Rural Funds Group (RFF) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the presentation of the financial results of the Rural Funds Group, or RFF, for the 12-month period ended June 30, 2020. This is James Powell speaking. Presenting today from Rural Funds management, the manager of RFF, will be David Bryant, Tim Sheridan, and Daniel Yap. Shortly, I will hand over to Tim Sheridan to present the financial results and capital management sections, after which David Bryant will provide a portfolio update, forecasts and conclusion. [Operator Instructions] Thank you, Tim?

Good morning, ladies and gentlemen. This is Tim Sheridan speaking. This will be a great pleasure that I present to you the financial results for the Rural Funds Group, in what has been in an eventful, but successful year. As you can see, the first page of the financial results section lists the key activities conducted by RFM on behalf of the Rural Funds Group from July 2019 to present. As noted in the top left of this page and in the adjacent chart, RFF sold 17 poultry farms in December 2019. As has been previously articulated, the decision was made to sell these assets and recycle capital into higher returning assets. RFF also sold unleased groundwater to capitalize on higher trading prices. The majority of the capital realized from the disposal of these assets has been redeployed during the year into development productivity CapEx across the portfolio and the acquisition of 8 cattle properties for $68 million. Investments in the cattle sector has been a focus of RFM since 2016. During this period, cattle properties have continued to trade at higher prices, which has benefited RFF, including in FY '20. This year, 5 cattle properties have been independently revalued, collectively increasing by $14.3 million. The higher valuations reflects a combination of improved sector fundamentals and productivity improvements on the RFF assets. Moving down the left-hand side of the page, independent valuations were also conducted on almond orchards, macadamia orchards and unleased water entitlements, resulting in a combined valuation increase of $40.7 million. Similar to the cattle sector, almond orchards, too, are in high demand in Australia, which in turn has increased the value at which these assets are trading, and therefore, their independent valuation. Capital expenditure of $16.5 million for developments and productivity improvements were deployed on many of the assets across the portfolio, providing both immediate and long-term benefits to the group's earnings. As a result of these assets, adjusted property assets totaled $990 million as at June 30, 2020. Further to this, RFM, as previously indicated, our intention to make further investments into the macadamia sector. This month, RFM announced the contracted acquisition of a portfolio of cropping farms and water entitlements, suitable for the development to macadamias in Maryborough, Queensland. David Bryant will provide more information on this strategy later in the presentation. And finally, late yesterday, RFM announced that RFF had entered into conditional contracts for the sale of the Mooral almond orchard, which when completed, will provide a material gain for the sale of this asset and funding for acquisitions. These transactions are shown as a pro forma to the June 30 adjusted property asset value. I will now take you through the financial impact of the key activities on the FY '20 results. Page 6 of the presentation provides summaries of RFF's income, earnings and balance sheet for the year ended June 2020 compared to the prior 12-month period. Property revenue increased by $5.6 million, or 8%. This was driven by additional income from the JBS feedlot leases and increase in the J&F guarantee fee and other cattle property acquisitions. Total comprehensive income and earnings per unit increased by over 80% for the period, largely due to the independent valuations of cattle properties, almond and macadamia orchards and unleased water entitlements. Adjusted funds from operations, or AFFO, is a measure of cash earnings generated by the group net of expenses. FY '20, AFFO was $0.135 per unit, which was in line with the forecast. A key goal of RFF is to invest for the long-term AFFO growth to sustain distribution growth of 4% per annum. Distributions totaling $0.1085 per unit were paid in FY '20. This was consistent with prior forecasts and represented a 4% increase on the prior year, and therefore, consistent with our strategy. The payout ratio, which is the amount of AFFO paid out as distributions was 80%. Whilst this is pleasing, as it shows ample coverage of investor distributions, it is important to note that RFM does not target a certain payout ratio. Indeed, the payout ratio will change year-on-year as assets with differing income and growth profiles are brought and/or sold. However, in making these investment decisions, RFM is managing the portfolio to fund long-term distribution growth. The second table on this page presents a summarized balance sheet. Adjusted total assets increased by $66.8 million, or 7%, through a combination of increased independent valuations and acquisitions. The adjusted net asset value per unit increased 8% to $1.94 per unit. Gearing at the end of the period was 29.7% and is below the target range of 30% to 35%. Pages 17 to 22 in the appendices contain additional detail on the financial results and independent valuations of all assets. I will now move on to the capital management of RFF during FY '20. As noted on this page, no equity was raised during FY '20. The chart below shows the total return for RFF investors with dividends reinvested from July 2014 to present compared to the ASX300 A-REIT index. Around 18% of investors take advantage of the DRP facility and the 1.5% discount that is offered. During the period, RFM commenced discussions with RFF financiers to refinance the proportion of the facility due to expire in FY '22. RFM expects to complete these negotiations by the end of the calendar year. The debt facility has also been approved for an increase to fund the Maryborough property acquisition in the event the almond orchard is not sold. The next page of the presentation presents details on the debt facility as at June 30. At year-end, the debt facility had a headroom of $38 million. The loan-to-value ratio, or LVR, at June 30 is 39%, well within the 50% limit. The cost of debt funding and inclusive of the costs associated with the interest rate hedges for FY '20 was 3.7%, an ongoing reduction on prior years. 62% of RFF's debt is hedged for an average period of 8 years, and the 5-year hedging position of RFF is shown on the bottom of this page. A pro forma has been included on this page to show the impact of the Mooral transaction yet to occur -- the Mooral transactions and the Maryborough acquisition, which is yet to occur. I'll now hand over to David Bryant to provide an update on this and other portfolio matters for the group. Thank you.

