Full Year 2019 Rural Funds Group Earnings Call
Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Rural Funds Group earnings conference call or presentation Tuesday, August 27, 2019 at 1:00:00am GMT
TEXT version of Transcript
* David Anthony Bryant
Rural Funds Group - MD & Director of Rural Funds Management Limited
David Anthony Bryant, Rural Funds Group - MD & Director of Rural Funds Management Limited 
Good morning, ladies and gentlemen. Welcome to the presentation of the financial results for the Rural Funds Group for the 2019 financial year. This is David Bryant speaking.
This morning, we have made 2 important ASX announcements concerning the Rural Funds Group. The first announcement is the annual results presentation, which I will take you through shortly. And the second announcement is the release of a report from EY, concerning recent allegations made by Bonitas. The EY report confirms that Bonitas allegations are not substantiated and RFM's rebuttal of all allegations are corroborated. This concludes this matter for RFF.
RFM will commence legal action against Bonitas for its deliberate and malicious publication of documents, which we contend constitute misleading and deceptive conduct.
Let us now move to the real business of RFF, buying properties, improving them and renting them out. This morning, I will present to you the first 4 sections of the presentation. At the end of this, we will take questions when I'll be assisted by Stuart Waight, Daniel Yap and James Powell.
Page 5, tables various measurements of RFF's income and earnings for the financial year ended June 2019 compared to the previous financial year. Property revenue has increased by $15.3 million or 30%, primarily as a result of additional lease income from various transactions and acquisitions, which are detailed on subsequent pages of this presentation.
Total comprehensive income and earnings per unit are presented next in this table. Both of these metrics are lower compared to FY '18 due to an $18 million decrement in the value of interest rates swaps. This decrement is a noncash item and the consequence of decreased long-term interest rates.
The key metric of AFFO, being the measure of free cash flow generated by the fund, increased by $11 million and 4.7% on a per-unit basis. This is in line with the forecast made last year. The continued growth in funds from operations means that distributions paid for the year were 78% of free cash flow.
Referring now to the bottom table on this slide, FY '20 AFFO is forecast to be $0.14 per unit, representing a 5.3% increase on FY '19. You can just go back. I'll just draw your attention to the bottom table once more. Please note that there's a typographical error in this table. The top right cell of the bottom table should read $0.132, not $0.133 per unit, my apologies.
Page 6 of the presentation provides a summarized balance sheet and key portfolio metrics for 30 June 2019 compared to the previous financial year. An increase in adjusted total assets of $222 million was primarily a result of transactions funded from the entitlement offer conducted in July 2018, which raised $149.5 million.
The entitlement offer provided funding for 2 transactions with Australia's largest beef processor, JBS, as well as $100 million of balance sheet capacity for additional acquisitions. The acquisitions made using this capacity are set out in a footnote on the next slide.
RFF's gearing of 31.2% is within the target range of 30% to 35%. By the end of this calendar year, it is expected that 3 further acquisitions, listed at footnote 3 on this page, will be settled, and RFF's portfolio of assets will comprise 50 properties compared to 38. These acquisitions and forecast capital expenditure will be funded by unutilized debt capacity and retained cash. The weighted average duration of leases of RFF's properties is 11.2 years, which provides predictable income to the Rural Funds Group and its unitholders.
Page 7 provides a graph of the increase in fund's assets derived from acquisitions, capital expenditure and valuation movements. These have been categorized by agricultural sector and color-coded accordingly. Starting with the left-hand side of the chart, the poultry assets continue to be depreciated by the directors of RFM, reflecting the approaching end to the useful life of half of the shed capacity.
The next movement is the -- in this chart is $120 million in the cattle sector. The Rural Funds Group acquired 3 feedlots and 5 backgrounding properties during the FY '19 period. The transition into the cattle sector has been part of RFF's strategy to acquire assets, which offer the potential for higher total return through investment that generates increased productivity.
Moving towards the right of the chart is an increase of $51 million in the value of almond orchards. The majority of this increase is driven by capital deployed on the final stages of the development of the Kerarbury orchard.
The cotton sector grew by $19 million, primarily as a result of the -- an acquisition of a property called Mayneland, which also offers potential for development gains. Valuations for each of the 7 vineyards owned by RFF were recently completed. And as a consequence, these assets recorded an uplift of 34% compared to their prior book value of $48 million.
Finally, the portion of RFF's water not encumbered by a long-term lease was revalued, resulting in a valuation uplift to $5,500 per megaliter.
A table describing win assets were last independently valued, and the companies which performed these valuations is included in the appendices to this presentation.
This concludes the financial results section of this presentation. The appendices contain additional pages, which provide further detail.
We now move to the capital management aspects of RFF. The left-hand table presented here provides key movements for the period relating to the fund's equity capital. The most important point here is the expansion of -- in the fund's equity base, following the rights issue completed in July '18.
The chart at the bottom of this slide shows the performance of RFF's trading price compared to other REITs. As can be seen, RFF's trading price underperformed the rate index as short positions increased and following the release of the Bonitas document. The right-hand table provides details on RFF's expanded and extended debt facility.
