Rural Funds Group (RFF) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Thank you for standing by. My name is James Powell, and I'm joined today by David Bryant, Managing Director; Tim Sheridan, Chief Operating Officer; and connecting from Sydney is Daniel Yap, Chief Financial Officer. Further to disclosures lodged on the Australian Securities Exchange yesterday and today, Rural Funds Management, as responsible entity of the Rural Funds Group, is pleased to announce a non-renounceable entitlement offer, which provides investors the opportunity to acquire 1 unit in RFF for every 8.4 units owned on the record date at a price of $2.47 per security. The entitlement offer has been fully underwritten, as announced. The purpose of today's call is for management to provide details of the offer, including the use of proceeds and integration with RFF's strategy. Shortly, I will hand over to our presenters. [Operator Instructions] Please also be advised, the webinar is being recorded. I will now hand over to our first speaker, David Bryant.

Good morning, ladies and gentlemen. It's David Bryant speaking. I'm going to step through the presentation, probably take about 15 minutes, and then we can do some questions and answers shortly after that. With that approach, [ let's dive into the ] presentation, and we'll get -- I'll just address the first section of this overview slide, which is the purpose of the equity raising. So its purpose is to raise capital or provide capital for the development of 1,000 hectares of macadamia orchard development; to acquire cattle properties and possibly cropping properties, and I'll speak to that in a moment, which will be leased immediately to corporate lessees; and then thirdly, the acquisition of $38 million of water entitlements, which will be leased out immediately for the next 5 years. If you step back one slide, you can see there on Slide 4, that's a picture of macadamia trees, young macadamia trees that are sitting in one of our new orchards. What you can see in the background is sugarcane. This is taken at Maryborough in Queensland. So we've been pulling out sugarcane and preparing land to plant macadamias there. You can see those trees. Each of those is worth $17 each, and the reason why that costs so much is it takes 2 years to produce them. They're actually grafted, so you actually have a rootstock. You then graft [ on the petition of ] variety. So there's actually a lot of work that goes into them. You can see there on the pallets, if you -- at the bottom of the pallets, if you train your eyes carefully to the RFM on each of the pallets, these were ordered 2 years ago. The reason why I'm sort of dwelling on these is I'm going to make the point that what we're talking to you today in this equity raising, the purpose of it is actually a result of 3 years of planning. The transition or the development of macadamia orchards has been something we've planned for some time and prepared for by acquiring land and even selling assets to provide capital to do that. We'll now go to Page 6 of the presentation. You can see on the bottom right corner, the picture there shows some of those macadamia trees planted. So that's again at Maryborough, and we now have 100 hectares of orchard planted. We'll have 500 hectares planted in the next couple of months. And by this time next year, there will be 1,000 hectares planted in all. And so part of this equity raising is seeking capital to actually fund the planting phase amongst other things. Again, the preparation before you can put a tree in the ground is quite detailed, and it requires a very systematic approach to the development. You can see the slide above shows pictures of pipes that will be connected and laid -- buried underground. They are the main lines, then you have submains, you have valves, you have drip irrigation, you have pump sheds, you have earthmoving and land formation. All manner of infrastructure that has to be installed at these orchards are created. So that's well underway now for that 1,000 hectares, which by this time next year will be all in the ground. The first bullet point on this slide, you can see there that over the past 2 years, we've steadily acquired land and water to enable the development of 5,000 hectares of macadamia orchards. In fact, we're actually sitting on the fund -- on $104 million of land and water located at Rockhampton, Bundaberg and Maryborough, all of which is suitable for macadamia plantings. At Maryborough, we have 5,000 hectares of arable land. Half of it will go into macadamias, which will then fully commit the water entitlements we have there. At Rockhampton, we have thousands of hectares of land, and we have acquired sufficient water to plant 2,500 hectares to macadamias. The rest will be reserved for cattle and cropping. That land that we have, that asset bank that we have is currently earning a pretty low rate of return because we've got some cattle land adjacent and cropping going on, but it doesn't earn the sort of rates of return that you can get from long-term leases, particularly if they're macadamia orchards. So what we're going to do is -- what we are doing is RFM is not charging a management fee on $100 million until such time as we get those assets leased as macadamia orchards and