Good morning, ladies and gentlemen, this is David Bryant speaking. Before I move on to the next section of the presentation, I'll pause on this page of -- on this image of a mature macadamia orchard owned by the Rural Funds Group and managed by RFM. The harvester in this picture taken last week is collecting mature macadamias for what will be a record crop yield for these orchards. RFF first acquired macadamia orchards in 2016, and RFM have been managing them since. As part of the acquisition, RFM employed the management team, which developed these assets in 2006 and '07, so 13 years ago. These talented people added to our existing horticultural team that have developed some of the world's largest almond orchards and the vineyards shown in pictures earlier in this presentation. It's this extensive development and operating knowledge, which provides the skills to pursue the next phase of investment activity for the Rural Funds Group, and that is a material expansion in the macadamia sector. During financial year '20, RFM purchased 2 sugarcane farms and the macadamia tree nursery in Bundaberg. Developments have commenced on these assets. That is converting the cane farms to macadamia orchards and expanding the capacity of the nursery. The nursery will play a crucial role to the overall development by supplying uniform and high-quality planting material in a timely manner. More recently, RFM announced that RFF has contracted to acquire 21 cropping farms and substantial water entitlements in Maryborough. RFM expects the first plantings of macadamias on these assets will occur on some of these assets as early as autumn of the next calendar year. 3 cattle properties located near Rockhampton in Central Queensland have also been acquired in FY '20. These properties and another acquired previously, all have frontage to the Fitzroy River, and it is expected that sections of these properties will be developed to macadamias in time. Collectively, these acquisitions provide the natural resources, being fertile soils and access to water, which will support the future development of up to 5,000 hectares of -- or approximately $500 million of developments over time. This is around the same size the almond orchards owned and developed by RFF. As the orchards are developed, it is expected the Rural Funds Group will benefit from higher lease income and development gains as the assets are converted to higher and better use. Evidence of the success of this strategy is Mooral, an almond orchard, which was developed by RFM in 2006. In April of this year, RFM decided to test the market for Mooral, knowing that it is a very good asset with a history of high-yielding crops. As announced today, RFF has exchanged conditional contracts on this asset, which, if completed, will result in a 25% gain on the current book value of the asset. A key reason for the premium to book value is the fact that the orchard will be sold without the current lease encumbrance on 3 quarters of the orchard that was put in place 14 years ago. The motivation for selling Mooral is to fund macadamia developments on assets acquired at lower prices. If completed, the sale will create and unlock equity from a fully developed asset to be reinvested in the development of new projects, where land and water present considerable value. Adjusting for the acquisitions described in the presentation, RFF's pro forma gearing will fall to 28%, providing balance sheet capacity to commence the developments. As these developments are rolled out and the assets are leased, this is likely to increase RFF's weighted average lease expiry, provide higher AFFO growth and improve RFF's diversification by investing in a very good industry, an industry in which Australia is globally competitive and which RFM has detailed knowledge. The initiative of selling poultry assets, unencumbered water entitlements and potentially the Mooral almond orchard are examples of RFM's focus on seeking higher returns for RFF's unitholders equity. As capital is recycled, along the spectrum of agricultural investment opportunities, the level of AFFO generation year-on-year will vary. With that, I will turn to FY '21 forecasts. While plantings commence and lessee discussions continue, the Maryborough farms are expected to be leased as cropping operations, such as sugar and annual crops. Similarly, the Rockhampton properties are expected to be leased as cattle and cropping farms prior to the conversion of sections of these assets. During this transitional period, lease income will be lower. Consequently, RFF's FY '21 AFFO forecast is -- will reduce to $0.117 per unit. The reason for the reduction is that following the sale of the poultry farms and now probably Mooral, we will have sold nearly $175 million of mature high-yielding assets to reinvest in initially low-yielding natural resources. In time, though, as macadamia orchards are developed and leased, it is expected that we will achieve even greater income than if we had done nothing. Importantly, for unitholders, while this transition is occurring, RFM today confirms forecast FY distributions of $0.1128 per unit, in line with our 4% growth target. As the chart on the right of this page illustrates, RFF's AFFO and therefore payout ratio fluctuates from year-to-year as investments are required and developed. The chart also demonstrates that this approach has been highly successful as evidenced by the consistent increase in distributions. To conclude, in summary, the period ended June 30, 2020, has delivered a very positive set of results, with material property revenue growth, numerous positive independent revaluations, and AFFO and distribution forecasts achieved. During financial year 2021, RFM will be working to redeploy capital to higher and better use developments designed to achieve greater income growth over the long term. RFM will increase the Maryborough and Rockhampton -- sorry, RFM will lease the Maryborough and Rockhampton properties to lift revenue prior to macadamia orchard development. And we will work on the macadamia orchard developments and seeking lessees. While this occurs, existing earnings are well supported by a diverse portfolio of assets, leased by predominantly corporate or listed entities for a weighted average lease expiry of over a decade. Finally, RFF is assisted by RFM, a manager with 23 years of agricultural operating experience and a track record of delivering distribution growth and improved value for RFF unitholders. The appendices provide more information on the results, assets and lessees, which you might find useful. Some of the highlights of these metrics are presented on the right-hand side of this page. I'd now like to invite questions from participants.

