AFC Gamma, a cannabis-focused real estate investment trust (REIT), recently held its Q1 2024 earnings call. On the surface, things appeared rosy. The company highlighted a promising industry outlook, underscored by the Attorney General's proposal to reschedule cannabis, and touted its strong position to capitalize on the growth wave. A fourth consecutive $0.48 dividend was declared, seemingly reinforcing investor confidence. But beneath the optimistic narrative, a subtle shift in language and a critical financial metric hint at a potential storm brewing: a possible dividend cut.

While AFC Gamma emphasizes its commitment to paying out between 85% and 100% of distributable earnings annually, a closer examination of their recent actions and statements suggests a change in strategy. The company has repeatedly underscored distributable earnings as the "primary metric the Board considers when declaring quarterly dividends." This emphasis, coupled with the consistent $0.48 dividend over the past four quarters, created an implicit expectation of a stable payout tied to this metric.

However, a critical statement in the Q1 2024 transcript breaks from this pattern. Brandon Hetzel, AFC Gamma's CFO, states, "Year-to-date, we paid out dividends of approximately 99% of our distributable earnings. As a reminder, on an annual basis, our dividend policy is to pay between 85% and 100% of distributable earnings over the year." This shift in emphasis from "quarterly" to "annual" introduces a new degree of flexibility in the dividend policy, allowing for potential fluctuations in the quarterly payout to achieve the desired annual target.

Here's where the hypothesis emerges. AFC Gamma's distributable earnings have been steadily declining over the past few quarters. This sustained decline raises concerns about the sustainability of the current $0.48 dividend, especially with the new emphasis on achieving the payout target on an annual basis.

Declining Distributable Earnings

The table below shows the decline in distributable earnings per share over recent quarters.

Reference: <a href="https://seekingalpha.com/symbol/AFCG/earnings" alt="AFC Gamma Earnings Transcripts">AFC Gamma Earnings Transcripts</a>

If we assume distributable earnings hover around the current $0.49 per share for the remaining quarters of 2024, AFC Gamma would need to pay out a total of $1.96 in dividends to maintain the 99% payout ratio they highlighted in the Q1 transcript. This translates to an average quarterly dividend of $0.49. While this seems marginally higher than the current $0.48, remember, the dividend policy allows for a payout range of 85% to 100%. If AFC Gamma opts for a slightly lower payout ratio, say 90% for 2024, the total annual dividend drops to $1.76, or a quarterly average of $0.44.

This scenario, while hypothetical, illustrates the potential for a dividend cut in the upcoming quarters. By shifting the focus to the annual payout target, AFC Gamma has created a buffer to maneuver their dividend strategy without explicitly announcing a cut.

Adding to the intrigue, consider this: AFC Gamma is currently undergoing a spin-off of its commercial real estate portfolio into a separate publicly traded REIT, Sunrise Realty Trust. This complex transaction, while strategically sound, demands significant resources and could introduce financial pressure. It's plausible that the company is positioning itself to adjust the dividend in anticipation of potential challenges or opportunities arising from the spin-off.

Potential Dividend Scenarios

While the company maintains a positive public stance, the declining distributable earnings, the shift in emphasis from quarterly to annual dividend payout targets, and the ongoing spin-off create a compelling argument for a potential dividend cut. Investors should be wary of the rosy narrative and closely monitor AFC Gamma's upcoming financial performance and dividend announcements for confirmation of this hypothesis.

"Fun Fact: Did you know that AFC Gamma's Executive Chairman, Leonard Tannenbaum [Bloomberg Profile] [https://www.bloomberg.com/profile/person/16011953], is considered a pioneer in the direct lending industry? Before co-founding AFC Gamma, he built a $5 billion direct lending business, showcasing his expertise in navigating complex financial landscapes and identifying lucrative investment opportunities."