Rural Funds Group A Low Risk Agriculture Play

This story features RURAL FUNDS GROUP, and other companies. For more info SHARE ANALYSIS: RFF

-Attractive distribution yield
-Strong upside from Tocabil
-Scope for acquisitions
 

By Eva Brocklehurst

Rural Funds Group ((RFF)), an agricultural real estate trust, offers exposure to agricultural assets with minimal operating risk. The portfolio comprises almond orchards, poultry and vineyards, with water entitlements attached to each asset. The stapled security comprises $250m in established assets, underpinned by tenant covenants, and is externally managed by Rural Funds Management (RFM).

Moelis observes the security’s forward distribution yield is an attractive 7.9% and distributions are expected to grow organically at around 3.0%, given the terms of the leases. There remains scope for acquisitions as well, given a history of acquiring and developing agricultural assets. Moelis notes the stock offers investors visible earnings, strong yield and exposure to Australia’s agricultural sector. These features inspire the broker to initiate coverage with a Buy rating and target of $1.28.

Distributions in FY15 are expected to be 8.6c per security, rising to 8.9c in FY16, paid quarterly. The group is expected to deliver around 9.0c in earnings per security in FY15 following the $15m equity raising in March associated with the Tocabil development. Tocabil almond orchard was acquired last year for $5.2m. The tenant is Olam Orchards Australia, a subsidiary of the second largest almond grower globally, and the only supplier with production in both Australia and California.

There are limited capex requirements as Rural Funds Group employs a relatively standard lease structure. A stable income stream is expected from long-term leases to the likes of Olam, Treasury Wine Estates ((TWE)), Select Harvests ((SHV)) and RFM Poultry. Asset value is primarily concentrated on almond orchards and poultry infrastructure. Vineyards contribute around 16% with other areas relating to plant, cropping, grazing and livestock leasing.

Upside is expected to come first from the Tocabil acquisition which should, coupled with market rent review for two assets, deliver income growth of 18% in FY17 based on FY16 estimates. Moelis expects compression in cap rates – the ratio of asset value to producing income – in this segment, similar to what has happened in other non-traditional real estimate segments such as child care, caravan parks, self storage and data centres.

Downside risks centres on animal welfare standards, where the poultry tenant may be subject to making improvements which will come at a cost. There is also a risk of suspension events under the terms of chicken growing contracts. Under the terms of the lease any reduction in grower fee revenue relating to a suspension will result in a proportional reduction in the rent payable. Other risks include declines in asset values and natural disasters. Water availability is also a risk. Pursuant to the terms of the leases, Rural Funds Group is required to supply water from alternative sources for the orchards and vineyards where there is a reduction in entitlements attached to the asset.

The group owns 1,800 hectares of almonds at Hillston, NSW, supported by 27,210ml of ground water licence and irrigation infrastructure. Select Harvests leases 1,200 hectares with the remainder leased by RFM managed investment schemes. The weighted average lease expiry of the orchards is 14.1 years. The other mainstay, poultry, comprises 17 farms in NSW independently valued at $97.1m. The lessee is required to undertake maintenance with the group limited in its operating responsibility as the sheds are rented on a floor space basis, not a throughput basis. The sheds are leased to RFM Poultry, which has a long-term growth contract with Baiada, one of the largest processors of chicken in Australia.

At present Rural Funds Group has $152m in investment property, $67m in biological assets such as orchards and vineyards and $26m in water entitlements on its balance sheet.
 

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