JBS lessee, which leases our feedlots and to which we provide a cattle facility. And the question is, is regarding the impacts of drought and COVID and export markets on that business. And has there been any financial impact on the Rural Funds Group? And the answer is, no. These are leases that have consistent income. The JBS lessee is a fantastic lessee for RFF. It's a global business there -- in an industry that has seasonal impacts from changes in seasons, but this business is diversified globally. So Australia is a small part of their business. But because they're in an industry that sees this regularly, they have an excellent management team that will manage or do manage through these fluctuations -- normal fluctuations in the business. They've also been managing their COVID issues professionally and diligently, and continue to have excellent access to markets for their -- for the output from their business. And they remain an excellent tenant and a consistent tenant for RFF, and we're very pleased to be in partnership with them. So next question. There's a question there. This is a little bit local and specific to the Bundaberg region. There is a dam there that is having some engineering works done to it, which has reduced its capacity. And the question is, will it reduce -- have any impact on the RFF assets? And to which the answer is no. And we've targeted new assets that aren't exposed to that particular issue that's occurring for others naturally. It's a very good question about exposure to China. What is the exposure to China in the macadamia export market? China import quite a lot of macadamias. They're also planting a lot there themselves. The consumption of tree nuts in China is really significant, not just because of the population, but just because -- well, also because of their culture and nature of their diets or the makeup of their diets, I should say. Interesting example is walnuts. China went from being a small producer back in the 70s to now producing, I think, nearly 90% of the world's walnuts, but they are the world's biggest walnut consumer and importer. So they still are the world's biggest importer. They consume a lot of tree nuts and would consume more macadamias if they can get hold of them, as is the rest of the world. Having said that, the biggest market for Australian macadamias is the U.S. And there is really significant demand from Europe and plenty of places that want to see the increased availability of the product. Macadamias have actually -- they have less than 2% of the world tree nut market, and that's actually been declining as the other nuts have increased their production and macadamias have increased, but less so. So there's some really sound supply and demand fundamentals for this only commercialized Australian botanical species. And so we have a great deal of optimism for the future of the industry as to many of the senior people that we've spoken to within this industry and the wider tree nut industry. Okay. We've got a question that will come in by voice. Now James Ferrier has raised hand. So I'll just hand over to you now, James?

