Rural Funds Group (RFF) Earnings Call Transcript & Summary

Good day, and welcome to the Rural Funds Management Limited financial results webinar for the half year ended 31st of December 2022. [Operator Instructions] And finally, I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome James Powell to begin the conference. James, over to you.

Good morning, ladies and gentlemen, and thank you for standing by, and welcome to the Rural Funds Group financial results presentation for the half year ended 31st of December 2022. Also joining me today is David Bryant, Managing Director; Tim Sheridan, Chief Operating Officer; and Daniel Yap, Chief Financial Officer. As advised by a moderator, all participants are in listen-only mode. [Operator Instructions] And a reminder that the presentation itself, including Q&A, will be recorded. I will now hand over to our first speaker, Tim Sheridan. Thanks, Tim.

Thanks, James. Good morning, everybody. I will provide an overview of the financial results for the half year ended 31 December and an update on the capital management of the group. I'll then hand over to David, who will provide a portfolio and strategy update. Firstly, I'll cover the income and earnings for the group as presented in the table on the top of this page. Property income increased by 7% during the half year compared to the prior period. The increase is mainly driven by lease indexation both from annual indexation mechanisms and rent reviews as well as income earned on development CapEx and new leases. Earnings, as measured by total comprehensive income, increased by 50% compared to the prior period, following independent valuations for macadamia orchards and cattle properties, which are detailed on the next page. Adjusted funds from operations, AFFO, or the net cash generated by the group, was $0.051 per unit. This is lower than the prior period, mainly due to the impact of higher interest rates as well as the timing of the receipt of rent from the TRG macadamia lease, which commenced in January this year. AFFO per unit is in line with the corresponding period when adjusting for the rent attributable to the TRG lease. Distributions are in line with prior forecast being $0.1173 of cash and $0.0047 of franking credits per unit on a full year basis. Next, I'll look at the balance sheet metrics as presented in the second table on this page. Adjusted total assets of the group have increased by $96 million, following a relatively small number of independent valuations conducted during the half. 22% of properties were revalued during the period compared to 74% in the prior financial year. External borrowings increased primarily as a result of capital expenditure being deployed on the macadamia developments. And gearing ended the period at the lower end of the target range of 31%. Finally, the adjusted net asset value per unit has increased by 3% to $2.78 per unit. The table on the next page provides some more details on the contributors to the movement in property values within the portfolio. As shown in the chart, the macadamia and cattle sectors were the main driver to the increase in property assets. Macadamia orchard values increased as capital expenditure was deployed on the properties to develop the orchard and as properties were valued with the TRG lease in place. Two cattle properties were revalued during the period, Rewan and Cobungra. The revaluation on these assets represents a 16% and 28% increase since the last independent valuation. RFM adopted a director valuation, recognizing the impact of recent flooding, which resulted in 3 losses on a small area of the Yilgah Almond orchard. During the flooding in New South Wales, RFM employees worked with the lessees to put in place various measures to protect the Almond orchards from what was one of the most significant flooding events ever recorded on the Lachlan River. These actions have resulted in some additional costs during the half and a $3 million write-down in asset values. The notes on this page provide full details of various accounting adjustments, to reconcile to the total adjusted property assets to $1.5 billion at 31 December 2022. Detailed information on the financial results is contained on Pages 20 to 24 of the presentation. Moving now to the capital management of RFF. During the half, RFF's debt facility was increased by $150 million to $670 million. The expansion of this facility will be used for macadamia developments as well as for other CapEx within the portfolio. In addition to the increase to the core debt facility, a loan of $100 million will be provided by TRG for macadamia developments. As RFF's debt will increase over the forward period, RFM has been active in acquiring interest rate hedges, with $175 million of forward dated hedges entered into since the start of the financial year. As can be seen in the chart, RFF's hedging will increase from the $190 million to $402 million in FY '24 and increase again in FY '25. RFF's portfolio of hedges has an average weighted duration of 6.8 years at an average rate of 2.71%. I'll now hand over to David.

