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Advanced Flower Capital Group (NASDAQ:AFCG), a NASDAQ-listed commercial mortgage REIT, has positioned itself as one of the leading lenders in the cannabis sector.
As one of two major externally managed REITs focusing on the U.S. cannabis industry, AFCG benefits from a capital supply-demand imbalance.
This imbalance allows the company to generate high yield-to-maturity (YTM) rates, with a reported YTM of 19% as of August 1, 2024, on a loan portfolio valued at $287 million.
In a Wednesday note, senior analyst Pablo Zuanic of Zuanic & Associates explains how AFCG secures favorable lending terms due to limited capital access for cannabis operators, driven by federal illegality. With 24 states legalizing adult use and 38 legalizing medical cannabis, AFCG has become a key lender, benefiting from the capital imbalance to maintain high YTM rates while keeping funding costs in the mid to high-single digits.
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In July 2024, AFCG spun off its commercial real estate (CRE) loan assets into a separate entity, Sunrise Realty Trust (NASDAQ:SUNS), marking a strategic move to focus solely on cannabis-related loans.
Zuanic explained that this spin-off was well-received by investors, contributing to a 20% increase in AFCG's stock price since July 9. Following the spin-off, AFCG's loan book stands at $240 million, with an additional $67 million in cash reserves and $88 million in debt. The company has access to over $100 million in capital, which it intends to deploy in further cannabis-related loans.
AFCG's loan book has shown significant growth, with four new deals totaling over $70 million secured between March and June 2024. Notable deals include loans to Sunburn Cannabis in Florida ($36.5 million), SocietyC in Michigan ($15 million), a Tier-2 licensee in Georgia ($11 million), and Gron Edibles ($7.5 million).
In addition, Zuanic noted the company's loan portfolio is highly concentrated, with eight borrowers accounting for 96% of the principal. Despite this, AFCG has focused on expanding its reach by lending to operators in limited-license states, which tend to offer better financial stability due to restricted competition.
AFCG has encountered challenges with legacy loans, including two loans in non-accrual status totaling $62 million and a third loan in forbearance, valued at $79 million.
The cannabis industry continues to present favorable growth prospects for AFCG. Legal cannabis sales in the U.S. are expected to reach $42 billion by 2027, with a compound annual growth rate (CAGR) of nearly 10%.
Zuanic also noted that several key states, including Florida, North Dakota, South Dakota and Pennsylvania are poised to expand their adult-use and medical cannabis programs, potentially increasing the demand for debt capital by $1.7 billion.
According to Zuanic’s report, AFCG boasts a strong financial position, with a book value per share of $9.64 as of mid-2024.
The company's stock is trading at a price-to-book ratio of 1.04x, in line with its peer Chicago Atlantic Real Estate Finance, Inc. (NASDAQ:REFI) but below that of sector leader Innovative Industrial Properties (NYSE:IIPR), which trades at 1.82x. AFCG's attractive dividend yield, currently near 13%, makes it an appealing choice for income-focused investors.
The company distributes 85% to 100% of its distributable earnings in dividends and is projected to increase its dividend payout to 36 cents per quarter by the end of 2024.
AFCG offers a compelling investment case, driven by its high YTM rates, strong dividend yield and focused cannabis lending strategy. The company's proactive approach to managing legacy loan issues, combined with its access to capital and expanding borrower base, positions it well for continued growth.
Moreover, the potential for favorable federal cannabis reforms and continued industry expansion could further enhance AFCG's financial performance.
While the company's loan book remains concentrated, its strategic focus on lending to well-capitalized operators in restricted-license states provides a measure of security for investors.