Can I, first of all ask...

James, if you can hear me. I think we're having the inevitable technical issue of unmuting you. So you'll have to remain mute for a moment, while we look for other questions, and I'll come back to you. There's a series of questions here regarding the Chinese trade relationship and whether we see problems emerging with that. It's really clear that there's difficulties. One of our key tenant, Treasury Wine Estates, has been in the press recently with their success in the Chinese market is now possibly a risk for them. I think what -- it's important to understand that, largely speaking, what we own are natural resources that produce commodities; and China is one of many, many markets for those commodities. It differs from some of the other commodities, such as some of the metals or -- where China is actually the market for those commodities. China, in the case of agriculture, is one of many. It's a market that we really do wish to want to continue to service or to provide food to that nation. And I think that the opportunity to continue to provide high-quality and clean and green Australian food into that market will endure because of the demand of the population. But there will, from time-to-time, be volatility, and volatility that will be managed by Australian agri business' global reputation as a consistent safe provider of food. So it's something that we will see our lessees manage through and ride through, and we don't see it as a great risk to our business because the volatility that might [Audio Gap] our lease arrangements, which is the design of the business in the first place. Another question here. Any COVID-related border closures, seasonal worker issues for the RFF tenants? Nothing major that has been brought to our attention because they're all being managed. We're really quite comfortable with the way our lessees businesses are managed. And for our part, we have been largely been able to travel to destinations, for example, continuing the macadamia developments, acquisition of properties, the Maryborough transaction, all of those have been really significant transactions, which have required people on the ground and we've been able to do that. Another question there, the implications of the Mooral sale price for valuations on the other RFF almond orchards. I don't think that there's any great implications for the reasons I alluded to earlier. The orchards that RFF owns are leased for very long periods at predetermined rates. I think the valuations adequately capture those -- the current market value taking into account lease encumbrance and other factors. So we feel really quite confident and comfortable that our accounts are a very accurate reflection of the valuation of what we own. Okay. Now I think we'll try one more time to switch over to you, James Ferrier. So I'll just give you a queue when you come off mute. And you should be now, so speak, or forever, hold your peace.

Am I coming through clearly?

You are. Thanks, James.

Okay. Great. Thanks for your time this morning. The first question is in relation to some of the cattle properties. In the past few results, there's been some revaluation gains booked there, driven by productivity improvements. I know you focused your comments around the portfolio today in relation to macadamias. But could you just touch briefly on the revaluation gains in the cattle property segment in this result and some of the drivers there?

Yes, James, it's Tim speaking. In relation to the cattle properties, the valuations we got this period, it's really a combination. So we've seen the dollars per AE increase quite significantly. But we've also seen a portion -- the amount of AE we are able to carry on those properties increase. So I think I'm -- just to broadly summarize, I think it's probably 50-50, 50% to a shift in the market value and 50% due to an increase in the productivity of the assets.

