You May Have Been Looking At Rural Funds Group (ASX:RFF) All Wrong
Rural Funds Group is a AU$722m small-cap, real estate investment trust (REIT) based in Deakin, Australia. REIT shares give you ownership of the company than owns and manages various income-producing property, whether it be commercial, industrial or residential. The structure of RFF is unique and it has to adhere to different requirements compared to other non-REIT stocks. I’ll take you through some of the key metrics you should use in order to properly assess RFF.
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Funds from Operations (FFO) is a higher quality measure of RFF’s earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For RFF, its FFO of AU$31m makes up 69% of its gross profit, which means the majority of its earnings are high-quality and recurring.
In order to understand whether RFF has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take RFF to pay off its debt using its income from its main business activities, and gives us an insight into RFF’s ability to service its borrowings. With a ratio of 11%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take RFF 9.01 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.
I also look at RFF’s interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it’s better to use FFO divided by net interest. With an interest coverage ratio of 2.81x, RFF is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.
I also use FFO to look at RFF’s valuation relative to other REITs in Australia by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In RFF’s case its P/FFO is 23.53x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.
Next Steps:
In this article, I’ve taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Rural Funds Group can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:
Future Outlook: What are well-informed industry analysts predicting for RFF’s future growth? Take a look at our free research report of analyst consensus for RFF’s outlook.
Valuation: What is RFF worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether RFF is currently mispriced by the market.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
