I Am Buying These 3 Sin Stocks (RICK, VICI & NLCP)

Sin stocks are shares of companies that are involved in activities that are considered unethical or immoral, such as tobacco, gambling, adult entertainment, alcohol, or even weapons.

A lot of investors decide to exclude these investments because they are thought to be earning a profit by taking advantage of human vices.

But this is obviously very subjective. Someone may consider gambling to be unethical while someone else may consider it to be just another form of entertainment that we should have in a free society.

In today’s article, I will focus solely on the financial aspect of these investments… which can be very tempting.

According to several research studies, sin stocks like Philip Morris (PM) and Diageo plc (DEO) have historically outperformed the broader stock market by 2-3% per year on average. That’s very significant when compounded over long time periods.

What makes these investments so lucrative?

Well, there are several reasons.

Firstly, these sectors tend to be heavily regulated, which puts up barriers to entry for new competitors.

Secondly, the moral aspect may also limit competition even further. We all understand that adult entertainment can be lucrative, for example, but few of us want to actually get into this business.

Thirdly, valuations tend to be discounted despite strong fundamentals because a lot of investors simply won’t invest in them, regardless of the valuation.

And perhaps most important, we are only human and the demand for these products and services tends to be very consistent, regardless of economic cycles or new technological advances.

As surprising as it may sound, alcohol sales actually tend to go up during recessions, and gambling revenues are more resilient than the revenue of your average S&P500 (SPY) company.

Sins like gambling and alcohol provide people an escape during stressful times, resulting in stickier demand. To give you a concrete example, here’s how Altria Group (MO), one of the biggest tobacco companies, has performed relative to the S&P500 since going public:

But just because a company operates in a sin industry does not make it a lucrative investment. You still need to be selective to limit risks and maximize potential returns, especially if we approach a potential recession and the market becomes more turbulent.

In what follows, we highlight 3 of our favorite sin stocks to buy today.

RCI Hospitality Holdings, Inc. (RICK)

RICK is the one and only publicly listed strip club company.

I like to think of it as a “REIT” in that it buys strip clubs, including the underlying real estate, and operates them to earn a profit over its cost of capital.

In that sense, it is quite similar to a hotel REIT, but instead of investing in hotels, it invests in strip clubs, which happen to be a lot more lucrative.

RICK is commonly able to target 25-33% cash-on-cash returns by buying strip clubs, but you would be happy with just half of that if you bought a hotel.

Despite being a lot more lucrative, strip clubs are also safer. Unlike hotels that are highly competitive, strip clubs essentially enjoy a quasi-monopoly in their local markets because today it is nearly impossible to obtain new licenses to open new locations. No one wants a new strip club in their backyard and so there are significant barriers to entry.

Moreover, while hotels can be notoriously cyclical, strip clubs are quite resilient to recessions. RICK’s CEO explains that strip clubs aren’t recession-proof, but they are recession-resistant. Given that their returns are materially higher than your average property, they have good margins of safety even if profitability drops temporarily.

So, put simply, strip clubs provide higher returns with lower risk, which is precisely what investors should be seeking. However, because strip clubs are part of adult entertainment, most investors won’t touch this sector, and this is precisely why these investments can be so lucrative. There are few potential buyers, and it provides RICK an important competitive advantage as the only company in this space with access to public capital to roll up this sector.

RICK is also a fantastic growth story because it has a large pipeline (owns 50 clubs out of 500+ in its target market), it earns exceptionally high returns on equity, and it can finance these investments organically with retained capital and/or raise more equity and debt and invest it at a large positive spread. Rinse & repeat.

The company has guided for ~15% annual free cash flow growth, but over the past many years, they have achieved closer to 20% annual growth.

Despite that, they are today priced at just 6x free cash flow, which is a bargain for a company of this quality. The company is buying back stock and insiders are adding to their already large positions.

The CEO has 95%+ of his net worth invested in the stock and he just bought another 1,000 shares. That’s what I call alignment of interest.

I think that RICK will be a very rewarding investment in the coming 10 years and I have made it one of my largest holdings.

VICI Properties Inc. (VICI)

VICI is similar to RICK in that it is also buying real estate that most other investors refuse to buy.

But instead of buying strip clubs, VICI buys casinos.

It owns the Caesar’s Palace, the Venetian, MGM Grand, and many other world-famous casinos on the Las Vegas Strip, and it also owns a bunch of dominant regional casinos such as the Borgata in Atlantic City:

Here you may wonder: what makes casinos good property investments?

And it again boils down to the fact that there aren’t many investors who are willing or able to buy these properties. As a result, VICI is getting better terms since it has superior bargaining power.

Here are the typical terms of a VICI casino net lease investment versus a traditional Walgreens Boots Alliance (WBA) net lease property:

You’ll note that the returns that VICI expects from its investments are not nearly as high as those of RICK, but on the flip side, these returns are also a lot more consistent, safe, and predictable.

Importantly, VICI does not operate the casinos that it purchases. Instead, it leases them to companies like Caesars Entertainment (CZR) on a long-term basis, earning consistent monthly rent checks and reducing its investment risk.

Still, the returns can be very compelling. VICI currently has a 5% dividend yield and it has grown its dividend by ~10% per year during the past 2 years.

Even assuming that the dividend growth drops to 7% per year, that’s a 12% annual return with the dividend, and it is coming from a relatively safe and recession-proof investment. I also think that the company has further upside potential, as it is expected to be soon added to the S&P500 index, which should boost its earnings multiple. We think that its fair value is at least 20-30% higher.

NewLake Capital Partners, Inc. (OTCQX:NLCP)

The last sin stock that we want to highlight in this article is NLCP, a REIT that invests in cannabis cultivation facilities and retail dispensaries.

Cultivation facility owned by NLCP:

Retail dispensary owned by NLCP:

Just like VICI, it is getting exceptionally lucrative terms on its property investments because most investors simply won’t buy such properties. If you are a real estate fund, it is a much safer choice to just go for an apartment community as you likely have at least one or a few limited partners that don’t want you to get into the cannabis business. After all, it is still considered to be a Class 1 drug at the federal level.

The reduced demand from investors for this asset class gives NLCP and other cannabis REITs more bargaining power as they acquire cannabis facilities with landlord-friendly terms.

As an example, NLCP has so far acquired 29 properties with an average 12.9% cap rate. It has 14-year long leases, and rents automatically increase by 2.6% each year.

The company still has $100 million of liquidity to deploy, very little debt, and it recently secured a new $30 million credit facility with a 5.65% interest rate that can be later expanded into a $100 facility.

This provides the company a predictable path to growth in the coming years as its rents keep on rising and the company continues to acquire new properties with highly lucrative returns.

We expect the company to grow its FFO per share by 8%+ per year, and you can buy it today at a 7% dividend yield. Combined together, you get a 15% annual total return, and that’s without any multiple expansion. I believe that a REIT that’s able to grow at this pace should trade at closer to a 4% dividend yield. If that was the case, NLCP’s share price would be more than 50% higher.

Closing Note

As you may have noticed, all our favorite sin stocks have a real estate component. We like real estate heavy sin businesses because we believe that it makes them even more resilient.

These assets are moated and enjoy substantial barriers to entry, but despite that, they offer high returns, resulting in exceptionally attractive risk-to-reward profiles for investors.

It is in part thanks to our investments in companies like RICK, VICI, and NLCP that we have historically outperformed broader market averages.