Gladstone Land Corporation (LAND) Earnings Call Transcript & Summary

This is the quarterly conference call for Gladstone Land. I want to thank everyone for joining us today; we're grateful you're taking the time to tune into what we have to share. Ahead of kicking off the presentation, Michael LiCalsi is going to speak to us — he serves as our General Counsel and leads Administration. Michael?

Thank you, David. Good morning, everyone. The report we're giving today could contain forward-looking statements made under the Securities Act of 1933 and the Securities Exchange Act of 1934, and those statements cover things like how we expect to perform down the road. Such forward-looking statements carry specific risks and uncertainties, and they rest on our present plans, which we consider reasonable. Numerous factors could make our actual results come out materially differently from any future results those forward-looking statements express or imply, and that includes every risk factor described in our Forms 10-Q, 10-K, and the other filings we make with the SEC. Those documents are available on our website, on the Investors page at gladstoneland.com, as well as on the SEC's site, www.sec.gov. We do not take on any duty to publicly update or revise any of these forward-looking statements, whether because of new information, future events, or anything else, unless the law requires it. Now, today we'll talk about FFO, meaning funds from operations. FFO is a non-GAAP accounting term whose definition is net income, leaving out gains or losses on real estate sales and any impairment losses on property, then adding depreciation and amortization of real estate assets. We also cover Core FFO, which we generally define as FFO, adjusted for certain non-recurring revenues and expenses, and then Adjusted FFO, which takes Core FFO and further adjusts it for certain non-cash items, for instance converting GAAP rents into normalized cash rents. Our view is that these give better indications of how we're operating and permit better comparability for our performance from one period to the next. Please go once more to our website, gladstoneland.com, and sign up for our email notification service. You can also find us on Facebook. For that, the keyword is the Gladstone Companies, and on Twitter we're at @GladstoneComps. This call provides an overview of our results, so please look at our press release and 10-Q, both of which came out yesterday, for more detailed information. With that, I'll hand things back to David Gladstone.