the balance leased as cropping farms and cattle farms. Now the development of the remaining 4,000 hectares, that will occur over the next 4 years following the -- entering into the lease for this first 1,000 hectares. The third bullet point in the presentation makes some comments about the timing of the lease for the first 1,000 hectares. Importantly, it's not a question of if but a question of the return on capital that we get from the lease. So we could have had a lease already had we wished, but we believe -- or we know that by actually having the orchard planted, we can achieve a higher rate of return for our unitholders on that lease or on that investment for several reasons. First of all, seeing is believing. If you stand in a dusty paddock and tell someone about your vision for a macadamia orchard, they'll walk away thinking that [ helped so many flies ]. But if you can actually show them 1,000 hectares of orchard that's already planted, that's very tangible, particularly for institutional investors that are actually not experienced in agricultural investment. Secondly, by having the orchard planted, you're another year along the development time line. So the actual mathematics for the investment analysts looks better. And then thirdly, and significantly, by having the orchard planted, you've actually removed the actual planting risk and the risk of tree losses as the trees are planted. Now that's a risk that the fund is bearing, but RFM has been planting orchards and vineyards for over 20 years. We have a very systematic approach to the risk management of planting orchards. And by being organized and timely in operations and having the right expertise, it's possible to actually manage that risk such that tree losses are well below 0.5% of trees planted. And we budget for that at any rate anyway. So the risk for a newcomer can be significant, particularly if they're not good at managing these types of projects. But the risk for RFF, given the expertise of the organization and the experience of the organization, is very manageable. So it's a sensible approach towards further maximizing the return that we can get for these leases. So over the next year, we are working to sign on a lessee and working to sign on a lessee on terms that are attractive to the unitholders of RFF. We go to the next page, which is Slide 7. Before I move off macadamias, I'll just show you there's -- the 3 areas -- for those unfamiliar with the geography of Queensland, you can see the 3 areas where our macadamias are located. We've got existing mature macadamia orchards at Bundaberg in Queensland. Bundaberg is the -- arguably the center of macadamia production in the world. It's some of the biggest orchards, some of the largest growers in that area. At Maryborough in the south, we've got plantings underway there. We're not alone in planting macadamias there, but we'll probably soon become the largest grower of macadamia since we are, in fact, the largest landholder of arable land and water entitlements in that district. And then at Rockhampton, you'll be aware that some months ago, we were the successful bidder for 20-odd thousand megaliters of water that will come from the Rookwood Weir, which you can see Rookwood Farms in the circle that breaks out at Rockhampton there on the map. That's the location of the Rookwood Weir on the Fitzroy River, which is under construction as we speak. And in 2 years' time, we will make our final payment for the water entitlements there. In the meantime, development of 2,500 hectares of macadamia orchards is getting underway in that region. And in fact, we've moved one of our -- some of our almond team following the Mooral sale from Hillston in New South Wales to Rockhampton to supervise that development. Okay. And then just move to Slide 8, and this has a couple of case studies. And the one on the left, I actually -- I just realized -- we just go back one slide because I haven't commented on the cattle and cropping, excuse me. So part of the capital that we're seeking from this equity raising, when we combine the equity and the debt plus existing balance sheet capacity, we will use the capital firstly for the macadamia developments, and that's about $40 million of additional expenditure that will be outlaid there. There's $25 million that will be outlaid for the water entitlements I referred to at Rookwood. And there will be $100 million of capital left over, equity and debt, that can be allocated for cattle and cropping acquisitions. Now we've already agreed terms with potential lessees -- with lessees for cattle acquisitions, and we're actively seeking properties for that purpose. And as soon as those properties are acquired, the leases will commence and rents will be added to the funds from operations of the Rural Funds Group. We also have identified a couple of opportunities in the cropping sector, similar to the 2 properties we have already, Lynora and Mayneland, which you can see on the map at left. And now move to the next slide, and I want to highlight an aspect of this $100 million of acquisitions and emphasize a point in relation to them. So the case study on the left is about productivity improvements. In this instance, we'll use the property Comanche, which is a 7,600-hectare cattle