Page 10 provides more detail on the -- sorry, my apologies, Page 10 presents more detail on the debt facility and interest rate hedging position of RFF. At year-end, the debt facility had headroom of $44 million, sufficient to fund the acquisitions and capital expenditure discussed earlier.
RFF's loan-to-value ratio or LVR at 30 June is 41% compared to the gearing reported on Slide 6 of 31%. The difference between these 2 figures is due to the $75 million guarantee associated with the JBS transaction, which is added when calculating LVR. The LVR is well within the 50% limit. Finally, 56% of RFF's debt is hedged for an average period of 8 years.
In this next section, we provide an update on a number of the assets within RFF. During the past year, RFM has focused on refining the development programs of assets and improving lease structures. An example of such an improvement is the new lease of Rewan to the Australian Agricultural Company. As many of our investors would recall, Rewan was part of the first group of cattle properties acquired by RFF in 2016. Our strategy in making these acquisitions was twofold: diversify RFF climatically; and secondly, to invest in assets that possess the potential to be developed to improve their productivity, value and rental income.
Cattle JV, a wholly-owned subsidiary of RFM, leased the property because, at the time, no corporate third-party lessees could be arranged. During the intervening period, RFM managed development of additional water points, improved pass-through and cultivation area with the resulting increase in the productivity of the property. The improvements have increased the value of Rewan and income generated by this asset under the new lease.
We move now to an improvement being made to one of our almond lessees. RFM will seek approval from the investors of 3 tax-effective MIS schemes to merge and restructure their investments, which are lessees to RFF. Part of this process is the conversion of tax-effective MIS schemes to a trust structure. In RFM's opinion, this improves the investment for the investors in these funds.
During the period, RFF acquired Mayneland, a cotton property in Central Queensland, which is located 25 kilometers north of Lynora Downs, the other cotton asset owned by the fund. RFM will operate Mayneland during this current financial year on terms that exceed offers to lease the property from third parties.
During this year, RFM will manage the development of unutilized water entitlements on Mayneland to improve economies of scale and make the asset more financially attractive to third-party lessees.
Cotton yields achieved in the past year were up to 12.5 bales per hectare on Lynora and 15 bales per hectare on Mayneland. These are record yields for this district and support the investment in cotton farms in this region.
Turning to macadamias. RFF will acquire a small sugarcane farm to develop to a 40-hectare macadamia orchard. This property, called Cygnet, is within 1 kilometer of an existing RFF macadamia property. The development will be managed by utilizing the RFM management that run the existing RFF orchards. While the cost of this acquisition and development at $3.5 million is not substantial, it will provide an opportunity to expand in a prosperous industry and commence discussion -- discussions with third-party lessees.
Page 13 illustrates some lease developments underway on RFF's properties. The projects on cattle assets involved improving access to water and higher-quality feed and in the case of cotton properties, an increase in the irrigable area and water storage. The common element of these activities is that they are seeking to improve the productivity and, therefore, value of each asset. This increased value can then be monetized at either a rent review or lease renewal.
Page 14 shows the forecast FY '20 revenue impact of acquisitions and developments, which have been outlined in this presentation. This is being presented by agricultural sector, asset type, indexation method and climatic zone. There remains a clear opportunity to further improve climatic diversification. In a paper released in 2016 on the ASX, RFM identified 3 climatic zones within Australia and, since that time, has concentrated on opportunities in Northern Australia.
Page 16 shows RFF's historic and forecast distribution growth. RFF's distribution growth is supported by a relatively low payout ratio of the free cash flow or AFFO that is generated by the fund. The growth in AFFO is supported by rental indexation, market reviews and retained cash flow that is reinvested in income-generating assets.
In conclusion, RFM will continue to improve and refine RFF's properties. Examples in this results presentation include the lease of Rewan to AA Co, the almond merger and the development plans arranged for many of RFF's newly acquired assets. RFM will also continue to pursue additional acquisitions, which would benefit from productivity development. These acquisitions will most likely include a 5-year rent review in the lease, thereby adding to the pipeline of opportunities for increased cash generation.
This concludes today's presentation and the reporting of the full year results for FY '19. The appendices provide more information on the results, assets and leases, which you may find useful.
I'd like to now invite questions from participants. So if you bear with us one moment, we'll arrange for questions to begin.
Questions and Answers
David Anthony Bryant, Rural Funds Group - MD & Director of Rural Funds Management Limited 
Okay. The first question we've got by our email or via the facility -- the text facility is whether the cattle revaluations relate to just Rewan or other assets?
It's primarily just Rewan is the simple answer to that.
Now next question. Could you please discuss the change in FY '20 almond CapEx? Assume this reflects the use of existing water assets rather than seeking new acquisitions.
Just give us a moment -- that's a question from Jonathan Snape. Thanks, Jonathan. Give us a moment. We will clarify that.
Okay. And then there's a question, given the falling interest rates, will RFM be seeking to expand the debt facility available to it?
