Rural Funds Group (RFF) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and thank you for standing by. Further to the disclosures lodged on the Australian Securities Exchange this morning, welcome to the Rural Funds Group financial results presentation for the half year ended 31 December 2020. My name is James Powell. I'm joined today by David Bryant, Managing Director; Tim Sheridan, Chief Operating Officer; and Daniel Yap, Chief Financial Officer. [Operator Instructions] Please also be advised that the webinar including Q&A will be recorded. I'll now hand over to the first speaker, Tim Sheridan. Tim, please go ahead.

Thank you, James, and good morning, all. I'll now commence with an overview of the half year '21 financial results. Last year, RFM outlined a strategy to develop 5,000 hectares in macadamia orchards over a 5-year period in Central Queensland. The Mary River pictured here provides irrigation water to properties acquired in Maryborough as part of this strategy, which I'll now discuss further. As described on the left-hand side of this page, during the half year, RFM secured a number of assets for the macadamia orchard development program. In November 2020, RFF acquired over 5,000 hectares of land, currently sugarcane farms and water entitlements located in Maryborough. Throughout calendar year 2020, the fund acquired 5 properties with access to the Fitzroy River, West of Rockhampton. And in December 2020, RFF entered into contracts to acquire 21,600 megaliters of water entitlements that will be available from the Fitzroy River upon completion of the Rookwood Weir, which is estimated to occur in 2023. With the benefits of these natural resources, RFM has begun the development of 500 hectares of macadamia orchards in the current calendar year. The initial acquisitions and development costs will be funded in part by the proceeds from the sale of the Mooral almond orchard that was completed in December 2020. From January 2021, the group's guarantee provided 2 JBS for cattle housed in feedlots, which JBS leased from RFF, will be increased by $17.4 million. This increase will provide additional revenue to the fund. During the period, no rent relief has been requested by lessees as a result of the COVID-19 pandemic. As stated in the final bullet point of this slide, RFM confirms the full year AFFO and distribution forecast. In addition, RFM has today announced FY '22 forecast distributions of $0.1173 per unit, an increase of 4%, in line with RFF's distribution growth target. Page 6 of the presentation details the property transactions just described. The green bar on the left-hand side of the chart shows the disposal of the Mooral almond orchard. The adjacent gray, blue and light green bars illustrate acquisitions of cropping properties being the Maryborough sugarcane farms, cattle properties and properties earmarked for the development of macadamia orchards in the near term. Additionally, capital expenditure and revaluations are also factored into this chart. Notably, during the period, an independent valuation increase of $7.1 million was recorded for the cattle property, Rewan. The bar on the far right of the chart shows that adjusted total property assets at the end of December totaled over $1 billion as a result of these movements. Page 7 of the presentation details income, earnings and balance sheet metrics for the group at the end of the period. Consistent with prior forecasts, RFF recorded a reduction in property income during the half as a consequence of recycling capital, primarily from the sale of the poultry assets into the macadamia developments. The macadamia developments are expected to add to property income in future years. Earnings of $0.173 per unit were generated during the half, representing a 94% increase compared to the prior period. The higher earnings were driven primarily by the gain from the sale of Mooral. As footnoted on this page, for taxation purposes, the capital gain as a result of the sale has been partly attributed to the December 2020 distributions with the remainder expected to be attributed to the remaining FY '21 distributions. The adjusted net asset value of RFF units increased by 4% to $2.01 per unit as at 31 December. Gearing remains at the lower end of the target range at 30.2%. The cash generated by the group, which is measured by adjusted funds from operations of $0.066 per unit is on track with full year forecasts. So too are distributions. RFM is pleased to confirm current full year forecast AFFO of $0.117 per unit and distributions of $0.1128 per unit. Finally, FY '22 forecast distributions of $0.1173 per unit are announced today. Looking now at the debt facility and interest rate hedges. As included on the previous 2 pages, the assets of RFF now total over $1 billion, which has necessitated a larger debt facility, being $380 million at the end of the period. As at 31 December, 57% of debt was hedged. Therefore, falling interest rates continued to benefit RFF's debt funding costs. The total cost of debt was 3.2% for 6 months ended December, down from 3.7% for the prior period. Finally, the tenor of the debt facility was recently extended with a future expansion of the facility likely as the macadamia developments progress. I'll now hand over to David Bryant to provide an update on this program.