property that we acquired in July 2018. Since acquiring that property, we've installed center pivot irrigation, further watering points, improved pastures, cleared regrowth and improved infrastructure. So that capital expenditure of $3.2 million has helped us to increase the carrying capacity of that property by about 50%. That improvement in carrying capacity -- and this is, I suppose, an investment operation that we have been doing and highlighting in newsletters and communications for some time now. But by adding that carrying capacity, you're adding to the productivity to a farm. You're increasing the profits that the lessee can make from their cattle operations on their farms. And because the farm is more profitable, it is more valuable. After 5 years, the farm is revalued, and the rent is reviewed and increases. That type of investment operation, that type of investment in development has been very lucrative for the Rural Funds Group. And I could actually give you 10 of those case studies. Rewan and many other properties that we highlighted to you over the years are progressing along the same basis. So it's -- with a combination of buying properties at a reasonable price and buying properties with unutilized natural resources and then improving them, we're finding that we can generate 15% internal rates of return over a 10-year period with this type of asset. The case study on the right is in relation to higher and better use development and talks about the Mooral property at Hillston that we acquired, developed to almonds and then sold recently for $98 million, again, generating a greater than 15% return since we listed. That case study is provided because that is a direct parallel that correlates completely with what we are doing with the macadamia developments: buying cattle land, buying sugarcane land and then redeveloping it into a high-value crop, utilizing natural resources, particularly the water and soils and turning out much -- very good returns on investment. I'll move now to Slide 9, which is the water entitlement acquisition. So at Darlington Point, you can see there on the map at the right, the Rural Funds Group owns one of the largest almond orchards in the world, the Kerarbury property. So that has a lot of Murrumbidgee water entitlements there. The fund also owns another $70 million -- $75 million of water entitlements that we rent into the market each year, the high security river entitlements. With this acquisition, we're adding another 8,000 megaliters of groundwater entitlements in the Murrumbidgee aquifer. The Murrumbidgee aquifer is the highest-yielding aquifer in the country. It's highly regulated and highly monitored and a very sustainable resource. And so we're acquiring $38 million of water -- groundwater entitlements to add to our Murrumbidgee portfolio. And these investments have been very lucrative investments for the fund over many, many years, and we expect they will continue to do so. In this case, the water will be sold and is being acquired and leased back to the purchasers for -- the vendors, excuse me, for 5 years. Beyond that, we'll either look to roll over the lease again or rent the water into the market on an annual basis as we do with other entitlements. So that brings me to the end of my part of the presentation. James Powell will now take over briefly and just take you through some of the dates -- key dates in relation to the equity raising and then we can go to questions. Thanks very much for now.

Thank you, David. Just to provide some of the details of the entitlement offer for the unitholders that have dialed in today. As I stated at the start of the presentation, it is a fully underwritten 1-for-8 (sic) [ 1-for-8.4 ], accelerated non-renounceable entitlement offer, and this will result in the Rural Funds Group raising $100 million. The record date for the entitlement offer is the 12th of July. And the offer price is $2.47 per unit, which represents a 4.7% forecast FY '22 distribution yield. Moving now to the timetable. I will just call out a couple of key dates on this page. First of all, retail unitholders entitlement offer booklets will be dispatched on Wednesday, the 14th of July. We have received some calls regarding that already. However, the booklets will not be dispatched until that date. And they will also be made available to you electronically if that has been your communication nomination on that date also. The early retail entitlement offer acceptance is closed on Tuesday, the 20th of July. However, unitholders have until the closure date of the full retail entitlement offer on Wednesday, the 28th of July. For investors that are participating, we do encourage you to use the BPAY details, which are on your individualized entitlement offer and acceptance form. And I just would like to reiterate that if you have any questions, please don't hesitate contacting our RFM investor services team, who would be more than happy to help. The details to contact them are available on Rural Funds Management's website, www.ruralfunds.com.au. That concludes the formal part of today's presentation other than for question and answers. We have received some questions through already. [Operator Instructions] We'll just pause for a moment while we receive those questions.

