Rural Funds Group (RFF) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Rural Funds Group financial results presentation for the full year ended 30 June 2022. My name is James Powell. Presenting today will be David Bryant, Managing Director; Tim Sheridan, Chief Operating Officer; and Daniel Yap, Chief Financial Officer. For your information, all participants are in listen-only mode. [Operator Instructions] To all attendees, please be advised that the webinar, including Q&A, will be recorded. I'll now hand over to our first speaker, Tim Sheridan.

Good morning, and thanks for your attendance. I'll start today's presentation with an overview of the FY '22 financial results. Firstly, a quick recap of the activities undertaken during the period. During the period, RFF entered into leases for 5 cattle properties and increased the JBS guarantee investment, which provides lease-like income. Two cattle properties suitable for productivity developments were also acquired. Productivity improvements have been a big part of our strategy since 2016, and RFF is now benefiting from these acquisitions through rent reviews. One such rent review for the cattle property in Natal will provide a 60% rent increase in FY '23. Productivity developments are also occurring on cattle properties owned by the group, including a newly acquired cattle property in Central Queensland, Baamba Plains. As investors will be aware, a significant focus over the past 2 years has been securing land and water to develop an eventual 5,000 hectares of macadamia orchards. RFM is advising the market today, we're in lease negotiations for a portion of these developments, which is subject to an exclusivity arrangement. The next tie to this section details the income, earnings and balance sheet metrics for the group at the end of 30 June. An increase in property income of $7 million or 10% has been achieved in FY '22. The increase was driven by additional income from the J&F Guarantee, acquisitions, development capital expenditure, lease indexations and market rent reviews. Earnings, as measured by total comprehensive income, increased by $86 million in FY '22, which is a 70% increase compared to the prior period. This is primarily a result of positive revaluations of cattle properties and, to a lesser extent, almond orchards and water entitlements. Adjusted funds from operations, or AFFO, the net cash generated by the group was up 9% on an absolute basis year-on-year. On a per unit basis, AFFO was slightly lower than the prior period because assets added to the development pipeline are yet to generate AFFO. Distributions of $0.1173 per unit were paid to investors in line with forecast. Looking at the balance sheet, the group's adjusted total assets increased to $1.5 billion as a result of revaluations and acquisitions, both of which we presented later in the presentation. On a per unit basis, net assets increased 24% to $2.69 per unit. Whilst borrowings increased during the period as development CapEx was deployed by the group, gearing has reduced slightly to 30%, which is at the lower end of the gearing target of 30% to 35%, providing balance sheet capacity to fund further developments. Page 7 details the main components of growth in assets during FY '22. The graph on the left-hand side of this page shows these movements grouped by agricultural sector. The largest contributors to the $338 million increase in property assets being from the cattle, macadamia and cropping sectors. As described on the right-hand side of this page, during the year, RFF acquired $179 million of properties, including mature macadamia orchards, cropping properties and cattle properties. Existing properties have increased in value by $134 million, primarily within the cattle sector, and $46 million of development CapEx was recognized relating primarily to the macadamia developments, but also improved productivity from cattle and cropping properties. The next section will consider the funding sources of these activities. At the start of the previous financial year, $100 million of new units were issued at a price of $2.47 per unit via an entitlement offer. As outlined previously, this equity was used to support the group's ongoing acquisitions and development strategies. During the year, RFF's debt facility was increased from $380 million to $520 million. A third lender has also been brought into the syndicate, and a number of RFF's debt covenants have been revised, including the reduction in the ICR covenant from 3x to 2x. We've also continued to acquire additional interest rate hedges with $210 million of forward-dated hedges entered into during the year. The chart on the bottom of this page details RFF's interest rate hedges over the next 10 years, with hedges increasing materially over the next 3 years. Additional details of RFF's debt facilities are presented on this page. The current headroom of $65 million is sufficient for the near-term development CapEx requirements, noting the gearing capacity is approximately 110% -- $110 million, apologies, assuming a 35% gearing. While the average cost of debt decreased year-on-year, interest rates are, of course, rising in FY '23. Before handing over to David to provide a strategy and portfolio update, I'll conclude on this section of financial performance with details of the performance of RFF compared to the A-REIT index as well as the trading price compared to the net asset value. Additional information on the financial results are contained on Pages 25 to 31 of this presentation. I will now hand over to David.

