Rural Funds Group (RFF) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Rural Funds Group 1H '25 Financial Results Presentation. [Operator Instructions] I would now like to hand the conference over to James Powell, General Manager, Investor Relations. Please go ahead.

Good morning, and welcome to the financial results presentation for the Rural Funds Group for the half year ended 31 December 2024. Presenting today is David Bryant, Managing Director; Tim Sheridan, Chief Operating Officer; and Daniel Yap, Chief Financial Officer. After the presentation, we've allowed time to take questions from attendees. [Operator Instructions] I'll now hand over to our first presenter.

Good morning, everyone. I'll present the financial results for the half before handing over to David Bryant, who'll provide a portfolio and strategy update. Firstly, by way of summary, from an earnings perspective, as I'll detail on the next few slides, first half '25 has been a positive period for the group. Net property income is up 17%. Revenue from farming operations have reverted from a loss-making to a profit and AFFO is up compared to the prior period. From a balance sheet perspective, gearing has not increased despite income-generating CapEx being deployed on development assets. In line with our intention to bring gearing back towards the target range, RFF divested $55 million of assets in line with book values. An additional sale has been contracted, and we've identified further asset sales to target for the year ahead. Leasing activity during the period accelerated with 8 properties leased, demonstrating ongoing appetite from corporate and institutional entities to lease high-quality agricultural assets. These and other activities contributed to maintaining RFF's long WALE of 13 years, which supports providing stable income generation to our investors. By extension, we are pleased to announce that RFF has delivered on distribution and AFFO forecast in the first half, and is on track to achieve full year forecast, which we are reaffirming today. Now moving on to the financial results in more detail. The first slide of this section provides a more granular analysis of RFF's key earnings drivers for the period. Net property income from leased assets increased 17%, up $7 million to $45 million. The increase is mainly due to additional rent being generated from the lease of macadamia orchards, which are being developed. Also contributing to this was annual lease indexation and market rent reviews on 3 cattle properties. On a full year basis, these market rent reviews, which are based on independent valuations, resulted in a 34% uplift in rent. Net farming income, that is the operating result on approximately 15% of the assets which are operated by RFF, provided a positive contribution for the period, having incurred a loss in the prior period. This result is largely due to an improvement in agricultural commodity prices and completed CapEx programs coming online. The second half contribution of this segment is expected to be even greater again with the harvest occurring on many of the operated assets commencing over the next few months. Adjusted funds from operations, the net cash earnings measurement of the group, increased significantly compared to the prior period. However, we are forecasting less of a skew in the second half over the full year, resulting in a full year forecast AFFO of $0.114 per unit, which is a 4% increase on the FY '24 result. Earnings, including noncash items, were lower than the prior corresponding period. This current period result was mainly due to negative revaluations on interest rate swaps as well as property valuation movements, which I'll discuss in more detail on the following pages. Finally, on this page, RFF paid 2 distributions during the half, totaling $0.587 per unit, which was in line with forecast. Now looking at the balance sheet. Assets decreased marginally during the period through a combination of divestments and offset by valuation movements driven by CapEx. The adjusted NAV per unit at 31 December was $3.10 per unit. Gearing remained largely unchanged at 38.6% despite the capital deployed for the macadamia developments during the period. This was largely because of the mentioned divestments. These transactions demonstrate RFF's commitment to managing RFF gearing through appropriate asset sales. The next page provides a more granular analysis of the property valuation movements that have occurred within RFF over the past 6 months. RFF has a policy to independently revalue all assets at least every 2 years. During the period, 30% was subject to independent valuations with 70% revalued in the 12 months prior to this. Independent valuations provided a marginally positive result. And on the remaining portion of the portfolio, directors' valuation depreciated certain assets in line with accounting standards. Further evidence to support asset valuations is the divestment of farms, which have occurred in line with book values and favorable market rent reviews on -- which were based on independent valuations. Looking now at the capital management aspect of the group. During the period, RFF's core syndicate debt facility went through a scheduled refinance, including an $80 million increase to the limit for committed CapEx. The core facility remains within all covenants, including the LVR, which decreased during the period from 48% to 46% compared to the covenant of 60%. And the ICR, which improved to 2.2x compared to a covenant of 1.5x. Taking into account the fixed facility and interest rate hedges, 76% of RFF's debt was fixed at 31 December. During the period, RFM also suspended the distribution reinvestment plan given RFF's trading price relative to the adjusted net asset value. Whilst the convenience of the DRP was enjoyed by many of our investors, the dilution from issuing new units at a significantly discounted price to book value of units was deemed not to be in the best interest of all investors. Furthermore, the group does not require any additional equity given the debt funding arrangements that have been outlined. I'll now hand over to David.