Good morning, ladies and gentlemen. It's David Bryant speaking. Pictured here is a nursery acquired by RFF in May 2020. The young plants seen here are some of the 185,000 trees that will be planted by RFM for RFF's macadamia developments in this calendar year. The nursery and the plantings that they supply form an important part of the fund's expansion over the coming years. A total of 500 hectares of macadamia orchards will be established in 2021, funded in part by the disposal of RFF's poultry assets and the Mooral almond orchard, which was sold in December. Both the poultry farms and the almond orchards are examples of RFM's experience in developing productive agricultural assets, creating value through cash flow positive and profitable operations and then crystallizing that value via an asset sale. The pictures on the bottom of this page show that RFM's development expertise spans over 2 decades with the center and right-hand photos recording the early days of the establishment of the poultry and almond assets. We are now moving to repeat this process in the macadamia industry. Accordingly, key RFM operational staff, some of whom worked on the development of the Mooral almond orchard, have relocated to Central Queensland to oversee the macadamia developments. As shown in the map, land and water acquisitions are materially complete with assets in Rockhampton, Bundaberg and Maryborough. This means that we've now the natural resources in place to develop up to 5,000 hectares of macadamia orchards, plus many thousands of hectares of land suitable for cattle production, natural resources that RFF will now harness. The completion of the Rookwood Weir scheduled for 2023 will facilitate the supply of 21,600 megaliters of water to the Rockhampton properties. In the meantime, RFM will establish the first orchards at our other 2 regions, Maryborough and Bundaberg. The images on this page show works have already commenced with the conversion of 2 cropping properties pictured here at different stages. The bottom picture shows a laser bucket, which is using GPS technology to precisely level the block prior to planting. Accuracy at this stage of the development will result in efficient drainage for the orchard, providing the benefit of early access following rain events and uniform soil water moisture to maximize tree growth. The top picture shows tree planting with grafted macadamia trees being placed into rows that have been prepared with cultivation and irrigation systems, ready to supply water to the new trees when needed. The trees for these plantings were sourced from the nursery owned by RFF. As the output of the nurseries expanded, the developments will be accelerated or can be accelerated in future years. The development of this initial 500 hectares is within the financial capacity of RFF and are designed to demonstrate the orchard's scale and quality that RFF can provide to prospective lessees. Discussions with potential lessees are progressing satisfactorily, which makes us confident that we will soon have a lessee for this year's developments. RFF will generate additional income from properties which are not immediately required for the development. Discussions are concurrently occurring to lease several of the cattle properties in Rockhampton. In Maryborough, approximately half of the sugarcane properties are already leased and the remaining properties will be cropped by RFM. This approach is intended to provide higher returns and more flexibility in rolling out the macadamia developments. This is an exciting stage for the Rural Funds Group, and we look forward to continuing to provide updates as the developments progress. The rationale for undertaking the developments has been previously articulated, but it's worth revisiting. Macadamias have been a very good investment for RFF that represent only 2% of the current portfolio. The developments planned for RFF will further diversify the portfolio with additional lessees, an increase in allocation to the Northern Climatic Zone and a reweighting of sector diversity. Macadamias are also consistent with RFM's strategy of investing in sectors in which Australia has a comparative advantage and sells into global markets. RFM's view is that these sectors are more sustainable and less volatile than commodities for which Australia does not possess a comparative advantage or only produces for domestic consumption. Importantly, as lessees are secured for these assets, they will add to the existing revenue generation and the weighted average lease expiry profile. The current WALE or weighted average lease expiry for RFF is 11.1 years. Whilst the focus of the presentation today has been on the macadamia development strategy, productivity improvements continue on many of the other natural resource assets within RFF. As an example, Comanche, a cattle property on the Fitzroy River and pictured on the screen, has benefited from the planting of a forage crop, supported by the installation of a new center pivot irrigation system. These improvements seek to increase the assets -- and benefit the productivity of the assets and benefit RFF via increased earnings. A summary of these types of development activities are included in the appendices. I'll now hand over to James to conclude today's presentation and commence the Q&A. Thank you.