Okay, thanks, Michael. Let me begin by giving a quick look at the farmland we hold. Right now, we own roughly 116,000 acres spread across 169 farms, plus around 45,000 acre feet of water that's banked. That means water sitting in the aquifer that we're able to draw on. An acre foot comes to roughly 326,000 gallons, which means we hold close to 15 billion gallons of water. Taken together, the land and the water carry an estimated value of about $1.6 billion. Our farms sit in 15 states, and even more significantly, across 29 growing regions, with stored water located mostly in California. So as you can tell, our diversification is quite strong. To illustrate that diversification a bit further, more than 90 separate tenant farmers lease our farms, and not one of them is related to us. These tenants are cultivating 60 distinct crop types, though primarily fruits, vegetables, and nuts — the kind of items you'd find in the produce aisle of a supermarket, which is where the bulk of our products get sold. Now let me provide a quick update on certain tenant matters we've been addressing. On one California farm, we continue to farm with assistance from a third-party farm management group. We've been talking with that same group about signing leases rather than simply farming the property on our behalf. I think we're going to get that lease signed and wrapped up, ideally in the near future. On top of that, we had short-term leases on four blueberry properties over in Michigan — about 14 farms altogether — and those expired in October. From then on, we've been running three of those properties, which is 11 farms, with help from outside management companies. As for the fourth property, which covers three farms, it's currently empty. At this time of year, being vacant isn't a problem, because there aren't any strawberries on the, no blueberries on the bushes this season. We're talking with some groups about picking up all of these farms, and we're hopeful a deal can get done before the year is out. Lastly, over the course of the year, two additional tenants fell behind on the rental payments they owed us. We replaced one tenant, and that farm was fully leased as of July 1st, while the other tenant managed to catch up on rents and is no longer behind. The overall year-over-year effect on our operations from the issues I just described amounted to a drop in operating income of roughly $201,000 during the third quarter and approximately $814,000 for the year to date. I suspect much of that gets offset by the fact that we'll have certain properties that actually sell their crops and truly recover some of those, those difficulties we encountered. As we've mentioned during recent quarterly updates, we continue to exercise greater selectivity regarding the properties we consider acquiring, because our capital costs remain significantly elevated. Consider how we finance most of our deals — a primary mortgage that accounts for about 60%-70% of the purchase price. Consequently, our deal flow remains slow, reflecting the substantial increase in those expenses. This situation is evolving, and it will continue to evolve over time. Inflation continues to exceed the Federal Reserve's objective, meaning borrowing costs remain high for us, and that will persist into the foreseeable future, although our past experience with similar cycles tells us conditions will eventually shift. Even so, overall, the land we currently hold continues to perform about as we expected, aside from the matters I noted earlier. There are a few renters facing difficulties, though we consistently resolve those situations. Regarding leasing activity, from the start of this quarter we have renewed and modified 9 leases covering farms located in two separate states, and altogether, they came in as anticipated, producing higher yearly net operating income — roughly $275,000, which is 4.7% greater than what the earlier leases generated. Going forward, 3 leases are set to lapse within the coming six months, and combined, that represents under 5% of our overall annualized lease revenue. Talks are underway with several parties about leasing those farms. On top of that, we're exploring the option of selling one of them, since it sits in a development zone, and we hope to share details with you before this year wraps up. That said, we don't expect any of these farms to sit empty when their current leases expire. In other news, we just signed a water transfer deal with a California water district located nearby, which gives us the ability to buy as much as 15,000 acre feet — that's close to 5 billion gallons — of water each year, running through February 2031. To date, we've acquired roughly 7,000 acre feet of water for 2023, and the total consideration for that came to approximately $1.2 million. We recently finished building some groundwater recharge basins; those basins sit on unfarmed acreage at a couple of our large California properties; this will let us pump water onto those basins so we can store it as it percolates underground for later use on our farms. So when it comes to future water needs, we're in good shape. My guess is this will be a wet year, but who really knows? It's possible we're at the start of a drought lasting five or six years, so we have substantial water reserves available to carry us through whatever challenges arise. With inflation coming down the way it is, the impact of the Fed raising rates is now being experienced throughout the economy; nonetheless, the latest headline inflation number stands at about 3.7%, a level that remains above the 2% goal the Fed has established, and as the Federal Reserve sees it, core inflation has not been moving in the proper direction. We're also seeing signs that food prices are starting to moderate. They rose dramatically after the pandemic, but when we examine them now, we continue to meet or surpass inflation. We think grocery costs are going to continue either keeping pace with inflation or surpassing it once more, and that should provide some relief against the higher operating expenses that a large number of our farmers — the tenant farmers — have been facing. We feel good about the future. With that, I'll stop here and turn it over to Lewis, our CFO, to walk you through the financials in more detail. Lewis?