Good morning, ladies and gentlemen. I'll start by providing a portfolio and strategy update. In recent years, RFF's investment strategy has focused on assets in Central and Southeast Queensland. The map on this page shows properties located between the Sunshine Coast at just north of Brisbane, and Rockhampton in Central Queensland. In these regions, RFM is focused on the acquisition of cattle and cropping properties and assets which can be converted to macadamia orchards as well as established orchards. Over the past 2 years, RFF has acquired the majority of assets or natural resource assets required to develop 5,000 hectares of macadamia orchards, which will be completed at a rate of approximately 1,000 hectares a year. In September last year, RFM announced that it has entered into an agreement with The Rohatyn Group to lease the first 3,000 hectares. To date, RFM has substantially completed the first 1,000 hectares of this development. The locations of these plantings are in Maryborough, Bundaberg and Rockhampton. The specific properties are outlined in red on the map. And consistent with other horticultural leases within the portfolio, rent will be calculated on the cumulative capital expenditure, that is spent on the orchard developments as well as on the value of applicable land and water, which has already been acquired. The majority of the TRG developments are expected to be complete by the end of FY '24 with lower amounts of CapEx in the subsequent years. The completion of these developments will contribute significantly to RFF's AFFO over the coming years. The development of a further 2,000 hectares is forecast to commence in FY '25, and RFM will seek a potential lessee over the intervening period and particularly as we come closer to the commencement of these developments. The portfolio also includes several other properties that RFM will seek lessees for after initial developments have been completed. These assets include 475 hectares of mature macadamia orchards, 3 cattle properties and 2 cropping properties, and there's more detail on the following slides. One of the strategies RFM has been using to increase income and asset values within the portfolio is converting assets to higher and better use. As detailed on the previous page, to date, RFM has developed 1,000 hectares of cattle and sugarcane properties over to macadamia orchards as these assets are now valued as macadamia orchards with a lease in place. The properties have received an average 21% valuation uplift in the period. There are 2 main locations where the macadamia developments are occurring, but being Rockhampton and Maryborough. These 3 images in the top half of this page show some of the activity occurring on the Rockhampton properties and demonstrate the basis for the valuation increases. The first 2 pictures show the properties prior to development with the delivery of irrigation infrastructure. The poly pipes in these images are 20 meters long and 1 meter in diameter and will be used to construct a 6-kilometer -- or construct 6 kilometers of irrigation pipeline from the Fitzroy River to water storages on Riverton and Rookwood Farms. The third picture in this series taken this month shows new plantings, which form part of the initial 183 hectares planted at Riverton. The pictures along the lower half of this page show the progress of converting sugarcane properties in Maryborough. A total of 10 cane farms in Maryborough will be developed for TRG. Some of the stages include the installation of river pumps for irrigation, tree training for newly planted trees and Orchard maintenance for 1-year old trees. RFM is very pleased with the progress of the developments and the standard to which the orchards are being developed, which will benefit both the lessee and the Rural Funds Group. Another strategy being carried out by RFM is the productivity improvement of various natural resource assets. This is a strategy which RFM has successfully implemented on cattle properties such as Rewan, Comanche and Home Hill, increasing both their values and income production. Productivity improvements on cattle backgrounding properties seek to improve the rate at which cattle can be stocked and put on weight. This is broadly achieved by improving pastures developing cultivation area and adding irrigation infrastructure. The pictures on the right show cattle in cultivation areas on Rewan, the development of cultivation area typically doubles the carrying capacity compared to common pastures such as [ buffer grass ], irrigated improved pastures shown in the far right image would increase this again fourfold. Two cattle properties, Cerberus and Yarra are undergoing similar improvements, after which RFM will seek lessees. RFM has also overseen the development of cropping properties by increasing storages and irrigated cropping areas to provide higher and more reliable returns per hectare to their operators, supporting higher values and higher rents. The 2 properties are currently being developed, Mayneland and Baamba Plains. When acquired in September 2018, Mayneland had 4,350 megaliters of water storage and 485 hectares of irrigated cropping land. RFM has completed the development of 1 additional storage and 360 hectares of additional irrigated cropping area, and are planning a second water storage to support further irrigated area. Baamba Plains has similar developments underway in early stages, reflecting the fact that its acquisition was November '21. The development of water storage in the adjacent picture shows nearly 1 million cubic meters of earth or part thereof being moved for the first water storage. These 4 properties represent $104 million worth of assets, which will be developed for leasing in the coming years. An additional property aggregation, Kaiuroo, will be settled by RFF prior to November '23, and it too will have both cropping and cattle productivity improvement opportunities. As shown on the property compendium on this page, productivity improvement and higher and better use strategies are applicable to 47% of the assets owned by RFF. The macadamia development productivity improvements and the settlement of Kaiuroo will increase gearing to 40%, assuming no revaluations across the portfolio. I will now move to the outlook for the group. The map on this slide shows the current portfolio of assets, sectors and climatic zones. The majority of assets are leased with the majority to corporate lessees. In terms of the broad sector conditions, many agricultural operators across the continent are continuing to experience very good seasons. While some commodity prices have softened over the past 6 months from their highs, most remain above their long-term average. Cattle and cropping operators particularly continue to be profitable as do certain wine producers, as evidenced by the Treasury Wine Estates result released last week. And exemption -- an exception to this is the macadamia price, which has fallen to around $2.50 a kilogram from a 10-year average of $5 a kilogram. As outlined in the previous results presentation, RFM believes this fluctuation to be a normal response to supply and demand conditions, which were impacted during the COVID period for a range of reasons and which is likely to last a few years. While the lower macadamia prices impacted the forecast operating revenue from the 2 mature orchards operated by RFF, it is largely irrelevant for the orchards under development, which represent, by far, the biggest portion of capital as those trees will start to produce at time when prices are likely to be back on the rise. Almond prices have also declined, but not to the same extent as macadamias and producers in this segment remain profitable. The next slide shows the various lease indexation mechanisms across the portfolio grouped into 3 main categories. 1/3 of the lessee is index at CPI, another 1/3 have a market rent review mechanism, which seeks to monetize the impact of improving asset values such as through the strategies that I've discussed today. The portfolio weighted average lease expiry is 12.3 years, an increase of 3 years since the last reporting period, reflecting the impact of the 40-year lease with TRG. The completion of the TRG lease was one of the main highlights for the period. In addition, management are focused on capital management by increasing interest rate hedges as we enter a period of higher debt and interest rates. However, FY '23 forecast AFFO has been impacted by the expectation of further rises in interest rates, the impact of further deterioration in the macadamia price for that part of the macadamia assets that we're operating for now at least. And with the flood mitigation costs that were incurred on the almond orchards. As a result, RFM is revising FY '23 AFFO to $0.107 but will maintain the prior distribution forecast. To improve future AFFO generation for investors, management will continue to focus on the development of the macadamia orchards and productivity improvement for unleased cattle and cropping properties. RFM will also focus on the leasing of these assets at the appropriate phase in their development. This concludes the formal component of today's presentation, and we'll now address questions from the participants.