Good morning, ladies and gentlemen. This page provides an overview of the Rural Funds Group assets and lessees. The strategy for RFF, which is owned by approximately 20,000 retail investors and a number of institutions, is to generate capital growth and income from developing and leasing agricultural assets. Over the next few pages, I will provide an update on this strategy. A significant feature of the first half of the financial year has been the continued development of the leased 3,000-hectare macadamia orchards and the lease of developed cropping properties. The deployment of capital into these developments have improved a number of the portfolio metrics presented on this page, including forecast revenue generation, percentage of leased assets and weighted average lease expiry. The long weighted average lease expiry and high-quality lessees are an important feature of the Rural Funds Group. During the half, several leasing transactions were completed. This included lease extensions, which were negotiated for 5 of the 6 vineyards leased to Treasury Wine Estates for an average of 11.9 years. This is an excellent result that reflects the high-quality nature of these assets and their importance to Treasury's business. Rent reviews on cattle properties were also completed, resulting in an average increase in rent of 34% for those assets. Many of the assets which have achieved income growth or lease extensions have been developed by RFM. On the next slide, I will present a case study of the improvements implemented by RFM on 2 cropping properties leading to a lease to a global institutional investor. The first cropping asset acquired by RFF in 2016 was a property called Lynora Downs and was leased to a joint venture between Queensland Cotton and RFM. Queensland Cotton's interest in this lease was recently acquired by RFF and a new lessee will be sought. Overall, at the end of the period, 84% of the assets were leased for an average term of 13 years. A key transaction during the period was the 10-year lease of the cropping properties Mayneland and Baamba Plains. This transaction serves as a useful case study of RFM's approach to operating assets while developing and increasing their productivity, which seeks to achieve higher asset values and lease income. RFM managed these developments, which included increased water storage and expanded irrigated cropping areas. Images on the far-right show some of these developments. These improvements have increased the farm's potential profitability and appeal to lessees. Income was generated by RFF through development -- the development phase through a combination of farm operations and short-term leasing. The transaction also included the sale of a 50% interest in the properties, providing capital for RFF to reduce bank debt and provide a confirmation of asset values. Rural Funds management is using a similar approach to generate income from other unleased assets held by the fund. A somewhat unique feature of agricultural property is that it may be able to generate an income from operations when unleased. The table on this page provides an overview of the unleased development assets owned by RFF. During the recent period of lower nut prices, RFM has undertaken various improvements on areas in mature macadamia orchards owned by the group to increase their yield in future years. It is expected that the productivity improvements and macadamia price recovery will make them more attractive to lessees and provide a higher operating return to RFF in the interim. With the development of the 3,000-hectare TRG macadamia orchards expected to be completed this financial year, RFM can now turn attention to the next stage of development on Rookwood Farms. Plans are being finalized for 690 hectares of development, which is expected to commence shortly. Additional cropping properties, primarily sugarcane, are being operated as they are held for potential future macadamia development. Development plans are progressing on the cattle property Kaiuroo to maximize the value of water entitlements through the development of irrigated cotton fields. Similar improvements have been undertaken on Yarra. These developments and other improvements will increase productivity, enhancing value and rent payments once they are leased. Operating income will be generated in the interim where possible. CapEx, which has been committed for these developments is fully funded. Our priorities for the period ahead include continuing to progress asset improvements and seek lessees for these assets at the appropriate time. This is consistent with the broader strategy of the group of generating capital growth and income from developing and leasing agricultural assets. We will work to continue to progress asset sales with the aim of bringing gearing towards the target range of 30% to 35%. We reaffirm full year forecast AFFO of $0.114 per unit, representing 4% growth and distributions of $0.1173 per unit. We also forecast distributions for FY '26 to remain steady at $0.1173 per unit. I'll now invite questions from attendees.

[Operator Instructions] And our first question today comes from Cody Shield from UBS.