Okay. Thanks, David, and good morning to all of you. I'll start with a quick review of what we did on the financing side. We took on no new borrowings this quarter, though we've paid back roughly $7 million in loans since the quarter began. Turning to equity, since the start of the quarter we brought in net proceeds of approximately $2 million from selling our Series E preferred stock, plus $1 million from common stock sales made through the ATM program early in the quarter. Now for operations. In the third quarter, net income came to roughly $3.1 million, with a net loss to common shareholders of $3 million, which works out to $0.08 per common share. In the discussion of operations that follows, I'll be comparing the third quarter of 2023 against the matching third quarter of 2022. Adjusted FFO for this quarter was about $5.6 million, or $0.155 per share, versus $7.2 million, or $0.207 per share in the same quarter a year ago. Dividends declared per common share came to $0.139 this quarter, up against $0.137 in the prior year quarter. What mainly drove the drop in FFO was lower revenues year-over-year, combined with higher related party fees and increased financing costs, since proceeds from a portion of those financings have stayed uninvested. Fixed base cash rents fell by roughly $400,000, or 2%, compared with the prior year quarter. The main reasons are a decline in revenues from the self-operated and non-accrual properties, plus a lease we signed in the fourth quarter of 2022 where we lowered the fixed base rent in return for a larger participation rent component in that lease. How much the participation rent component ends up contributing won't be clear until the fourth quarter. Participation rents were also down by about $600,000 versus Q3 of last year; those numbers depend heavily on when the relevant information reaches us, but based on what we've gotten thus far, yields are lower and pricing for last year's crop is weaker. The lower yields were anticipated, given that the trees bear fruit in alternate years, and also because these crops were harvested at the close of a multi-year drought. Pricing remains somewhat depressed because of oversupply, and that's especially the case in the almond market. On expenses, if we exclude reimbursable expenses and certain non-recurring or non-cash items, our core operating expenses rose by roughly $370,000 this quarter compared with last year. The main factor there is an increase in related party fees, specifically a larger incentive fee that our advisor earned during this quarter. Once related party fees are removed, recurring core operating expenses stayed more or less flat versus the prior year quarter. Then, there's the matter of other expenses, which went down, mainly because we paid back loans during the last year, which cut our interest costs. That brings us to net asset value. We own 43 farms, plus our banked water, and all of it was appraised by outside parties during the quarter. On the whole, those appraisals came in roughly $1.1 million higher than the values we had about a year earlier. So as of September 30, the value of our portfolio stood at around $1.6 billion, every bit of which was backed either by third-party appraisals or by purchase prices. Taking those refreshed values, and factoring in the fair value of our debt along with all preferred securities, our net asset value per common share on September 30 came to $20.33. That's an increase from $19.15 on June 30, and also above the $16.56 we saw in Q3 of last year. Most of that shift came from a decline in the fair value of our preferred securities, which the high interest rate environment has been pushing down. Now for liquidity: counting what's available on our lines of credit and other undrawn notes, we can currently tap more than $170 million, plus roughly $155 million in unpledged properties. More than 99.9% of what we've borrowed sits at fixed rates right now, and on a weighted average basis, those rates stay locked at 3.35% for another 4.3 years. Because of that, rising interest rates have barely affected our operating results. As for the debt we're carrying today, we think we're well shielded from any additional rate increases for the foreseeable future. On the subject of debt maturities ahead, roughly $41 million comes due within the next 12 months. That said, around $24 million of it is made up of various loan maturities, and the properties securing those loans are worth a combined $7 million more than when each was acquired, so we don't expect trouble refinancing any of them should we decide to; strip those maturities out, though, and only about $17 million of amortizing principal payments comes due within the next 12 months, which is under 3% of the debt we currently have outstanding. One more thing worth mentioning: our lines of credit with MetLife are set to run out in April of 2024; we're near completing a long-term extension with MetLife on each one, and we're hoping to finish that up in the fourth quarter. Last, on our common distributions, we just lifted our common dividend once more, to $0.0464 per share each month. That makes the 32nd increase to our common dividend across the past 35 quarters, adding up to a 55% rise over that stretch. With that, I'll hand the program back to David.

All right, thanks, Lewis. That was a solid report. We're still staying active in the market if a strong opportunity comes along, though we've grown more careful when it comes to acquisitions. Things are shifting out there. Some owners have started lowering what they're asking for certain farms. With other REITs, that adjustment occurs far faster, but when it comes to land, the property owner can simply keep running the farm and earn a little money. A few more things to add — this is the last point I want to raise — we think putting money into farmland and raising crops that support a healthy way of living, things like fruits, vegetables, and nuts, is in line with a trend visible in today's market. Across nearly every region where we operate, demand for top-quality farmland growing berries and vegetables is holding steady or running strong. In the places where our farms sit now, especially along both coasts, east and west, we're seeing solid gains in value. On the whole, farmland keeps delivering strong results relative to other asset categories. Take the NCREIF Farmland Index — right now it consists of roughly $16.4 billion in agricultural properties — its average yearly return across the past 25 years comes to 11.4%, and it has never posted a down year. That's far superior to the S&P Index and the broader REIT index, since each of those has seen six or more losing years, and during those stretches, if you pulled out, you stood to lose money provided you'd bought in at a particular price. In the farmland index we've seen zero such years, so this demonstrates its resilience, because it's something we can always go out and secure financing against. Plus, the banks we work with are quite eager to lend us additional funds. Naturally, the cost is higher. To wrap up, just keep in mind that buying shares in this company amounts to a long-term commitment to farmland. I look at a stock investment as having two components. It resembles gold. It's a tangible asset. It's farmland. It's soil. It carries intrinsic worth since the supply of quality farmland is finite, and urban developers keep consuming it, particularly in California and Florida, where a great number of our farms happen to be. And the second part: unlike gold, it's an alternative asset, yet it's a productive holding that generates cash flow, with investors receiving money each month. Our view is that it beats a bond fund, since we continually raise the dividend, and that's not something a bond fund does. We anticipate inflation, especially within the food sector, will keep climbing as time goes on, and we anticipate the value of the farmland underneath will rise accordingly. We think this holds particularly true in the fresh produce segment of food, given that the trend of a growing share of people in the U.S. eating healthy foods keeps expanding in that direction. Now, I have a few questions from those who follow us. Operator, could you please join us and assist in hearing a few of these questions?

