MW These yield-rich stocks aren't typical dividend plays. Why they're worth the risk.

By Michael Brush

Cannabis-sector lenders offer attractive upside potential

Cannabis consumers look at the world of weed as a place to find products with whimsical names like "Khalifa Kush" or "Zen Leaf." It's also a sector offering rich dividends for yield-seeking investors.

Publicly traded cannabis-company lenders are looking at favorable trends that support the health of their borrowers, which typically have few outlets for funding. Traditional banks rarely lend to cannabis companies; regulatory compliance requirements are onerous.

So, specialized cannabis lenders have their choice of customers. They can pick borrowers with the least leverage and the most reliable cash flows. They get their choice of collateral, like real estate or sales licenses. They impose favorable covenants and command the top slot in the capital structure.

And they can book loans at higher interest rates, one reason why you get rich yields if you own these names. As of the end of 2024, for example, Chicago Atlantic Real Estate Finance $(REFI)$ had a weighted average yield to maturity of 17.2% across 30 portfolio loans.

Cannabis-sector analysts worry about the proverbial "wall of debt" coming due in the next two years. But Chicago Atlantic CEO Peter Sack said in a recent interview that such fears are exaggerated. Yes, some companies in the space will fail, but many have the strength to simply refinance. Because of limited competition from banks, cannabis lenders can do business with the stronger borrowers.

Chicago Atlantic, for example, lends to companies that operate in several states for geographic diversification. It prefers to lend in limited-license states like Missouri, Illinois, Maryland, Minnesota and New York. This lowers the risk that politicians and regulators flood the market with licenses, which can put downward pressure on prices.

One of its loan-portfolio companies is Fluent, which operates in Florida, Pennsylvania and New York, and has a medical cannabis sales license in Texas. It has a diversified mix of retail, wholesale and cultivation operations coming online.

But because you can never really predict what politicians will do, Chicago Atlantic keeps loan length short - typically two to four years, Sack says. Even if regulators decide to issue a lot of new licenses, it would take a few years for new operators to set up. Loans roll off in the meantime, freeing Chicago Atlantic to exit the affected market.

These factors help explain why Chicago Atlantic has had just one bad loan in four years of operation. They also help explain why the company is the third-best-performing mortgage real-estate investment trust $(REIT)$ since it launched in 2021.

Negative sentiment, positive trends

Sentiment is extremely negative on the cannabis sector. But there are positives which support borrowers.

For starters, exposure to the Trump administration's trade tariffs is limited. "Our borrower exposure to tariff risk is low," Sack notes. "The market is domestic, and only a small portion of the cost structure is imports."

Additionally, cannabis sales may hold up in a recession. Demand will likely be steady in a downturn, as it typically is for alcohol and cigarettes. At cannabis retailer Verano (VRNOF), chief investment officer Aaron Miles expects that core recreational and medicinal users won't cut back. "Cannabis has a very loyal customer base, especially medical," he said in a recent interview.

Also helpful is that cannabis prices seem to be stabilizing after years of declines. "Some of the markets are starting to reverse the trends that have soured commentary on the space. That's extremely encouraging," Sack said. "Eventually there is consolidation and companies go out of business. But that does not happen immediately. It happens through a process of a lot of pain, and we are in the middle of it. It is market by market."

"We are seeing prices level out in certain states," said Miles at Verano. "We are starting to see stabilization in Florida, Illinois and New Jersey." This trend is not getting priced into cannabis stocks, he noted: "The normalization of the market is overlooked."

Other positive factors include federal-level reforms that are still on the table. President Donald Trump campaigned in favor of moving cannabis to Schedule III from Schedule I under the Controlled Substances Act. This would help cannabis companies by neutralizing an Internal Revenue Service rule barring the deduction of operating expenses against sales from Schedule I drugs like cannabis. If this happens, cannabis companies expect a huge jump in cash flow.

"From what we are hearing, there is positive momentum at the federal level," Miles said. "We are still hearing that rescheduling is a big priority for this administration."

Miles also expects that a cannabis banking-reform bill could be reintroduced in Congress soon. It will be similar to past versions of the SAFER Banking Act, which would help cannabis companies gain access to essential banking services. Trump also endorsed banking reform during his campaign.

Three cannabis lenders to consider include Chicago Atlantic Real Estate Finance, Chicago Atlantic BDC $(LIEN)$ and Advanced Flower Capital $(AFCG)$.

Chicago Atlantic Real Estate Finance (CAREF) and Chicago Atlantic BDC have close ties, and Sack is the CEO of both companies. As of the end of last year, CAREF had a loan portfolio of $410 million across 30 companies. It says it has a pipeline of potential business worth $500 million.

Chicago Atlantic BDC, meanwhile, acquired much of its cannabis loan book from Chicago Atlantic in a recent transaction. About 77% of its loans are in the cannabis sector; the rest is mostly in finance, insurance, retail, healthcare and real estate. Chicago Atlantic's investment portfolio recently had about $275 million in loans across 28 companies. The weighted average yield on debt is 16.5%. This company recently declared a fourth-quarter dividend of $0.34 per share. It had no leverage at year-end and no bad debt.

Advanced Flower Capital had a loan portfolio of $368.8 million as of the end of March. The weighted average portfolio yield to maturity was about 18%. The company is working out some bad loans; reserves against underperforming loans stood at $30.6 million, or almost 10% of loans.

That forced AFC to cut its dividend in mid-March. But AFC has a good record in working out bad debt, and insiders recently purchased around $920,000 worth of stock, suggesting that further damage may be limited. Buyers included the CEO, a director and the president, who bought at share prices ranging between $6.15 and $6.52. That's a good signal given the size of the purchases and because it is a "cluster" buy from insiders.

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned AFCG and LIEN. Brush has suggested REFI, LIEN and AFCG in Cabot Cannabis Investor and his stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks.

-Michael Brush

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

May 08, 2025 15:43 ET (19:43 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.