demonstrated ability to secure and actively manage leases with high-credit-quality multi-state operators (MSOs), as well as to re-tenant properties and participate in like-kind exchanges, suggests ongoing resilience in occupancy and rental revenue despite individual tenant challenges.
  
• The industry-wide openness to sale-leaseback arrangements among MSOs, combined with the company's expertise in structuring and managing these transactions, positions NewLake to benefit from continued institutionalization and capital needs in the cannabis sector, supporting long-term top-line and bottom-line growth.

Valuation

• The analysts have a consensus price target of $16.0 for NewLake Capital Partners based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $39.2 million, earnings will come to $18.0 million, and it would be trading on a PE ratio of 23.2x, assuming you use a discount rate of 7.5%.
  
• Given the current share price of $14.83, the analyst price target of $16.0 is 7.3% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.