It’s been a while since I wrote an article on the AFC Gamma (NASDAQ:AFCG). Since May, the stock has been pretty much cut sideways (while paying two quarterly dividends of $0.56), but I thought it was high time I wrote an update on this cannabis. Mortgage REIT.
AFCG is a small cap lender focused on the cannabis industry. Due to regulatory complexity and uncertainty, they are one of the few publicly traded companies that operate in the space. Because of this, they are able to get double digit returns on their portfolio. This leads to a hefty dividend yield of 13.1% as the company pays almost all of its profits to shareholders. One of the red flags that investors should be aware of is external management, but I think this is offset by significant insider ownership. They also intentionally targeted limited license jurisdictions, which I believe reduces the risk of the loan portfolio. Despite the risks and complexity of the market, the imbalance between supply and demand for capital in the cannabis industry should lead to attractive returns for AFCG.
AFCG operates in a space that most financial institutions have avoided by lending to cannabis companies. Due to regulatory complexity, AFCG can guarantee significant returns on its loan portfolio. The cash interest rate on the portfolio is 11.8% based on the most recent investor presentation, and the yield to maturity is 18% after taking into account various fees. Although I consider AFCG a more speculative bet than REITs like Innovative Industrial Properties (IIRP) or NewLake Capital Partners (OTCQX: NLCP), I still like the risk/reward proposition.
The AFCG is betting on two things: a continued mismatch between the supply and demand of capital available to the cannabis industry and investors who continue to seek revenue opportunities. As long as the legalization effort remains stalled, the capital available to the industry will be limited. This should give cannabis REITs looking to step in and fill this gap with attractive opportunities, whether on the real estate side for IIPR and NLCP or on the lending side for AFCG and Chicago Atlantic Real Estate Finance (REFI).
Insider ownership, external management and portfolio strategy
The company has significant insider ownership, so management should have an incentive to maintain dividends as it continues to grow the loan portfolio. However, AFCG is externally managed, which most REIT investors consider a red flag. In a previous disclosure they included language on how they could internalize management once they reach a certain size, but I still see external management as a downside.
They continued to avoid unlimited license states, which is a prudent choice in my opinion. While some states have chosen to go in different directions with legalization and regulation, and this has its pros and cons, licensing in limited license jurisdictions can be a valuable safeguard if a business is not able to meet its obligations.
At present, this does not appear to be an issue for AFCG, which said in the latest earnings call that all borrowers are up to date with their interest payments and no loans are unaccounted for. . We have seen tenant issues with IIPR in the last quarter, so it may become an issue for AFCG in the future. While worth watching by investors, the AFCG is currently trading around book value as of the end of the second quarter.
At the end of the second quarter, AFCG’s book value was $17.03, down one penny from the prior quarter. I think we’ll probably see stocks stay fairly close to book value, but I’m curious to see what book value will be with the upcoming Q3 report. As a relatively young public company, AFCG does not have a long operating history, but as an investor, I would like to see the book value grow over the long term with the dividend. As a mortgage REIT, most of AFCG’s return will be driven by the juicy dividend which has seen impressive dividend growth since its IPO.
In my last post, the AFCG had offered investors juicy dividend increases for several consecutive quarters. Since then, there was a token rise of a penny in Q2, then the dividend was flat at $0.56 in Q3. I won’t increase my position unless the stock price drops even further, but I expect the company to at least maintain the dividend over the next year. They only have a few loans maturing in 2023 and this is a relatively small part of their portfolio of around $15 million. I don’t count on further increases, but the dividend yield now sits at 13.1%, which is attractive. I plan to continue to reinvest dividends unless we see a significant increase in the stock price.
My speculative position within the AFCG is small due to cannabis industry risks and regulatory complexity. However, with stocks trading close to book value, I think we will see attractive returns driven by the large dividend. The company has impressive returns on its loan portfolio, and the portfolio is expected to continue to grow over the next two years. External management is something to consider, but the insider ownership and limited licensing strategy for the portfolio makes me bullish on AFCG. Investors who understand the risks associated with the industry might consider AFCG and its hefty dividend.