Hello again, ladies and gentlemen, it's David Bryant speaking. So I've got some questions here. There are several questions regarding macadamia supply and demand, whether there will be a glut in macadamia orchards and what impact our developments would have -- questions along those lines. So our macadamia orchards, once they're developed, would add about 8% to world production and that's including the fact that actually our orchards will be very high-yielding orchards, that we're investing a lot of capital and using the best irrigation systems. And we've actually got a track record on existing orchards of these high yields. So even allowing for that, it would add 8%. So over 5 years, we'd be adding about, say, 1.75% to world production. Demand or consumption globally of macadamia orchards is growing at 10% per annum. It would grow faster than that but for the fact that production is only growing at that rate. There is significant demand for macadamia nuts globally, partly as a trend to healthy eating, changes in diets, the westernization of diets in Asia. And by way of example, in China, over the last 20 years, tree nut imports have been increasing 26% per annum compound over that 20-year period. That's massive growth if you work out that compound rate of growth. So the macadamia production could grow faster, but there are actually no institutional investors, to my knowledge, actively involved in the macadamia industry other than one Canadian pension fund and the Rural Funds Group, whereas if you looked at almonds, walnuts and other tree nuts and other agricultural commodities, there's a lot of institutional capital that are organizing very large-scale developments and lifting supply of commodities that is actually needed as the world gets richer and as food consumption increases. The opportunity is there in macadamias to do the same, and that's what we're doing. I'll just dwell on this point one moment longer. If you look through the portfolio of assets that the Rural Funds Group owns, all of them, all of the commodity sectors that we're involved in are commodities where Australia enjoys a comparative advantage in production. So we can compete with anyone in the world and produce those commodities profitably as commodity prices rise and fall. And that's really fundamental to the investment strategy, the Rural Funds Group. Macadamia is another example of that. It's Australia's only commercialized native food, which would imply perhaps some advantage, to start with. But importantly, because of our large farm sizes, we're able to mechanize the production, which makes us more competitive with lower cost of production and higher quality nuts than our competitors. And so whilst macadamia prices will rise and fall with seasons as all commodities do, we are confident that we are engaging in an investment that -- where Australia has comparative advantage and will be a core producer, core profitable producer over the very long term. So that's the thinking behind macadamias. I'll pause now and just gather another question. There was one question about adverse effects of -- what -- adverse weather during planting and growth of the orchards. Sometimes you can have periods of really wet weather when you're planting, so you've just got to actually build that into your development program. We're planting these orchards in the subtropics. You get a distinct dry and wet season. So planting in the dryer period of the year is the best time to do it because you know that there's much less rainfall, next to none in some years. And so you know that your development time line can be adhered to pretty easily. Of course, to do that, you've got to have your irrigation systems in place in advance. And we've got the people and the contractors and -- to ensure that that's all laid out and ready to go before the trees go in the ground. The other adverse weather event that you can have is cyclones or really heavy winds while you've got young trees. And the key to that is to ensure that you manage the growth of the trees so that they don't grow too quickly and become dense canopy sails that can blow over before they establish their root systems. And that's something that our horticulturists are adept and experienced at. So it's a risk that we manage. Okay. So there's a question about which potential corporate institutional lessees have you've been in discussion. I'm not in a position to name names because it's subject to confidentiality agreements, but it's worth commenting that there's really 2 types of lessees that we're in discussion with, and we're attracted to both types. And they are institutional investors that are typically pension funds that are scouring the globe looking for cash flows. And macadamia orchards, once established and mature, produce cash flows really good and attractive cash flows for decades. And so these are attractive to pension funds. Particularly, there's a really strong interest from North American pension funds. And there is also some interest from Australian superannuation or industry funds. But then the other class of lessees that we're in discussion with, businesses -- corporate businesses that -- whose business is the cultivation, processing and marketing of tree nuts and adding macadamias to their portfolio at scale