I'll now hand back to the operator to unmute the lines of any participants who may have questions. Thank you, operator.

[Operator Instructions] And your first question comes from the line of Annabelle Atkins from JPMorgan.

Just on your revals being driven from the cattle and the macadamia sectors of the market. Just wondering if you can give a bit more color on transactions you're saying that would underpin those revals?

Yes. So those revals are all based on comparative sales that have occurred. So they're supported by transactions in the relevant areas. But there have been -- the last few months since interest rates have really increased, there haven't been that many transactions occur. And that's because farmers typically don't sell their farms over summer, and they wait until the growing season in the autumn or spring. So there haven't been that many transactions, but they're the ones -- those values are supported by transactions that occurred within the area.

Okay, right. So then transactions over BCR, but though you is basing their valuations on transactions over the past 12 months, is that what you're saying?

Yes, that's right. That's right. They look back several months and just get a pool of acquisition. So sometimes -- as the market increases as it has, valuations can slightly lag because they're looking at the average of the data set of transactions.

Yes. Okay. Also putting a number of forward-dated hedges, just wondering how you're feeling about your head rate going forward and whether you'll interested in lifting that hit rate further?

We'll look first -- further opportunities as I present, but we have significantly increased it next year. And the TRG loan that's coming in, it is also fully fixed. So we do have quite a high level of hedges going forward, but we'll continue to look for opportunities.

Your next question comes from the line of James Ferrier from Wilsons.

Could I ask, first of all, perhaps probably a question for Tim, given it relates to some of your earlier comments, the reval uplift on the 2 cattle properties, Cobungra and Rewan. Rewan, we've seen sort of a series of reval gains and a lot of that has been driven by the productivity improvements, on the property. Can you just clarify whether there have been further improvements to the carrying capacity there or whether it's purely market transactions? And then likewise, on Cobungra, to what extent there have been productivity improvements that have sort of driven or influenced this reval?

Yes. So first, talking to Rewan. The improvement in carrying capacity since the last independent valuation is about 10% and then the rest is market. So yes, the carrying capacity increased by 900 head, I think, on that property. So it makes up a fairly large portion of it. In relation to Cobungra, that, it was mainly the market. So the carrying capacity did increase, but it was immaterial increases. So it still continues to be main lead of the market.

Yes. And with Cobungra, just remind us where it fits in terms of the rent review timing with the tenant there?

Yes. So the rent review on that property, I think, is due in 12 months -- or -- yes, about 12 months. So that property is up about 40% [ since ] purchase. But when you're looking at the rent review, you need to back out the annual indexation that occurs on that lease and CapEx. So you could expect, based on the current valuation, that rent should pick up by about 30%.

Yes. And Tim, that sort of 30% figure, you mentioned there that's essentially backed by the productivity gains that have been realized since acquisition.

Yes. Productivity, well, the market rent reviews are just based on the valuation. So it captures both market movements and productivity gains. So it's because of a combination -- I don't think the productivity improvements on Cobungra are yet up by that much. It is mainly market that's driving that. But I mean that's certainly the focus now. As land values -- I think the growth in land values will ease. Our focus is very much on getting the productivity realized in these valuations.