Just one on the further asset sales for the year ahead. Can you give a feel for what's being considered here just in terms of asset type and potentially quantum?

Thanks for that. We're looking at assets that are generating low rates of FFO primarily. There's some assets that have increased in value substantially and the FFO or the ranks that they're producing have not. And these are assets where we don't have great optimism about capital growth over the medium term. So it's those types of assets that we're selling. I don't wish to be specific because there's discussions underway with several of these assets, and it's hence commercially sensitive. And so apologies for not directly answering your question.

No, that's fine. And maybe just on the revaluation piece then. How are you kind of thinking about the potential for further asset -- or positive asset revals, I should say, over the next 12 to 18 months? And where does that fit in terms of the gearing outlook?

Look, I think that we've probably reached a stage in the cycle where valuations are going to remain fairly flat. There are some assets that are waiting for valuation and there's some lag, and we'll see some increases. There's nothing to indicate that there is a cause for decreases. Historically, a decline in agricultural land values is driven by commodity price declines, significant commodity price declines. That's not the case. In fact, most agricultural commodities, almost all agricultural commodities seem to be in an up cycle at the moment. But it's the monetary -- where we are in with interest rates, interest rates at these levels are not encouraging farmers or investors to go out and bid up asset values further. The only thing that would change that holding interest rates constant would be a change, a movement in either direction with agricultural commodity prices. But as I say, the outlook for those is pretty good.

The next question is from Adam Calvetti from CLSA.

Just from the directors' report, it looks like you've acquired a 50% interest from Queensland Cotton Corp, and you've also invested in Inform Ag. Is there some kind of rationale and potential ROI on those investments?

Sorry, I picked up the Inform Ag investment. What was the other one, sorry?

Queensland Cotton JV.

So Cotton JV. Queensland Cotton wanted to exit that due to a restructure in their company. We felt that the timing -- the lease didn't have long to run. The timing was good from our perspective from seasonal commodity prices. So RFF bought out that 50% share, and we'll now look to re-lease it, enter into a longer term lease. But that was a -- it was an attractive opportunity from a timing perspective. The Inform Ag decision has been discussed previously, but the -- that's a small investment in a business that has developed a whole range of electronic equipment and software, which RFF has been a very large customer of. Due to the quality of the equipment and software, we could see that there was benefits to investing in the business for a return on investment and also assisting the business with -- in growing itself by a closer relationship. In terms of ROI, both of those investments are predicated on a 15% plus ROI, predicated on that, and of course, time will tell as they are exactly that and an investment.

Yes, that's pretty clear. And am I reading this right, you divested $56 million to bring the LVR down and then you've lent TRG debt drawn down $60 million. Is that right? So the LVR is essentially neutral?

TRG have provided us with a loan, which was -- that was entered into some years ago at the commencement of that 3,000-hectare lease. So TRG have actually loaned RFF and it's a separate facility that gets amortized down throughout the course of the lease.

That makes sense. And it's still one more.

Sorry. It's David Bryant back again. But that -- the loan relates to the 3,000-hectare macadamia development and the $50 million asset sale.

Yes. So that was the 2 cotton properties as well as some sugarcane properties. And we've also entered into contracts to settle a further cattle property in the coming weeks.

And just on the macadamia price, where is the current price at? I think you're assuming $3.70, almost $3.40 in your guidance for the full year. What's the current price?

There is no current price because the market is essentially reopened for the year, but the consensus is that it's up by better than 20%.

Your next question comes from James Ferrier from Wilsons Advisory.

Just firstly, on the Lynora Downs property now that you bought back half of the Queensland Cotton side of things. What's the timing do you think on re-leasing that property? And do you think there's upside in terms of the current lease rate?

Yes, re-leasing, we will enter into the discussions immediately with potential lessees. And in terms of upside, yes, we do think that there is upside on the lease rate, predicated partly on property value, but also due to the performance of the farm. We're expecting much higher crop yields from that farm this year, driven by developments in growing methodology and technology where we're seeing yield increases, so crop yield increases through these new growing systems of 33% to 50% increases in crop yields. And that's a productivity gain based in sound technology that's proven, and we're expecting that will be delivered this year on that farm. And we think that, that will stand in very good stead for re-leasing at better terms.