And it's David here again, James, and ladies and gentlemen. So those assets that I highlighted at Rockhampton, they're located along the river, there is really big opportunities there for further productivity increases on those assets. They have access to water. We're investigating the installation of further irrigation on the Comanche property that we've owned for a couple of years now. There are actually center pivot irrigators going onto that farm, as we speak. And that will increase the reliability and quantity and quality of grass production in those areas. That will increase productivity, and we think that we can roll that out along the river as we access additional water entitlements. And with the balance of the cattle properties in the portfolio, there is still more productivity improvements that can be gained, and we'll keep working at that. We've got segments of the RFM team that are dedicated to that, whilst others are chipping away at the macadamia project.

And another question for me, if I may. You talked quite a bit about the macadamia development time frame and locations and assets, et cetera. On the tenant front, how well progressed are you in identifying a tenant or tenants plural for that asset?

Naturally, not as progressed as I'd like to be, which would be to have dry ink on leases. But -- and look, really, that's going to take time. We've got discussions going with 4 different parties at this age, and we think there might be others. And one thing we have is time because we can continue to meet our objectives for distributions, gearing and so forth at -- providing we lease out the Maryborough properties for cane and cropping, and the Rockhampton properties for cattle and cropping, we think we will have those assets leased out for those purposes well within the next 3 to 6 months. In the case of Maryborough, probably by the end of October, when the transaction settles. That will increase FFO. And then moving on to the macadamia developments, will take time to obtain the lessees, just as it takes time to execute the developments. But we'll use that time to get the best lessees and to get the right deal for the long term. And providing we use that time, it will set this business up, RFF, beautifully with a really substantial bunch of assets leased for very long periods because of the nature of these trees, their long-life, their long-term ability to produce higher yields. So this is a -- I was laboring the point somewhat, but this is a long-term investment decision, and we're really excited by it and looking forward to signing up those lessees when the moment and opportunity is right. Now we've got another question that will come in via voice from Jonathan Snape. And Jonathan, I'll let you know when we -- we've got you unmuted now. So a way you go.

Can you hear me okay?

We can. Thanks.

Great. Look, just 2 questions, if I can. One, around the AFFO guidance in 2021 and the assumptions, particularly on the cropping properties. If I look at the year-on-year uplift in rental revenue, I think you highlighted in the slide deck, it's only about $600,000. And obviously, you put about $81 million -- you're looking at putting about $81 million into these properties. Can you just touch on, have you -- when you formulated that '21 guidance, have you assumed really only leasing the 25% that's under lease that I think was referred back to in the early August, October announcement?

I'll give this one to Tim, Jonathan.

Yes, Jonathan. Yes, that's correct. We've assumed -- the AFFO has only assumed 20% -- or 25% are leased out. Hopefully, when we get to settlement, we'll have all of the portfolio leased out, but we're only assuming the guidance 20%.

Okay. So if you were have speaking hypothetically, annualize that rate and lease that or those properties, it would probably be another $2 million-odd worth of rental income?

Yes, that's right. So yes, in relation to both Maryborough and the Fitzroy, we think we can lease it out in line with the natural resource rates that we've shown previously. But keep in mind, these properties aren't setting until later this calendar year. So if you annualize it, it would be pretty awesome.

Yes. No, that's great. And I just wanted to follow up one other one on the Mooral sale, if I can. I think the headline number was $98 million. You've put out book value, including the PPEs, about, I think, $80 million. And you've mentioned the crop prices are in there as well, which I think when I went back and looked at some of the documents for RFM almonds, it was about $10 million. So that $98 million number, does that include the $10 million of crop rights that would be paid out to the RFM almond holders?

No, no, it doesn't. So the $98 million will be paid to RFF.

Okay. So there's the additional component on top of that to the crop price?

Yes, that's right. There's additional payments, which may be in the form of crop revenue that's sitting in warehouses for the almond growers or payments for operating expenses, but they are separate payments. RFF will receive the $98 million.

