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Date : 10/05/2021

Rural Funds Group

ASX :

RFF

Market Cap : $839.55 Million

Dividend Per Share : $0.028

Dividend Yield : 4.52 %

Buy

52 Week Range : $1.83 - $2.72

Share Price : $2.47

Rental revenue is set to increase, resulting in higher dividends. We recommend long-term investors to "Buy"

Company Analysis

Rural Funds Group (ASX: RFF) is a Canberra based REIT (Real Estate Investment Trust) that holds and leases agricultural land and equipment. They are essentially an agricultural landlord, and they are extremely good at what they do. RFF generates sustainable revenue through lease payments. Their agricultural lands consist of assets from a whole set of diversified commodities such as – almonds, orchards, cotton, vineyards, cattle farms, etc.

Essentially, Rural Funds Group gives an investor access to the rural agricultural property market. The requirement for food is always increasing and Australia is a large exporter of commodities. In recent times, the management has done extremely well in restructuring the portfolio of assets that RFF owns and leases. The largest asset classes in RFF’s portfolio are cattle and almonds. As farmland gets more expensive, RFF will generate more revenues from lease payments. In addition to this, they are also helping themselves by switching some of its low value assets such as cotton towards higher value assets such as nuts such as almonds.

Currently, Rural Funds Group is implementing a strategy of investing in sectors in which Australia plays a vital role of an exporter. Their asset allocation strategy ensures that the firm is able to generate increased returns. The 67 assets in the portfolio are diversified by revenue as follows:

  • Almonds – 44%
  • Cattle – 38%
  • Vineyards – 6%
  • Cropping (Sugar and Cotton) – 5%
  • Macadamias – 2%

Chart

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Source: RFF

Since these properties are only as good as the lease payments they generate, RFF goes to great lengths to have a safe customer base. The graph on the right in the above picture shows the lease expiry profile of all the contracts the Rural Funds has. The weighted average of these profiles is over 11 years and it demonstrates longevity of the leases. 78% of RFF’s customers are corporates and/or listed entities. A couple of big name tenants of RFF are Treasury Wine Estates and Select Harvests. A long lease profile and quality lessees together ensure sustainability of revenues for RFF. The rental revenue increases with inflation and several other contracts have a 2.5% per annum fixed increase built in. This ensures that RFF is protected against inflation, especially now, at a time where inflation is starting to creep into every sector.

In addition to the rental payments that grow over time with market rent mechanisms, RFF also restructures their portfolio. For instance, they can implement a growth strategy by selling assets and buying newer assets such as nuts farms that yield better growth in the long-term than a cattle farm. On the flip side, the management can also decide to sell their asset, generate additional cash flows and distribute some of it to shareholders. Either way, as a shareholder, you stand to benefit – either from dividends or gradual share price appreciation. However, a long-term play is required.

To sum up, RFF’s assets have the following characteristics:

  • Long lease profile and quality lessees
  • Guarded against inflation
  • Potential for growth and dividends

Company Updates

Now that we know Rural Fund’s strategy and their portfolio, let’s have a look at the current optimization and what they point towards.

Rural Funds Group disposed of their Mooral almond orchard for $77.1 million. After accounting for depreciation and development capital expenditure, the firm was left with $74.1 million. The proceeds have been used for several acquisitions recently. RFF acquired 22 sugarcane farms in Maryborough for $56.4 million and have spent a few million developing them.

In Rockhampton, additional land was purchased to increase the existing cattle property for $4.3 million. Long story short, the picture below shows the asset movements by sector that RFF has adjusted during the recent half-year.

Chart, waterfall chart

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Source: RFF

These movements tell us that RFF is altering their strategy towards growth. Macadamia farm lands are natural resource dependent, rather than infrastructure dependent. Therefore, they support increased land value and income than almonds. Given the soaring commodity prices and real estate prices, RFF was able to sell the almond orchard at a 21% premium to its adjusted book value. This has also been the primary source of funds for the other acquisitions.

In addition to the real-estate, RFF also purchased 21,600 ML of water entitlements for $32.4 million in Central Queensland. This was done to help the macadamia orchard asset as the company is looking to increase the macadamia asset to around 500 hectares in 2021. As of December 2020, the net asset value (NAV) of Rural Funds increased by 4% to $2.01.

The share price performance of RFF has been performance in the past year. RFF shares have returned 28% during this time, excluding the dividends. RFF is a fairly good place to hide as well at a time when volatility is wreaking havoc to the adored growth shares. Overall, RFF is not as defensive a stock as investors make it out to be. The share price performance has been synonymous with the ASX 200 index and the ASX Real Estate sector during the past year. The added benefit of over 4.4% annual dividend yield is a very lucrative proposition during periods of volatility.