Good morning, ladies and gentlemen. This is David Bryant speaking. Before I continue the presentation, I'll pause on this slide, it's a picture of one of -- or it has a picture of one of the macadamia properties under development near Rockhampton. In the background is the Fitzroy River and the construction site for the Rookwood Weir, and this will supply water to our Rockhampton orchards once complete. As you can see, it's well underway. RFM has been identifying and acquiring assets that can benefit from 2 strategies designed to increase their capital growth and income generation. The strategies are: firstly, creating productivity improvements; and secondly, conversion to higher and better use. Over the past 2 years, RFM has been positioning the RFF portfolio to take advantage of these 2 strategies through the acquisition of properties suitable for development. The orange properties on the map indicate acquisitions in the last financial year located in Central Queensland. RFF entered into our extended leases on 6 properties in FY '22. This includes the 20-year lease of 2 properties, [indiscernible] and Mort & Co as well as the 25-year lease for a portion of the cattle property to Clarke Energy to install wind turbines for renewable energy production. 4 cattle and cropping properties continue to have their productivity improvements under development, 3 of which RFF will operate prior to seeking leases -- lessees. Similarly, 2 mature macadamia orchards acquired during the year will be operated by the fund until a lessee is arranged. These activities are expected to provide additional value and income generation for the group in future years. [indiscernible] the Central Queensland properties are 24 sugarcane farms, which are assets acquired in 2020. The map on the right-hand side of this page shows the locations of these farms, which will form approximately half of the 5,000 hectares of macadamia orchards that are proposed to be developed by the group. RFM expects the first 1,000 hectares of this program to be planted by November this year. This slide contains -- considers Lynora Downs, the cropping property whose development has been recently completed. Since its acquisition in 2016, RFM has increased water storage capacity by 4,000 megaliters. This is used to support additional irrigated area, which at RFM has doubled to 1,500 hectares. The combination of these 2 improvements has increased the amount of cotton and other crops that can be produced on the property and improve the consistency of production and the quality of those crops. This provides higher and more reliable cash flows for the lessee and higher rents over the lease term for RFF. As a consequence of these advances, RFF and the lessee have renewed the lease for an additional 5 years. Similar productivity developments are underway on 2 other cropping properties that RFM or [indiscernible] downstream on the Comet River in Central Queensland, namely Mayneland and Baamba Plains. The next section of the presentation, we'll look at the portfolio impacts of acquisition and development activities. The RFF portfolio consists of 68 properties diversified in multiple rainfall zones, as denoted by the different colors in the map. Agricultural sections in which RFF is invested are also shown. The RFF -- the next page shows the FY '23 forecasts from each of these sectors. The second chart on this page at the center presents a breakdown of our lease indexation mechanisms. The bulk of RFF lessees or leases have CPI linked or fixed indexation. In addition, approximately 1/3 of the leases also have a market rent review mechanism, which seeks to monetize the impact of changing asset values as RFM improves assets through productivity development. The benefits of owning agricultural assets during periods of inflation are well known, and we believe this diverse portfolio of assets with their indexation mechanisms will provide unitholders with the right mechanisms by generating income growth. Looking specifically at the lease revenue generated by RFF, you can see weighted-average lease expiry is 9.1 years. Throughout the year, RFF has continued to progress sustainability initiatives and is reviewing the applicability of reporting frameworks including the task force on climate-related financial disclosures. The table on the right shows RFF's largest lessees by asset value and their commitments with respect to the environment. The table notes several lessees are planning to align future disclosures with the task force frameworks and have net 0 greenhouse gas emission targets in place, which would incorporate RFF assets. Before concluding, I'll now cover the FY '23 forecast. The FY '23 forecast adjusted funds from operations is $0.101 per unit. This is less than AFFO generated by the group in FY '22, due primarily to higher forecast interest rates but also interest expenses on developments. Specifically, our forecast assumes interest rates rising to 3.5% by 31 December this year, then holding at that level for the balance of the period. Over the past several years, RFF has acquired development assets, which are generating relatively low levels of income. The total value of these assets, including improvements to date, is $261 million. The purpose of acquiring and developing these assets is so that we can lease them out and generate higher reliable returns. As detailed at the half year results, cash distributions for FY '23 will not increase, although franking credits will be distributed with a value equal to 4%. Forecast distributions have been maintained at $0.1173, based on a reasonable expectation. Our macadamia developments will be leased in the near term. This would cause a material increase in FFO, and therefore, a reduction in the high payout ratio presented here. In conclusion, the Rural Funds Group experienced a very prosperous financial year to 30 June 2022. Profits and asset values increased considerably, while productivity improvements and property developments have created a pool of assets that have been prepared for new leases. The Rural Funds Group has entered this new year facing the challenge of rising interest rates at a time when our larger hedges do not start until FY '24. Added to this, at the present time, we have some valuable assets that are not leased. We are confident that FY '23 will be a successful year for the group because we anticipate leasing macadamia assets that will provide an uplift in funds from operations for the current year and many years beyond. Beyond 23, RFF will generate higher rents if inflation remains high. because we anticipate -- our interest expenses are well hedged, our asset values will most likely remain stable as inflation is reined in, and finally, we have more assets to develop and rent. Thanks for attending today. I'll now hand over to James to conclude the presentation.