is something that a lot of them have been attracted to, been unable to secure the scale by embarking on 5,000 hectares. It gives them that scale. It would give them real presence in the industry. So they're the 2 types of investors that we've been talking to and we'll continue to talk to. The question whether China is actually imposing trade restrictions on macadamias as it has on barley and wine and so forth. So a quick comment on that. So the answer is no, but it's worth emphasizing that if you produce a commodity, you've got 100 markets that you can send it to -- sell it to because it's unbranded and it's undifferentiated. And Australian macadamias are a commodity until they go in a bag and get branded. And so it is possible to ship macadamias to any country in the world. And 2 things do occur -- 2 aspects eventuate from that. Firstly, if you're eating an undifferentiated macadamia in China, you won't know the difference. And if it is -- if we are unable to import -- to export them directly, they may arrive there through other markets or we can sell those macadamias into the 100 other markets that demand the commodity. In big -- Europe, the U.S. and Japan and those other developed countries are big consumers of macadamias and will consume more if they could get them. So the -- and the same goes for the rest of Australia's agricultural commodities. Just by way of example, so Australian tree nuts -- I mentioned before the China's tree nut consumption has been growing by 26% per annum for 20 years. Australia is the second largest provider of tree nuts into China with 14% market share. Beef consumption in China has been growing 48% per annum since 2012. So it's a massive growth over the last 7 or 8 years. Australia is the second largest provider of beef into China with 21% market share. So even with these trade restrictions, there are still big opportunities in that market. We have complementary needs. China has a massive deficit of arable land and can really only produce the staples. It's unable to produce many of the other commodities, higher-value commodities that would consume too much land and jeopardize food security in that country and something that the older generation in China are acutely aware of. And so there is a real complementarity between Australia, the U.S. and China when it comes to food trade. I'm just going to pass over to Tim Sheridan, who will address another question.

Thanks, David. I'll give you some time to gather your thoughts and answer a couple of questions. Well, we've got a question on what systems and processes do we have in place to make sure our lessees manage the properties correctly. We have terms written into the leases, and we regularly inspect those leases. So if our lessees don't adhere to those terms, we can terminate the lease. We have mechanisms written into the leases. I've got another question relating to the yield on the Murrumbidgee border that we've acquired. So Slide 20 of the presentation shows the spectrum of investment opportunities in Australian agriculture, and the yield for that Murrumbidgee water fits within that spectrum. So you can see their water entitlements. They are lower income-yielding assets, but they do provide higher levels of capital growth.

It's David Bryant again. So we've got some questions about water entitlements around Bundaberg. There is a dam there that's got some structural problems, and it's caused a reduction in water entitlements to people that use that dam. The question is, has that affected the RFM or Rural Funds Group assets in the Bundaberg region? The answer is no. We are on another dam. There's a question regarding cattle farm pricing. Can we talk to the ability to deploy the capital earmarked for cattle acquisitions? So I'd draw your attention to the newsletter article, the lead -- the newsletter that we recently published. You can get that from the RFM website or the ASX. The lead article goes into agricultural land values in some details -- in some detail and also focuses in on cattle values. Land values have doubled in the last 5 years. However, beef prices have tripled in that time. We would expect beef prices to retrace somewhat, but the higher prices definitely justify most of the cattle land transactions that we see occurring. We were the underbidder on a very large property last week by about 5%. Had we bid the additional 5% or more, it would have been a rational acquisition that would stack up for our lessee. And I actually want to emphasize that we're working actively with lessees. We have terms agreed, and it imposes a discipline because we need to acquire the assets at prices that can work for those lessees, so they can make decent profits from running cattle on those farms. We're confident that -- particularly in the larger scale assets, where you're not competing with a neighbor, that it's possible to acquire cattle properties at attractive rates of return, particularly where the farms have the attributes I was talking of earlier, and that is where the natural resources on them are not fully utilized, but a combination of buying the right farm and then -- and with that development, we can achieve the returns that we're seeking. A question regarding the risk level for water assets from poor government management or changes