Morning, everyone. David, aside from those 4 blueberry properties, which other crops fall under the struggling operator farms you mentioned?

Sure — right now there's too much almond supply on the market, so I'd put that in the problematic category. The upside with almonds, though, is that since they're nuts, you can package them and keep them in storage for some time. What we've seen is that almond buying from abroad has dropped a lot, and the only reason I can figure is the price. Still, our view is that this will turn around, and my sense is that happens within the coming year.

Okay.

Go ahead.

Rob, no, no. I was simply going to ask — setting aside that Michigan blueberry matter, I believe you mentioned one in California. At this point, are there any additional markets where problems are coming up?

David, we've got a vineyard that isn't earning what it ought to, so that's the one I'm watching.

All right. How are you all weighing the chance to monetize these assets and what you'd receive from doing that, against simply divesting them, using the cash to pay down borrowings or acquire something different and then move forward?

Yes, that subject comes up every single day around here; consequently, we hold a single property located in Florida; it's a pretty big, big farm. Berries and produce are what it's growing at present, yet the drive toward that sector is going head-to-head with Mexican produce entering the market. Consequently, the majority of produce folks aren't willing to pay that much. So here's what we did: we found a few parties interested in purchasing it. It sits squarely within the path of development in Florida, and someone stands to earn a buku of money, yet when you consider it, we would need to hold it at a negative carry to reach the point where selling it off becomes possible. Certain investors exist who aren't really concerned with income. They simply want to hold it and then sell it to a few of the developers; and so with luck we complete that before the year ends, though perhaps not. In any case, I don't want to land myself in trouble. I've been through this previously, saying that something will occur, but it has progressed. We possess a letter of understanding, though it isn't binding, and right now we're getting the property into shape, so it can be transferred. And I believe it will take place within the next 90 days, without a doubt.

All right, and the final question from me: why does it make sense to purchase additional water right now, considering the current conditions and the fact that your cost of capital is what it is, rather than putting that money toward a farm that generates income?

Sure, a farm that produces income would be great, but not many are available for purchase, since the amount sellers want is far greater than what the cash flows can support. That's true across the whole sector. So this isn't limited to strawberries, blueberries, almonds, or any other crop. Things are extremely pricey out there at the moment. Inflation has pushed up the cost of every input needed to grow, meaning almonds and pistachios cost far more to cultivate now than they did 2 or 3 years back. The people operating our farms and leasing from us can sell and turn a profit, but they aren't earning huge amounts; because of that, once the Fed finishes hiking rates for good and the situation stabilizes, we'll return to a mode where we can pursue those purchases. We're already observing a few farms in California and definitely in Florida listed for sale at reduced prices. And if you're looking to exit now — which, as you may recall, roughly 58, no, 80% of the farms belong to families who want to leave the business or find some way to boost profitability. For us, that's what's propelling everything at present: if you wish to get out, you must accept a lower price than what you'd been hoping for. That will shift within a year or 2, those prices will recover, and they'll sell to us. The financing we rely on will become fashionable once more, and as a result, we'll be operating again. We've already come across 3 or 4 farms listed for sale that we rejected due to excessive pricing, and now they're beginning to lower the price. So I believe we'll be back to purchasing farms within the coming year.

