13-Year Lease Extensions And Orchard Developments Will Strengthen Future Income Streams

Key Takeaways

• Development of macadamia orchards and improved commodity prices support revenue and earnings growth through higher yields and enhanced net farming income.
  
• Stable income streams from long leases, asset divestments, and debt management enhance revenue stability and reduce interest expenses.
  
• Challenges in asset value growth, commodity price cycles, and revaluations affect Rural Funds Group's financial stability, with asset sales and costs straining earnings potential.

Catalysts

An agricultural Real Estate Investment Trust (REIT) listed on the ASX under the code RFF.

• Rural Funds Group's development of 3,000-hectare macadamia orchards and other cropping properties is expected to enhance future revenue as these assets mature and generate higher yields, leading to increased rent from lessees and contributing positively to net property income.
  
• The completion of capital expenditure programs and improvements in agricultural commodity prices are expected to bolster net farming income, enhancing overall earnings and supporting better performance from farming operations in the second half of the financial year.
  
• Successful lease extensions, rent reviews, and a long weighted average lease expiry of 13 years indicate stable and growing income streams from high-quality lessees, which should positively impact revenue stability and cash flow.
  
• Asset divestment plans and debt management strategies, including the reduction of gearing through asset sales, position the company to better manage its capital structure and enhance net margins and earnings by reducing interest expenses.
  
• Increased efficiency in cropping operations, particularly with developments that expand irrigated areas and improve water management, is expected to lead to higher crop yields, further improving the profitability and value of these assets, which could drive revenue and earnings growth.

Rural Funds Group Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Rural Funds Group's revenue will decrease by 2.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 39.8% today to 58.1% in 3 years time.
• Analysts expect earnings to reach A$65.8 million (and earnings per share of A$0.16) by about May 2028, up from A$48.6 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting A$114.7 million in earnings, and the most bearish expecting A$46.6 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.0x on those 2028 earnings, up from 14.2x today. This future PE is lower than the current PE for the AU Specialized REITs industry at 20.0x.
• Analysts expect the number of shares outstanding to grow by 0.38% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.72%, as per the Simply Wall St company report.

Rural Funds Group Future Earnings Per Share Growth

Risks

• Negative revaluations on interest rate swaps and property valuation movements have contributed to lower earnings, affecting the financial stability and overall attractiveness of the Rural Funds Group's financial results.
  
• Asset sales are being targeted to manage gearing levels, indicating potential challenges in maintaining asset value growth, which could impact the earnings potential if returns from these divestitures are not favorable.
  
• The fixed and variable costs associated with ongoing developments and expansions in cropping properties and macadamia orchards may strain net margins in the short term, especially if expected productivity gains are not realized promptly.
  
• The group’s reliance on agricultural commodity price cycles poses a risk to revenue stability, as sudden downturns in commodity prices could negatively impact income from farming operations and leasing.
  
• A potential stagnation in asset valuations, as suggested by flat valuation trends and the influence of interest rates, could pressure future earnings growth and leave less room for leveraging asset appreciation to bolster financial performance.

Valuation

• The analysts have a consensus price target of A$2.192 for Rural Funds Group based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$2.51, and the most bearish reporting a price target of just A$1.84.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be A$113.2 million, earnings will come to A$65.8 million, and it would be trading on a PE ratio of 16.0x, assuming you use a discount rate of 6.7%.
• Given the current share price of A$1.77, the analyst price target of A$2.19 is 19.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.