Thank you, David. We will shortly take questions from participants. [Operator Instructions] I'll now hand back to our operator to unmute the necessary lines.

[Operator Instructions] But our first question comes through from James Druce from CLSA.

My first question is around FY '23 guidance. Can you just confirm the capital, do you capitalize any interest on the macadamia developments that you've done so far and the policy for this year, is that continue that -- is that to expense that as well?

Thanks, James. I'll hand this one to Daniel Yap.

Thanks, James. We do have a policy of capitalizing interest expenses on development assets. So there is some capitalization of interest being included as part of the macadamia developments.

Okay. Is that on the whole of the spend or a portion of it? Can you provide any color on that?

Yes. Sure. So we are able to capitalize interest expenses to the value of our target gearing, which is approximately 35%. So approximately 35% of the development costs, the interest costs on those are able to be capitalized.

Okay. And just rate's in line with what your cost of debt?

Yes, that's correct.

Okay. And then you talked about a [indiscernible] with the partner for the macadamia orchards. It sounds like it's part of it. Can you provide any color as to where that's at? And any sort of feel for the nature of the lease that you guys are thinking about?

It's David Bryant speaking, James. The color is pretty great because we're subject to confidentiality clauses. It is for a material portion of our proposed development. A bulk of that is underway, and that's the expenses that are being incurred and subject to the previous discussion. So there was a second part to your question, which is -- was there a second part to your question, James?

It was just more about just what color you can provide. And if there's anything about the -- how you're thinking about the nature of the lease that will be entered into that you can talk about?

Yes. Yes. Okay. So look, it's the horticultural assets that if you think about that spectrum of assets in that diagram that we've had running for many years, whilst there's certainly been yield compression in that data diagram, it still holds these horticultural assets fit halfway in that spectrum between natural resource and infrastructure assets. The rental yields will reflect that and the capital growth and the indexation and so forth that you can expect from an asset like that, again, are pretty much aligned with what's expressed in that document. So -- in that diagram. So basically, at rates similar to horticultural assets is the answer.

That makes sense. And one more, if I may. Just thinking about FY '23 guidance. Are there any other big rent reviews coming up in '23? And also, what are you assuming for just general like-for-like growth from your rental portfolio for '23?

Yes. No, I don't -- there are a few rent reviews, but there's certainly no material ones like the Natal aggregation, which we reviewed this year. So the -- I mean the growth that we will have in FY '23 there, as David pointed out, about half of our leases are linked to CPI or fixed indexation. So some of those -- so we're assuming sort of inflation numbers in line with the market on those. But keep in mind that leases like the Olam lease, they don't reset until halfway through the year. So the growth we get out of those that are linked to, say, CPI, we only get half a year's growth with the higher inflation. But yes, no material rent reviews this year, but obviously, the high inflation will continue the growth in rent.

Our next question comes through from James Ferrier from Wilsons.

Can I, first of all, ask you about the Baamba Plains and Mayneland properties and what your current thinking is or expectations around where a likely tenant is going to come from and timing there?

Yes. Thanks, James. Look, I think it will take 1 to 2 years to get those properties into shape so that we can rent them out. It takes time to do development. It takes time to get development approvals. So 1 to 2 years. I would not expect leases on those properties during FY '23.

Okay. Second question is around guidance. Can I just confirm that the guidance excludes -- this is FY '23 earnings guidance, excludes any potential income that may come through from many new macadamia leases signed? Did I hear that correctly?

Yes, you did.

Terrific. And the second part of the question around guidance is, there's obviously some net income flowing through the P&L at the moment from these directly operated assets. Can you give us some color, please, on what sort of assumptions you've made around that contribution to income from the directly operated asset in FY '23 guidance?