All right. Thank you, folks. I appreciate you making time for us this morning.

All right. Latoya, who do we have after this?

Yeah. Hey, everyone. Appreciate you fielding my questions. Even with the problems on the tenant side, I'd say it was mostly a solid quarter. So just, I suppose, a few fast ones from me. Once more, on the M&A side, you touched briefly on, well, pricing. Any color on, you know, what implied cap rates look like? Is there anything out there that's gotten done, clearly not involving you folks, that you might reference, or simply to give us a feel for where cap rates sit right now?

My sense is cap rates are near 5.5%, possibly above that now, though they need to come back down before we'd step in. That said, certain nonprofits purchase properties purely for an ESG rationale, and profit isn't really their concern, and. They do want profit, but they don't; it isn't the main motivation. So a few of those exist, and I'd say if your goal were paying 8 cap rates, every deal you could want would be available, yet I'm not sure how anyone could ever get financing for that in the current market. So from our standpoint, it's a period of making certain the farms we own remain in solid condition. Right now we're working on a number of these transactions, together with farmers we already have, which will deliver additional income to us on a straight line basis, rather than receiving surplus money at year end and getting paid; so we're trying to smooth everything out and make it function for us. And we're in excellent shape. We hold cash. We could remain afloat for three or four years should that become necessary. Still, my expectation is the market will shift quite dramatically in 2024.

Understood. Understood. Yes, and you're correct — your balance sheet is strong, and there's ample liquidity. Your situation allows you, I suppose, to hold off for a while. Let me probe further into what the tenants are facing. Clearly, they're watching property costs, or simply expenses, rise across the board because of inflation. Financing, as you're aware, becomes harder, and then you brought up something like too much almond supply. So where do you think most of these problems are coming from? Is it truly about supply and demand? Is it the inflation angle? Actually, the real question is: what would give them the most relief? Would it be inflation easing, or more of a rebalancing in the specific crop they grow? Two of your tenants got behind. As I recall, you managed to swap one out, I believe you mentioned, on a higher lease — higher lease income — and the second one eventually got current. Using that second tenant as an illustration, what shifted for them? Does that follow?

Well, they likely regained control over every one of their costs and restructured how they operate. The hard part about selling to the buyers we deal with — the grocery stores — since that's where the bulk of our goods wind up, is that those grocery stores aren't handing along the full amount. They're holding onto a big chunk; as a result, we aren't receiving improved pricing on our almonds, pistachios, and strawberries. Our returns are solid, but if we could get beyond the markup being applied by Safeway and the rest, our situation would improve. Everything shifts once grocery stores figure out they need us more than just about anyone else, since they must have goods on shelves, and then you'll witness a change in the marketplace. As for the tenant who got current, they're skilled growers, but they simply had a bad year, so their position now is stronger than it was when they quit paying or requested we accrue something rather than receive cash; naturally, our business involves paying dividends, and that's our expense, if you look at it that way; so we treat this as merely another bump in the market, and with luck, within the next 30 to 90 days, the situation will improve. I realize folks are taken aback by what's happening with interest rates in the market, but this isn't new. My first mortgage carried a rate of about 7.8%; and naturally, rates have returned to that level now, yet it won't persist, and I believe many people are simply moving forward and paying 7% or 8% on mortgages. And honestly, I figure within 12 months, they'll be able to refinance at a better rate. All of that is taking place right now. I believe the majority of farmers working today are sitting in a solid position regarding their place in the market and the buyers they deal with. That's just how it is. Things get difficult from time to time, and folks run into those issues. One situation we're facing — the farmer passed away; this marks roughly the third instance of that happening for us — and the woman attempting to keep things going alongside her son isn't anywhere near as strong as she and the farmer used to be. We're cooperating with her, though we'll likely locate someone different to assume control of that farm, should she wish for that. My worry is she'll sink too far into it, so we've been attempting to cooperate with her. There's no single thing that will solve everything — except that interest rates are simply too elevated. Yet markets shift, and everyone is aware that corn and wheat are expensive commodities right now due to the conflict in Ukraine, which is a major producer, plus the droughts that occurred in Brazil and Argentina. So those crops are riding high, and folks are forking over large sums for them. We endured 6 years where the opposite was true, when you practically couldn't give away certain corn farms; but I believe over the long haul, everything sorts itself out for everyone in agriculture. You heard Lewis mention our net asset value keeps progressing, and I simply believe the farmland portion of the business will never hit zero. It might decline or climb, based on what's happening in the market, but it will never resemble 1929, when crops couldn't be grown since there was no water. Nowadays, in California, we might drill down 1,000 feet for water, or we bank our water — that means placing it into the aquifer to draw out later when it's needed. And this rise or fall in water demand will continue in California for as long as California is around. There's simply no possibility of one extended stretch where we have every drop of water we require out there. That's the reason we're banking. We're likely well banked for the coming 2 years. I'd say this year, the one arriving in summer 2024. We're in exceptionally strong shape on that front, and it'll decrease as we consume the water, and ideally we won't need to consume any water. That would simply mean we're in stronger shape moving ahead. I don't know, Mike, it's tough to comprehend this business, since we resemble the weatherman you watch on TV. His odds of getting it correct are 50/50, and that roughly matches our situation, yet over the long run, we perform well.