Thank you, David. As noted, we will shortly commence Q&A. If you have a question which you would like answered, you can type it into the questions field or alternatively use the raise hand function. In summary, the financial results presented today reflect a good portfolio of assets with a good track record of performance, specifically and notably, distribution growth of at least 4% per annum which is in line with RFF's stated target. The transactions completed over the past 12 months have secured RFM's ability to commence the rollout of 5,000 hectares of macadamia orchards with 500 hectares planned for the current year. RFM can confidently commence the developments, drawing on the existing balance sheet capacity and earnings generation of the RFF portfolio and has today announced FY '22 forecast distributions of $0.1173 per unit, a 4% increase on FY '21. This concludes the formal component of today's presentation, and we'll now pause for a moment while participants type their questions in, which we will receive and answer shortly.

I'll now hand over to David Bryant for the first question, which is in regards to the target weighting for macadamias.

Okay, it's David Bryant speaking again. The first question is what is our ultimate target weighting for macadamias. Just to refer you, I think we've brought Slide 13 back up, which shows the sector weighting on the left-hand side. You can see at the moment, we've got a pretty heavy concentration in almonds and cattle. The objective with macadamias is to actually dilute that concentration, increase the diversity of the portfolio. But it's dependent upon, of course, lessees. And as I said in my presentation, that those discussions are going satisfactorily. But over the coming years, we will need to sign on additional lessees. But I don't anticipate or aspire to getting the macadamia allocation to 25% of the portfolio. It's an industry where Australia is a world leader. We have a comparative advantage in production. And so the economics of the industry will always, well, I believe, will remain very attractive. So that 25% is the short answer. The next question associated with that from the same questioner was, what is the target cash yields on cost? So and what is the yield that we would expect to receive on an investment like this? I suppose it would be in the range of 6% to 9%. And the reason why I'm providing a range is that we keep lessee lease rates commercial in confidence for the benefit of both the lessee, but also for the benefit of RFF as we talk to a range of lessees about a range of possibilities. Okay, had another question about macadamias, which is how long does it take for a tree to produce nuts? You can actually get nuts off the trees within -- in the third year, but it's a very small crop. It's a tough industry to go into. And the reason for this is it takes about 8 years for the orchard to turn cash flow positive. But if you recall, Mike, for the first slide in my presentation, there was a nursery. It takes 2 years to produce the actual planting material. So really, what you've got is a 10-year project. So it takes a lot of planning and a lot of investment. And that's actually a barrier to entry, which is actually a very attractive attribute for RFF because RFF has the financial capacity and its business is actually providing financing arrangements or -- in developing orchards, long-term investments for other businesses that may have shorter-term priorities. So we think that attribute or that long duration for the establishment of orchards is actually -- is a very attractive thing. The next question we had was just regarding lessee performance over the period. There was -- we made a comment in the presentation that no rent relief was sought. Were there any concerns raised by lessees at any point during the pandemic? No is the answer. The -- our lessees are producing food. I think the results from the supermarkets, actually, over the last couple of days is a pretty good indication of what happened to food during the pandemic. People stayed home and bought a lot of it and ate a lot of it. But -- so our lessees have sailed through the pandemic very well. There's a question about the current trend for pricing of macadamias. Macadamia prices are very -- they're quite high. We would expect them to come off a bit, and they probably have started to come off a bit. And it's interestingly, it's because macadamias are often a snack food that are purchased perhaps at a convenience store or a service station, and people have traveled less, have been out less, and there's been slightly reduced sales through those channels. But nevertheless, macadamias are priced more highly and valued more highly than any of the other nuts. So we would expect that, that position will remain because of the attributes of the nut. And there's a fair bit of commentary about that in the last newsletter, and I'd refer people to that newsletter to get some more information on the macadamia, the attributes of the macadamia industry and why it's so attractive. Another question about pricing for cattle. The outlook for cattle prices. Cattle prices are very high at the moment with the good season being experienced in Australia. So you're seeing an increase in the value of breeder stock as farmers or cattle farmers seek to rebuild their herds. And the prices being paid for cattle -- for breeding cattle at the moment are unprecedented. They are probably, I don't know, I'd say about 30% to 40% above long-term recent averages, which are pretty high, too. The important thing to keep an eye on is actually the price for beef as opposed to cattle. In other words, the finished product, the product that's being consumed. And again, beef prices, Australian beef prices are very high. And that's because the Australian beef is very much in demand in our overseas markets. It's viewed as of the highest quality of beef. It's very attractive to our customers, our trading partners, and that's supporting prices. And we're seeing evidence of that price support and that confidence particularly with the increase that we've had with the JBS facility. They've got more cattle on feed, processing more cattle. So the industry is enjoying good times. I will just hand over to James with another question.