in government approach to water management. Perhaps there's a few questions around that type -- of that nature. The some -- about 15-or-so years ago, the Council of Australian Governments signed an agreement called the intergovernmental agreement on the Murray-Darling Basin plans. That's where a lot of our water entitlements are. The comments here that I'm about to make in relation to that apply also to Queensland and that is that we do have permanent water rights, and they are subject to compensation should there ever be reductions in those entitlements other than for the point -- purpose of climate change. I think it's worth emphasizing that Australian government and Australian regulators or the Australian water bureaucracy is actually the world leader in managing the sustainable use of water entitlements. And we've seen regulations come in, particularly -- it was about 15 years ago that they were most intense. And they were designed to get the allocation of water, the supply of water and extraction of water back into balance with the environment. If there was ever any change in that agenda other than for climate change, then the water entitlements would be subject to compensation. We -- water is one of the scarcest natural resources on the planet and particularly in relation to agriculture. Whenever there's any new technologies that come through that allow us to grow an extra kilo of macadamias or an extra ton of wheat or something like that from irrigation, that flows through to the value of the water entitlements because farmers know that they can now produce greater profits. And that's why, over time, we've seen really high growth rates in water entitlements and expect to do so in the future. It's -- like any investment, there are risks, but on balance, the returns considered against the risks make it a very attractive investment. It's proven to be over the last 2 decades for the Rural Funds Group or for RFM, and it will -- I expect it will continue to be so, and we'd buy more water tomorrow. In fact, we continue to look at it. There's a question about the $98 million from the almond orchards and whether that will be recycled into the macadamia developments. Yes, that is the case. It is being recycled. We could have done the 1,000 hectares without actually doing this equity raising, but because we had the balance sheet capacity after buying the land and water to do that development, we chose to do an equity raising now to -- because we can see these acquisition opportunities that will achieve high rates of return in these other assets as well. I'll just pause for a moment to see if there's other questions that I can answer.

We've got a question about the credit assessment we go through with our tenants. I'll draw your attention to Slide 18, which outlines the counterparts to RFF's lessees. Over 80% of our lease revenue comes from either large corporates or ASX-listed companies. So they have full disclosure in RFF. We have a direct look into their financial capability to pay the rent. Where it isn't a large corporate or an ASX-listed company, we do require things such as rent payments in advance or security deposits.

There's a question here -- there's a few questions regarding water reliability. One of them is in relation to almonds, that almonds are a water-intensive crop and could drought change the water -- make the water entitlements or availability at risk. Another question in relation to water and storage in Queensland and could that affect future water supply. I just want to emphasize that when RFM enters into these developments, we do so by securing high security water entitlements to underpin those developments. So for example, New South Wales, the Riverina just went through one of the worst droughts in decades. It was a very fast and severe drought a couple of years ago. Kerarbury and our other Riverina orchards at that time enjoyed full water entitlements because they're high security water entitlements. And the same applies for what we're doing in Queensland. So we see water as a key risk, but we manage it by paying up in the first place and getting the right type of water to underpin the asset. All right. Look, I think there's still a few outstanding questions, but we've largely addressed the key themes in the questions that have come in so far. I think I'll hand over to James Powell now who will wind up. And thank you very much for attending your -- attending our presentation. If your question is unanswered and you really want to follow up on it, by all means, send us an e-mail, and we'll definitely answer your question, and we really appreciate your interest. Thank you.

Thank you, David. And I'd just like to reiterate my thanks to everyone for participating in the call today. In terms of the documentation, there's been a few questions just around the method of delivery. If you have nominated to receive documentation by post, that will be the case. Otherwise, you will receive it electronically. But in any event, please don't hesitate to contact our investor services team, and we'd be more than happy to assist you with your queries regarding your entitlement offer documentation. Thank you very much again for your attendance, and we'll draw the webinar to a conclusion. Thank you, and good morning.