Of course. Yeah, there are certainly plenty of shifting components at play, and I think, you know, how quickly rates went up has left, you know, quite a few of you folks scrambling. Just a couple more from me. I'd like to revisit, you know, I suppose, the topic of pricing, especially for items such as blueberries, almonds, strawberries, that kind of thing. I mean, you've seen several cycles at this point. What's the likelihood that, I guess, supermarkets will essentially let you begin shifting some of those expenses along? You know, is it

Well, we are.

When it comes to the grocers, do they basically have the upper hand in that situation? Is this something consumers are driving? From what you've observed previously, what stands out?

A grocery store needs to stock produce, and if produce is available at a cheaper price, they will choose the cheaper option, unless it's an upscale grocery store, in which case you want the finest berries available and you're prepared to pay for them. As for us, I believe we're currently midway through the cycle, and eventually the grocery stores will recognize they need to pay more, and they will; however, grocery stores are profitable today, and they likely always will be since people have to eat. Consequently, grocery stores will remain destinations people visit. We aren't in the locations that are harder to protect, such as, for instance, some of the spots where people purchase groceries at smaller shops and also the standalone locations. You can obtain favorable pricing if you visit the right grocery stores. One thing all our people understand is that if you commit to supplying a grocery store with strawberries on Monday when shoppers come, you must deliver, because they rely on you; they don't keep extra strawberries in the back or anything like that. Therefore, a symbiotic relationship exists between the two parties, and they will do well, and we will do well.

Right.

Every one of our growers is familiar with those supermarket chains. Back when I owned a farm in that area, I recall inviting folks from Kroger's or Safeway over, yet we couldn't really host them properly since company policies prevented their purchasing staff from accepting gifts or benefits from suppliers. Still, things evolve, and they're going to need the items we produce. Take us — we have 60 items, and the majority sit at the store's front, in the produce area, which means they sell quickly, and they must sell quickly since there's only so much time a strawberry or a salad can stay on a shelf. So because of that, we'll do just fine. Folks will want food, and they'll head to the supermarket to purchase it, and that's the space where we lead. Our growers are present there, and; however, I can't predict what will occur with those supermarkets. I'm no specialist in grocery retail, and my view is that if supply is abundant, prices will drop. If supply is tight, prices will rise; that's true for any item and any area. If you're cultivating strawberries in Michigan, you fetched a strong price in the prior year. Every one of those folks earned quite a bit. Will they do the same in the coming year? I have no idea. I doubt anyone does, since you can't predict how many strawberries Michigan will yield in the coming year.

Understood. Thanks. My apologies — please continue.