Author: Alex Carchidi

RXRX – Recursion Pharmaceuticals Is Going Big on AI. Here’s Why It Could Be Worth Buying

On May 8, Recursion Pharmaceuticals (RXRX 3.12%) announced that it was going to buy a pair of AI-enabled drug discovery biotechs, Cyclica and Valence, for a total of $87.5 million — paid in stock.

Management says that the moves will help the company use digital chemistry and machine learning to calculate promising targets for drug development, which — if this is the first time you’re hearing about Recursion — has always been its entire shtick. The deal is expected to close before the end of the second quarter of this year.

But is Recursion’s stock a smart investment, and do these purchases change anything? Let’s find out.

Why this biotech is worth knowing about

Recursion’s pitch to its customers, which are major biopharma companies, is that collaborating with it will reduce research and development (R&D) costs and timelines. To accomplish that, it employs a handful of AI-enabled methods to identify the biological targets and pre-existing or novel molecules that are the most likely to be effective.

Plus, it maintains a gargantuan hoard of chemical and biological data that it says includes upwards of 3.1 trillion different relationships between components, many of which could be targets for drug development efforts.

Powerful players like Roche and Bayer are already among its patrons. The new acquisitions are aimed at making it even more effective at its core capabilities although it’s unclear exactly how that will translate into increasing revenue by securing more collaborations, or bringing milestone payments from existing collaborations into reach. But if it can prove that its approach driven by AI and machine learning does what it claims, it should have collaborators lining up around the block.

Aside from its drug discovery capabilities, Recursion also has a development pipeline of its own, featuring three programs in phase 2 clinical trials, all of which are intended for rare diseases. For example, one of its programs is for neurofibromatosis type 2, which it estimates affects only 33,000 people worldwide.

In the long term, its pipeline projects could bolster its top line significantly, though it might struggle to satisfy shareholders if its rare disease markets prove to be too small for the costs of development. On the other hand, favorable clinical trial results would also help substantiate its claims about the merits of its discovery platform.

Key aspects of the business model are still only theoretical

Recursion’s deepening delve into AI is a positive development for investors, especially considering that the deals didn’t use any of the company’s cash. But the risks of an investment are significant right now despite the opportunity for a large upside in the long run.

While first-quarter revenue rose from $5.3 million last year to reach $12.1 million, growth is a key concern since at the moment the company is entirely reliant on milestone payments. In the trailing-12-month period, Recursion burned through nearly $134 million in cash, leaving it with around $473 million. The company will eventually need to become profitable, too.

Of course, there’s the risk that its clinical trials will go off the rails, or that its drug discovery platform won’t actually provide as much value to collaborators as it hopes. Given the presence of similarly positioned competitors like Schrödinger, 23andMe, and several others, there’s also a substantial risk of the biotech getting its lunch eaten; it doesn’t presently have a demonstrable competitive advantage.

Nonetheless, there’s a solid chance that as the costs and timelines of drug development continue to increase, Recursion’s AI-forward strategy will pay off. Don’t invest in this business unless you are comfortable with plenty of risk and you’re willing to wait a handful of years for its value to be revealed. If that doesn’t bother you, buy away — just understand that you’re investing in a biotech that’s relatively early-stage despite the impressive-sounding capabilities of its platform.

Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool recommends Roche AG and recommends the following options: long January 2024 $75 calls on Schrödinger. The Motley Fool has a disclosure policy.

IIPR – Want $1,000 in Annual Passive Income? Investing $36 in This Stock Per Week for 5 Years Could Do It.

For most people, building passive income is a marathon, not a sprint. The longer you’re willing to spend on buying shares consistently, the less you’ll need up front. 

In that vein, Innovative Industrial Properties (IIPR 0.85%), the marijuana cultivation facility landlord company, is an appealing option for dividend investors thanks to its ownership of real estate that’s very much in demand for the steadily growing cannabis industry. Happily for investors, it won’t take a very large investment to yield a significant inflow, even if you only invest a relatively small amount each week. Let’s do a quick calculation to see exactly how little money it’ll take you to get to $1,000 in yearly passive income with this stock.

Here’s how to make a grand in passive income each year

IIP’s forward dividend yield is presently at a sky-high 10.8%, which makes it especially appealing to passive income investors who don’t have a huge amount of capital ready for investing right now. You’d need a total of around $9,300 invested all at once to make $1,000 in dividends annually, but you can get away with a lot less up front if you’re willing to be a bit patient. For a low-low cost of $35.7 each week, assuming you buy fractional shares, you can get your IIP position delivering $1,000 per year in just five years. 

Five years might seem like a long time to be making regular share purchases. But if you’re willing to then hold your shares for the rest of your life, your passive income stream might continue to grow. Over the last three years, the company’s annual dividends per share grew at an average pace of 36.6% per year. That growth rate is almost certainly unsustainable in the long run, but the good news is that there’s still probably enough money coming in to continue with hiking it to some degree. 

IIP’s trailing 12-month funds from operations (FFO) rose by 280.5% since three years ago, reaching $224.5 million. For the record, it only paid $185.2 million in trailing-12-month dividends. So even if it doesn’t continue to expand, and it definitely will, it would still have enough money coming in to keep increasing its payout by a decent amount for at least a year or two before it’d become a problem. 

The plan isn’t without risks

It’s very much within the reach of most (patient) investors to build up a position in IIP that could yield a grand in annual dividends. Similarly, it’s clear that the company’s prospects for continued payment are good enough that a dividend cut is very unlikely in the next couple of years, though it’s not something you can completely rule out in the long term. Now, let’s take a moment to understand the risks of the plan to slowly accumulate passive income from this stock to see how things might go awry. 

Innovative Industrial Properties is a real estate investment trust (REIT), which implies that it offers investors higher-than-average dividends that are financed by the company’s ownership and rental of valuable property. REITs are a standby for most passive income investors, though they aren’t necessarily always the ideal stock to buy in every economic environment. After all, if shareholders are expecting their dividend income to grow via ownership, the REIT itself needs to grow, typically by financing acquisitions (or construction) of new real estate with newly issued debt. And right now, the cost of that debt is higher than in the last few years thanks to the Federal Reserve’s action to contain inflation by hiking the prime interest rate, and it could keep rising. 

The business has nearly $38 million in cash and equivalents, and $302 million in debt. That level of debt isn’t very concerning yet, but every new dollar of debt that IIP takes out will mean less capital to distribute to investors down the line compared to before. As a result, the market sometimes punishes REITs in the short term when the interest rate rises. In other words, if inflation continues to be an issue, expect the market to trade shares of this company at a lower price level as interest rates rise further. That will actually make it cheaper for you to get enough shares to make $1,000 in dividends, though you’ll need to accept some losses on your existing holdings.

In fact, for the purpose of passive income, the actual risk to the plan is if the shares rise in value by a lot, driving the dividend down. Marijuana legalization, marijuana banking reform laws, or a boom in the cannabis industry in the U.S. could all have the effect of sending IIP’s shares skyward — and making it take even longer to buy enough shares to hit your target income level. And there’s always the standard set of REIT risks to know, like the threat of tenants defaulting on their rent payments, or a downturn in the industry. 

Given Innovative Industrial’s strong balance sheet and good track record so far, even in the face of several tenants defaulting on rent, if you’re chasing passive income, an investment is worth the risk. Just remember that the longer you’re willing to space out your purchases, the less your position will fluctuate from day to day, which can be a blessing if you tend to be nervous about your investments.

Alex Carchidi has positions in Innovative Industrial Properties. The Motley Fool has positions in and recommends Innovative Industrial Properties. The Motley Fool has a disclosure policy.