Understood. On Slide 16, you run through a few of those properties that are currently unleased, development and operated assets. What's your expectations around the revaluation potential on those? I get to the earlier question. David, your comment was that you felt like valuations were fairly flat from here. But on these assets that are undergoing productivity improvements and the like, what's your view on the revaluation potential for those, probably more the cattle and cropping really, less so the macadamia ones?

Yes. Thanks, James. I'll start with the macadamias first. We can develop a farm for, say, roughly $115,000 a hectare fully irrigated with absolutely best-in-class irrigation development and electronic hardware and so on and so forth. Those farms, as they mature and get to full cropping potential or delivering full crop -- and that takes a decade -- but as they do, the capital value for those types of assets approach would be in the range of $160,000 to $200,000 in this market. And that's in today's dollars or both -- all of those figures are in today's dollars. So there is actually capital growth or development profits to be had over time with macadamias, but it takes time. Moving to cattle, productivity gains that we're pursuing on the Kaiuroo, on the cattle portion of the Kaiuroo property, it will be productivity gains that will drive increases in value there. That takes time to flow through those several years. The cropping -- the development of cotton assets in Central Queensland is where we see the most upside from property development, and it's driven by these higher yields that are being achieved by people in Central Queensland and by ourselves. And it's getting real recognition within the very well-capitalized privately-owned cropping industry. There's also significant interest in the institution. So the asset values there, we see more upside in asset values, cotton cropping assets in Central Queensland than we do in any of our other sectors at the moment.

Sorry, were you going to add something there?

No. I was going to ask, did that answer your question? I hope it did.

It did. Last question for me and maybe one for Tim. Some of these comments originally came from Tim at the top there. The guidance for full year AFFO unchanged. I mean, simplistically, if we take the first half, double it and then add on the context of your comment that the farming income in the second half will be a little bit stronger than the first half, that scenario shows an AFFO for the full year above guidance. So just what am I missing or doing wrong in that simple calculation?

There is -- as these developments have been completed, there is some more interest costs flowing into the second half compared to first half. And along with that, some of the water -- all of the water sales for the unleased water were sold in the first half this year. But that being said, I think if -- with the operation -- operational results are looking positive, and we could see some potential for a little bit of upside in the second half. So I guess there is a minor upside risk if it all came through in the second half to the AFFO upside.

There are no further phone questions at this time. I'll now hand over to James for the webcast questions.

Thank you, operator. Just a reminder to all of the unitholders on the line. Thank you for dialing in today. [Operator Instructions] We've had a few people already typed those in so bear with us a moment, and we'll provide some responses very shortly.

That's David Bryant speaking again. We've got a question from -- that is, is it possible that distributions are cut to sit below AFFO, which would, of course, get our payout ratio below the 100% or that the group considers buybacks rather than dividends as it could potentially be a better allocation of investor capital? Thanks for the questions. Our modeling suggests that over the next couple of years, we are headed below the 100% payout ratio. So growth in AFFO will allow us to maintain distributions and have a payout ratio below 100%. And it's based on that, that we see no need to cut distributions or undertake buybacks. So we are, I suppose, steering the ship in a steady course based on the developments that come on stream and the cash flows that are being delivered to the business. If we became -- I mean, if our outlook changed or if it was warranted to undertake a share buyback funded by asset sales in order to, I suppose, prove to the market that these values are real and that they support both the valuations and the share price, that would be something we would consider in the future. But it's not on our radar at present because our objective is to pursue some asset sales to reduce our gearing to within our target range and allow our growth in funds from operations to deliver a payout ratio below 100%. We've got another question now directed to Daniel. I'll hand over to him. I'll just read the question while Daniel is gathering his thoughts. Please tell us more about the interest rate swap revaluations that made such a hole in earnings.

Thanks, David. So I'll just note that these interest rate swap revaluations relate to the derivatives that the Rural Funds Group holds. These are noncash revaluations as well. The valuations are determined by typically market forecasts on interest rates. So that they would look out on a longer term basis and would depend on how the market perceives the interest rate outlook. So as the interest rate outlook decreases, we would expect valuations on these swaps to decrease. But as I mentioned, these are noncash. The swaps are currently in the money position. So they're in about a $30 million asset position. But the reason for the decrement has been that, that valuation has decreased from the prior year.

Seems we have no further questions. So thank you very much for attending our meeting today. We appreciate your interest and look forward to reporting again in 6 months' time. Thank you.

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