We have a policy -- I'll address this in 2 ways. We have a policy in relation to hedging, which is to maintain hedging at about 50% of outstanding debt. We'll continue to adhere to that policy despite the mark-to-market losses that we've experienced this year.
In terms of expanding debt, there is no intention to expand debt unless we were to consider raising new equity. There is no plans to do that at this stage.
There is a question, is any formal report by EY on the Bonitas Shorts or paper being provided.
Yes, that was released on the ASX this morning that -- it would have been posted just after the financial accounts.
There's another question about the -- this Bonitas paper and the lease calculations and how were they verified.
EY provides a large amount of detail in how they verified the lease calculations or lease rentals. I think it's adequately addressed in the report. So I'll leave it at that.
We have another question. Having regard to the anti-animal protest taking place, do you intend to expand cattle acquisitions?
Yes, we do. And we will expand cattle acquisitions, equity and debt permitting on the basis that they -- that the animal welfare aspects of this industry are appropriately addressed by our lessees, as is the case at present. Might just also draw your attention to a research report, which we have posted on the RFM website in relation to meat substitutes.
There's been a lot of news recently about impossible burgers and things like that but use a meat substitute. There is a very good research report published by Rabobank. We've made that available on our website. If you go to the home screen on the RFM website and just scroll to the bottom, you will see a reference to it there. Longer term, we will have it posted probably for some time in the new section of the website as well.
Another question, a general comment on the outlook for large-scale macadamia developments.
That's something we're doing quite a bit of work on. The Cygnet acquisition is only a small-scale acquisition but -- or development, but the idea is to start a conversation with lessees about leasing larger developments. The macadamia industry is a very prosperous industry though relatively or very small by world standards compared to the other tree nut crops.
Some of the cattle assets that we have acquired in RFF have that dual-purpose where they could be converted. They have irrigation entitlements and access to further entitlements possibly, and that would enable them to support large-scale macadamia developments. The cost of the acquisition of the land for these developments would be very low by comparison to other districts. So RFF is positioned very nicely to pursue development in that area, assuming that we can attract lessees and assuming that we can get the numbers to add up, which at the moment, I have no doubt about because of the acquisition price of some of these assets and also just the prosperity in that industry.
Longer term, will macadamia prices decline? There's no evidence of it yet. Chinese production has increased enormously, but seeing consumption of tree nut crops double within a decade is not uncommon for other tree nut crops. And so the ability for the market to absorb increased macadamia production we think is very strong.
There's a question about whether we consider legal action regarding to Bonitas, even though it's -- they're maybe outside our legal jurisdiction. That's something we've considered. And for that reason, RFM, not RFF, will bear the costs of that legal action.
We have a question here, general comment on water prices in the Southern Murray-Darling Basin and implications for development activity.
Water prices have gone up considerably in the last 5 years, I suppose, and we think that they're at levels that make construction of new developments unviable. So if you were to fully water those -- a new development and do that with water acquired at the current market prices, it is no longer economically viable to -- in our opinion.
So we don't expect that the Rural Funds Group will be acquiring any more assets for development in the Southern Murray-Darling Basin because of that. And that's why we have, I suppose, shifted our focus further north. We think there's more economic opportunity in those regions. If we may still acquire marginal additional amounts of water in the south, but they won't be to capitalize or to underwrite any new developments.
Next question we've got is considering our poultry businesses. Can we speak on the direction of that business?
Our lessee rural funds poultry or RFM Poultry, I should say, will report its annual results I think at the end of this week. It's provided market updates by the NSX where it is listed about difficult trading conditions that, that businesses incurred this year. It's incurred an operating loss. This is something that we will just manage. It's, I suppose, over the past -- over 15 of the past 16 years, that business has been managed by RFM profitably. In the past 12 months, it has incurred additional expenditure in relation to repairs and maintenance, energy and labor costs. That is something that we are addressing, and it's just typical of the volatility of an agricultural operating business where things need to be managed, and that is what will be done.
I'm just returning now to one last question. It's come from Jonathan Snape. It's regarding the FY '20 almond CapEx.
I assume this -- Jonathan's question is regarding a change there, and I assume this reflects the use of existing water assets rather than seeking new acquisitions. We've actually reached an agreement with Olam, where their requirement or the requirement to acquire additional water under that lease for Kerarbury has been limited. So it's actually now the actual water requirement that we've agreed is less than what was acquired at the outset or what was agreed at the outset. That reflects the dramatic movement in water values that have occurred. But I will add that RFF holds water entitlements in excess of what is required to adequately water the Kerarbury orchard. And for that reason, we were quite relaxed in reaching that accommodation with Olam.
Ladies and gentlemen, that's -- I think we're going to wind it up now. I think we've covered most of the questions and avoided duplication. There are still some questions that have come in regarding the Bonitas document. And our response side, I'll just ask that you read the EY report, because we think that it very adequately addresses that whole saga, which, as I said at the beginning of my presentation, is now -- it's now time to move on and that we've now, with the release of the EY report, concluded this matter for RFF.
So thanks very much, ladies and gentlemen, for your attendance, and we look forward to presenting to you again in 6 months' time if we don't get to meet earlier. Thank you.