We have a couple of other questions. There's a couple of questions regarding the short sellers. Do I have any updates? And are we in position to resist another short selling excess? I said, there's no real update. We think that, that's well behind us now. The RFF has been -- has had the benefit now of substantial scrutiny and has stood the test. And I think we've just about seen a full recovery in the share price. In the meantime, though, we've been busy with investment activity that will actually further improve the strength and the earnings of the business, and in terms of resisting short sellers. That's the best thing that one can do is make good investments and pay distributions. And so if they are the criteria, the answer is yes. Okay, Pat. Pat Barrett, you can talk now, you're unmuted.

Sorry, Sorry, it's Winston, okay, my apologies. Well done to you and the team on the results. I just have a question about the water rights and the value of water rights, given that there's been a reasonable amount of rain around the place. What has that done to water pricing?

Yes. Thanks, Winston. So typically, what you see is -- so the spot market or the market for the annual right to take -- to use that water, that declines and has declined for this year. And -- but the actual -- the permanent ownership of the entitlement, so in other words, I suppose, by way of comparison, the property [ of crop ] ownership to have that water each year, those values have remained stable. They're still very strong or very high. And so I think we've seen our water entitlements go up in value this year. We've got forward sales on a large component of the water that is not subject to a lease. So we're expecting quite stable earnings from our water entitlements this year and stable values on the underlying assets. All right. I think we're getting -- there's a couple of questions here, just about other export markets and things like that. Whether -- is RFF exploring new markets in India? Or do we produce organic products? I suppose just to remind investors that RFF is a REIT, and we don't produce commodities. We lease them out to lessees. Some of those lessees have large markets in India. And in fact, it's been commented that the market opportunities for macadamias into India are enormous. There's no -- in relation to organic products, there's no organic products produced on the RFF funds to my knowledge, none of our -- it's not a strategy that we have in seeking to acquire assets with organic certification. We'd never say never, but it's just not something in the portfolio at the moment. Another question about Vineyard Holdings and see whether there's any -- is there opportunity there for above-average income or capital growth given very little CapEx? I think that, that industry is going to remain probably to be a bit flat. But our assets are positioned at the very top end of wine production. Treasury Wine Estates, who have magnificent wines at magnificent prices, has been very successful in building those brands on the back of high-quality fruit coming from vineyards, such as the RFF vineyards. And we're a key component of that strategy. And that's the area of the industry that we want to be positioned in. We have a question now from Paul Spear that will come via voice. And Paul, you've been taken off mute. So please speak. Okay. So just -- Paul, we might return to you given -- see if we can give it another go. But I'll just have a question here by Larry Schlesinger. Good morning, Larry. What other high-yielding asset classes is RFF seeking exposure to? None at present. We're very, very, very focused on delivering these macadamia developments and all of the components of that, which is leasing them out for sugarcane and cropping, leasing the cattle properties out for cattle and cropping, improving those assets, productivity in those where they remain in that and then taking sections of those properties and converting them to macadamias. So it's a combination of increasing productivity and higher and better use, and that's our focus. And we have eyes for no other at present. Another question, do you see -- foresee any competitive challenges against the increase in foreign ownership of Australian farming land? So Australia remains open for foreign ownership of farming land. It's -- they do not dominate farm ownership for foreign investors, but it has increased significantly and particularly in the logically institutional scale end of the market, and our Mooral transaction is a real classic example of that. The -- and we don't make government policy. We just simply observe and react. And we, at the moment, feel that it's been part of Australia's history that foreign investors corporatized largely or institutionalized foreign investors have sought ownership of Australian farmland, and they have invested in Australian assets, developed them and improved them. And so we think that Australia continues to need to do that. And we will continue to conduct our business with that in mind because I don't see that there will be any large change in what has in effect been a 200-year-old government policy. Look that's -- I think that's about the end of the questions today. So thank you all very much for attending, and we look forward to presenting you the half yearly accounts or speaking to you sooner if you have a question or if the opportunity allows. Thank you very much, everybody. Goodbye.