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Source: Tradingview.com

Industry Analysis

Just like the residential housing market, the agricultural property market in Australia is skyrocketing. In the past couple of decades, the farmland market has been on a steady incline and has performed similar to the stock market in recent times. Some of the catalysts for the booming agriculture property market are:

  • Record low interest rates make debt cheap
  • Recovery from the drought
  • High commodity prices supporting export market

These triggers have ensured that all Australian states have recorded a growth in the agricultural property market, and this is the first time in 15 years this has occurred. The country’s farmlands have seen over a 12% rise in median prices recently.

Fund managers from across the world have entered the Australian rural property market for the same reason. The attraction of good long leases, the increasing price and demand security over food commodities has resulted in the likes of fund managers such as Macquarie and private fund managers such as Warakirri and Stafford Capital into this sector as well. These private funds have been raising additional capital from high-net-worth individuals to expand their portfolios and hold a position in an asset that looks to be going in just one direction – that is, up!

The increasing global demand for food, especially in Asian countries as most economies in the region are growing very rapidly is very good news for the Australian agricultural sector. These strong commodity prices have a knock on effect to rural real estate prices. With interest rates close to zero and likely to persist at these levels for a few years (as the government desperately tries to keep inflation at levels above 2%), delivering long term returns on rural properties looks very positive for the next few years.

Investment Thesis

The sale of Rural Funds Group’s poultry assets has resulted in a decrease in H1 FY2021 property revenue that the firm usually generates. However, this was expected, and the strategy should pay dividends in the long-term. As we have already mentioned earlier, the proceeds have been reinvested, rather wisely, and should generate income soon.

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Source: RFF

The total comprehensive income, however, has increased by 97% and Earnings per unit increase by 94% as income from acquisitions has offset the decrease from property revenue. Adjusted funds from operations, that is, the rental profit that the firm generates decreased by 6.3% to $22.17 million. On a per share basis, the AFFO decreased by 7% to 6.6 cents from 7.1 cents a year ago.

Despite this decrease, since RFF earned revenue from the sale of assets, they have been able to increase their distribution to 85% of AFFO to shareholders. The NAV or the net asset value of the firm has increased by 4% to $2.01 per unit during the half year period. The firm is also on course to meet its FY2021 full year guidance AFFO of 11.7 cents.

Rural Funds Group aims to keep gearing in the 30%-35% range and in the latest statements, gearing comes in at 30%. They have extended their debt facilities as well to further mitigate risks (not that there were any red flags). As of December 2020, RFF has $320 million in drawn term debt, which is not required to be payable until FY2023 when they have $270 million due and $50 million in FY2024. In addition to this, the firm also has $60 million in additional headroom when it comes to the undrawn debt facility, if drawn, will not be due until FY2024 – this ensures that the firm will be no risk in the short-term. While Rural Funds Group has a cost of debt of 3.2%, over 57% of their debt has been hedged at 3.06%.

When it comes to dividends, RFF has tried to maintain a 4% growth in distribution year-on-year. With property prices soaring, we do not expect RFF to acquire additional assets without disposing off their existing ones. If they do decide to dispose and add new assets, just like they did in H1 FY2021, it will come as a benefit to shareholders, as it just did.

The dividend forecasts are as follows:

  • FY21 forecast AFFO of 11.7 cents per unit
  • FY21 forecast DPU of 11.28 cents per unit
  • FY22 forecast DPU of 11.73 (representing 4% increase on FY21).

The performance of RFF, purely as a fund is what is underpinning the dividends. In the past three years, the firm has grown its revenues by an average of 18%. In FY2021, considering the restructure of their portfolio, and the temporary decrease in property revenues, we expect them to grow by a modest 4%. This should also be in line with the guidance provided by the firm. The strong EBITDA margins of over 75% is estimated to be maintained over the foreseeable future.

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Source: RFF

In the above chart, we can see the performance of RFF’s share price has been excellent. Over the last 6 years, the ASX 300 index has returned 75%, while RFF shares have returned 304% – growing at a CAGR of 15.6%. The adjusted NAV growth showcases growing productivity and the gains from development of RFF’s portfolio of assets. The last 6 years reflect a 9.5% CAGR in NAV.

The adjusted funds from operations (AFFO) have grown by 4.3% CAGR – which is above the 4% growth in dividends that the firm has also hit over the same period. This puts RFF is an excellent financial position to continue their dividend policy and continue to grow their dividends.

Following the completion of developments, the AFFO is projected to increase further. Macadamia orchards will underpin income and growth if the value of the lands. Once leases are secured for their new assets, the revenue generation will be boosted. This will further reinforce the already strong dividend policy.

Recommendation

Rural Funds Group is one of the best dividend stocks on the ASX. The firm is restructuring their portfolio which will in turn increase their rental revenue and grow its net asset value. This underpins their dividends, which are set to grow by at least 4% annually. Strong financial health and quality lessees boost already strong characteristics of RFF. We recommend long-term investors to “Buy”.

 

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