Yes. Okay. That's very helpful. Second question is just around the first half AFFO. Can you just clarify what you mean by the adjustment to the lease payment attributable to the TRG lease? Because I guess our understanding was that the lease income there was effective from a P&L perspective effective on the 1st of July. So just, Tim, can you clarify what that reference means.

Yes. It is -- so it's backdated to the 1st of July. However, following serve approval, which occurred in late December, there was a notice period until the lease commenced. So the lease didn't actually commence until January. So -- but it is backdated to the 1st of July. So the earnings will all be realized in the second half, but it will be unchanged from what we were forecasting.

Okay. So the $0.051 doesn't have anything in it for the TRG lease from an accrual accounting perspective?

That's correct. So if you add what it would have been in the first half and what we -- the additional amount we will receive in the second half, it would take it to $0.058, so be in line with the prior period. So we'll see a much higher in the...

Yes. Okay. And that's sort of just -- and finally for me then just linking into David's comments around the adjustment to full year guidance. There's nothing in relation to the TRG lease that's influencing that change in guidance. It's the further increases in interest rates, the macadamia prices on the operated orchards and the flood mitigation efforts for almonds.

That's correct, James -- roughly speaking, that account for about 1/3 each of the reduction in AFFO forecast.

[Operator Instructions] And there are no further questions on the phone at this time. So I'd like to hand back to James.

Thank you, moderator. We do have some questions that have come through via the questions box to click on the hand button to submit a question to us if you do have one. I'll hand our first one to Daniel Yap, which is just referring to the income attribution of operating assets.

So the question is asking how much of -- how much of the AFFO is being contributed by the operating assets that the group is currently operating? So these are relating to the farming operations that the group is currently conducting, including cattle operations, the macadamia -- mature macadamia operations as well as cropping operations. So these are influenced by the timing of when the crops are realized or the farming operations receive cash. So we recognize AFFO in line with the cash that we received from the farming operations. So for the first half of FY '23, the AFFO contribution from the farming operations was approximately $700,000. We are expecting the second half of FY '23 to have an increase in farming contributions, and that's really due to the timing of when we are realizing some of these farming AFFO. So over the course of the year, we're probably seeing the AFFO contribution from the farming operations being about 5% over the course of the year.

David Bryant here again. We've got a question here, which is, what is the longer-term outlook for AFFO earnings given you have lowered FY '23 guidance. Thank you for the question, Larry. So the longer-term outlook is for AFFO to rise and that is driven primarily by the indexation mechanisms in our leases, the rent reviews to markets that occur in our leases and then you can have the valuations of properties rising without us doing anything to improve the property, the valuations can rise simply because commodity prices are rising. And keep in mind that commodity prices are food and food causes inflation, and we're in a period of inflation and what have we seen rising commodity prices. So it's a large component of the valuation increases that we've been seeing on our assets. So the second component is an increase in the value of properties and therefore, that flowing through to increase rents. And then the third driver of this outlook for rising AFFO is the productivity improvements that we continue to achieve through investment and through management of these properties. And that's actually a very significant component of what's occurring in the portfolio and those increases that we'll see on AFFO, significant component of the investments that we're making as well. So one tailwind that we -- sorry, one headwind that we will have to that outlook for rising AFFO is increasing interest rates. Now we're managing that primarily through hedging and also through our expectation that monetary policy will work and that over time, the need for interest rates to continue to increase, will diminish because the pain will start to bite. And I suppose we can see even evidence of that in our own AFFO. So that monetary policy will work. Inflation will subside and interest rates will, at the very least, stock increasing but most probably come off somewhat. We're not expecting to return to a period of free money that we experienced in -- during the COVID period. So we think that, that headwind that we currently have will subside and that the drivers of AFFO will come to the fore and continue to increase.

And Larry, you had another question on, [ it was Yarra ] AFFO due to higher interest rates, macadamia prices and floods and the timing of TRG income, I guess, correct. But the only point I'd make is the timing of income from the TRG lease will be caught up in the second half.

We currently have no other questions through to our speakers. So we'll just pause for a moment, and I'll allow for any final questions.

Actually, just -- or we pause, probably just worth emphasizing that higher interest rates are going to be with us for some time. Lower macadamia prices will be with us for some time. And in both instances, I'm talking, I expect 2 or 3 years, within the next year or 2, we should start to come through the peak in those cycles, and we will start to see improvements. But it's just worth noting that those 2 challenges will be with us for a period of time. The floods have been and gone -- and so that's been dealt with.

We don't have any more questions. So thank you very much, everybody, for your attendance and your interest in the Rural Funds Group. We look forward to reporting to you again in 6 months' time if we don't speak before then. Thanks once again.

That does conclude our conference for today. Thank you for participating. You may now all disconnect.