We have a few more questions that have come through and some people with raised hands, so we'll get to those with their hands raised shortly. But I'll hand over to Daniel Yap for a question on the tax implications from the Mooral sale. And after which, he'll hand over to Tim Sheridan to provide a response to a question on water entitlements. Thank you, Daniel.

Thank you, James. As noted in the presentation, there has been a capital gain as a result of the sale of the Mooral property from both an accounting and tax basis. For tax, the capital gain is added to the income component of the distributions. This gain for the current year is in excess of the amount of the cash distributions. The capital gain will be attributed to 3 quarters of this year, the December distribution that was paid and the next 2 distributions. This, however, may result in an increase to the tax cost base for certain unitholders in RFF, which means that when these unitholders dispose of units in RFF, a lower capital gain will be realized. We will be providing more information on this topic, and we'll publish this on our website. I'll now hand over to Tim.

Thank you, Daniel. We've had a question come through about the temporary market for water entitlements and also the permanent water entitlements. Due to recent rains that we've experienced, the dams, the storages have refilled, and we've seen the water allocation significantly increase. As a result of that, the temporary water market has come off quite somewhat. I think it's probably come off from $500 a megaliter to about $50 a megaliter. Fortunately, for RFF, all of our temporary water was sold in the prior half, and we did achieve those higher prices. So that the revenue from that is included in the half year just gone. In relation to permanent entitlement, so the actual entitlements people hold forever, we haven't seen much movement in that. But those tend to keep growing in value as new almond plantings and the like occur, but the temporary market does fluctuate year-on-year based on seasonal conditions.

It's David Bryant here. I'll just add to that. The amount of temporary water that we hold is quite marginal, so that movement in prices as said, as they go up and down has only a marginal impact on earnings. I've got another question here. We've got James Druce on the line, and he's going to ask a question over the system. I'll just -- one moment, James Druce, while I have somebody give me the thumbs up so that you can -- okay. You're good to go, James.

David, just looking at the -- your prepared comments around the 500 hectares that you're developing. It sounds like you have a lessee or you're close to signing something with a lessee for that. Can you give us a sense around timing and how that lease is structured? Will you be getting income from day one? Or is it more in line with the cash flow of the orchard?

Okay. Thanks, James. Look, as I stated, the lessee negotiation -- negotiations are progressing satisfactorily. If they were progressing unsatisfactorily, I would say that, but that's not the case. As to timing, I would anticipate that we would be signing a lessee this calendar year. The timing of cash flows, and this actually leads me to answer -- to assist answering another question. So associated with your question, James Druce, is another question, which is, will the long lead times for developing macadamia orchards hold back our earnings growth as we ramp up macadamias? So all of our leases will be struck on the basis that lease payments are paid from day one based on the amount of capital outlaid. And in time, we would expect that we would review the value of those orchards to market as it's appropriate and as occurs with all our other assets. So what that means is that it will not hold back these long lead -- development lead times will not hold back earnings growth. We will see steady earnings growth as capital is invested in developing these natural resources. So at this stage, it's 500 hectares for this calendar year. And subject to lessees and subject to financial capacity, we would expect to then start another round of development in the next calendar year.

Okay. Just kind of a follow-up question, if I may, one or two more. Do -- in the past, you've also talked about getting up to 1,000 hectares in a relatively short order. Should we be thinking about another 500 in 24 months' time? Or do you think things can ramp up a bit faster than that?

I think another 500 hectares next year is -- well, certainly, logistically, it's achievable. We could ramp up further than that, but that would be subject to demand from lessees. So we are -- the nursery that was pictured before, we've expanded that. And so the capacity is being put in place to ramp up further than that. But at this stage, the assumption is that we'll do another 500 hectares next year. The aspiration is 5,000 hectares. I do not anticipate that, that will take 10 years. I would expect that we can halve that time. But again, this is -- we're talking in -- the only knowns we have here is that we have the natural resources. The timing is up to us, and that will depend on lessees though.

Okay. And one final one on the macadamias. The lessee -- what sort of capacity do the lessees have that you're talking to? I mean could they do 1,000 hectare chunks? Or is it going to be around that sort of 500 number?

Yes. No, we're interested in talking to institutional scale lessees. And those 1,000 hectare chunks is actually probably a minimum hurdle for institutional scale investors. So yes.

Okay. And I'm being a bit greedy, but I might have one more, if I may.

We'll indulge you.

The -- just the first half earnings, I mean, your $6.6 million, double that you're at $13.2 million. You're sort of guiding to $11.7 million for '21 AFFO. I mean, you've got a little bit of dilution coming in for Mooral, but not that much. You got the JBS guarantee coming through. Lower cost of debt. I mean, is there any reason why the second half would be softer than the first half?

I'll just hand this over to Tim Sheridan, James.

Yes. Thanks, James. No, I mean the AFFO we've put out is what we think we're going to achieve. The first half, as you pointed out, did have the Mooral almond orchard in it for the full period. So if you drop that out, our target is our target, and that's what we think we'll achieve.

Okay. But do you think the second half will be weaker than the first half?

Yes, that's right. Slightly weaker because it's got Mooral in there.

So that -- it's David Bryant here again. That weakness is kept -- will occur -- is occurring because of the transition from a high-yielding almond asset and it's going to take time to transition to the ramp-up of the macadamias as we sign on lessees. So thanks for that, James. I'll now just move to some other questions. So there's some questions from a mini shareholder, but reading the questions, a very astute shareholder. Questions are regarding the macadamia industry. Is water a concern in the Maryborough area? Not for us. We have sufficient water entitlements to do the developments that we're targeting there. And the river itself is very reliable. It's a really good region to be expanding macadamias. And then a question about supply chains in agribusiness, and there's a question just from the same questioner and also from another investor who had a similar question regarding processing. But first of all, I want to emphasize that we will be leasing these orchards out. And the decisions regarding processing and marketing will be made by the lessees. At the moment, the existing orchards owned, the mature orchards owned by RFF are leased to a fund, which has, I think, about 300 investors in it. That lessee is managed by RFM. We actually manage the orchards, and that's why we've got the experience in this industry. That lessee, it has its macadamia processed by a cooperative. It's the largest cooperative in the industry, a very efficient processor and marketer of the nuts. So that arrangement works very well for that particular lessee. What occurs with the other lessees will be up to them. There was another question here. I'll just finish with this, and I'm now going to hand over. There's a question coming in from Jonathan Snape, but one moment, please, Jonathan. There's a question, if the price dropped by 20%, what will that look like in the payback period? Again, that would not alter our arrangements, it would reduce the profitability for the lessee. But what you find in these commodities is that low prices make high prices and the reverse. But we -- what you see in nut crops is because they actually have such a long time to build capacity, you see prices move in a sine wave as opposed to perhaps, say, an annual commodity like wheat, which has a much more volatile movement in prices. But anyway, if prices did drop for a period by 20%, then the lessee would experience less profitability, but then they would see a recovery typically as the freeze on extra capacity tightens up supply. Okay. Now, Jonathan Snape, so I'm going to hand over to you. Your -- you've been taken off mute, so your question, please.

Yes. Great. Can you hear me okay?

We can. Thanks, Jonathan.