FPI - Farmland Partners Moving Aggressively On Asset Sales

2023-05-06 08:21:13 ET

Summary

• Farmland Partners released Q1 results which were broadly in line with expectations/guidance.
• Far more interesting was data they provided about their asset sales and buybacks.
• They announced up to $100m in planned asset sales and guided towards buybacks of up to 10% of shares outstanding.
• Their action validates my FPI investment thesis, which is built upon the underlying value of their farmland assets.

Introduction

Farmland Partners (FPI) released Q1 results. They already guided cautiously in their Q4-2022 call and overall results were in line as was guidance. AFFO/share guidance was upped by 1c on the upper end of guidance. This is due to the much more interesting part of the press release. FPI gets serious in selling assets and buying back their undervalued stock instead.

In this article I will examine their asset disposal and buyback plans in more detail as a positive catalyst for my investment thesis. In addition I will also make some calculations of what it could mean to NAV/share development.

I will mostly refer to their Q1 supplemental package , their Q1 conference call and the 10-Q filing. For more background on FPI I suggest you (re-)read my latest take on them where I laid out in detail what I expect from an investment in FPI.

Q1 results and guidance unexciting

I will keep this short. Q1 results themselves were not too exciting. It shows AFFO being lower than last year mostly driven by higher interest expenses. This effect will only get bigger during the year as the latest Fed action feeds through their variable debt and some more contracts reprice higher.

They also updated their guidance.

As one can see, there is no major change there. Those parts that move a bit are due to the main message in Q1 results: FPI gets serious when it comes to asset sales and buybacks. This results in lower revenue (due to less farms owned), lower interest expense (due to partially repaying debt) and higher AFFO/share due to lower share count vs. their prior guidance. This new data on asset sales is what I want to focus now.

Asset sales and buybacks - FPI gets serious

Here is what Farmland Partners had to say about asset sales and buybacks:

To summarize: They already bought back 2.64m shares. This is roughly 5% of shares outstanding. They sold some farms for $3m after close of Q1 and have contracts in place to sell another 11 farms for $42m. Weirdly enough they seem to know how much they get for those farms but not how much their aggregate gain on sale is. This does not really make sense. Furthermore, they plan on selling additional farms in the range of $37-42m. This adds up to roughly $85m+ in planned disposals. When they provided updated 2023 guidance they also gave more insight into how to use those proceeds:

They plan on using the proceeds to repay debt and repurchase stock. $15-35m goes into debt repayment and $50-60m into buybacks. As this is the full year guidance this should include the 2.6m shares they already bought back so far (for roughly $27m).

While they mentioned buybacks in their prior conference call after Q4 results I admit I am positively surprised by how quickly they got into action. Back then they stated they wanted to reduce their exposure to specialty crop. Is that what they are selling now? No. When they were asked during the conference call whether they sold these specialty crop farms they answered the following:

But to your broader question, most of these sales have been row crop but not in the Midwest, row crop in other regions of the United States. The auctions are going to be a lot of our Eastern Colorado assets and some Nebraska assets where we have water risk. And then we haven't yet but we may consider selling some of the specialty crops for the reasons you and I talked about that you mentioned a second ago, as well as the fact that, of course, those things -- California has long term water risk on many of the assets.

In my opinion this is somewhat unfortunate in that it will further increase FPI's concentration on California and Illinois. On the other hand California should benefit shorter term from recent wet conditions whereas it seems they are selling assets with more current water risk. While they have a clear road map for roughly $85m in sales they guide up to $100m. Therefore it seems that they might actually do more sales of specialty crop farms later in the year and maybe more next year.

About specialty crops they stated the following in their Q4 conference call :

So the lack of rainfall behind us will lead to a relatively challenged specialty crop performance in the 2023 calendar year.

That being said, it does sort of set the stage for what hopefully would be a pretty strong 2024 because we're going to see, a substantial return in specialty crop volumes a little hard to predict price. But we'll see volumes recovers substantially. But that doesn't have an effect, unfortunately, until 2024.

and this about crop:

This is the boom times for row crop, it will go on for at least another year on the row crop side.

While I dislike the increased concentration for California and Illinois shorter term I do believe it is a sensible strategy to not sell specialty crops while they experience some short term issues but when they operate in a more normalized environment. That should maximize sales proceeds. Therefore, I am overall happy with how they approach their asset sales.

Impact on NAV and valuation

How do these asset sales impact NAV/share and valuation? What does it do to my investment case?

Firstly, those sales confirm that the market value of FPI's farmland is well above book value. FPI is able to realize sizable uplifts of around 30% on their sales vs. book value. This is also in line with the estimate they gave on their conference call:

The stock is trading at a substantial discount to what it's worth. It appears to us that the market values our assets at about $1.1 billion. The private market values our assets at approximately $1.4 billion, that difference is what is created a huge discount in our stock.

$1.4bn is 27% higher than book value and seems reasonable given the land price increases over the past years and the gains they can achieve on their sales. Taking that $1.4bn number instead of their $1.1bn book value increases their equity value by $300m.

Adding $300m to $577m and dividing it by 53.1m shares outstanding gives a NAV/share estimate of $16.51. In my past article I estimated it to be about $16/share. Therefore, management statements as well as their transactions confirm this as the right ballpark. I am pleased to state that recent transactions and management commentary all confirm my asset based investment thesis.

How much value do buybacks add?

FPI guided towards $50-60m buybacks which is roughly 10% of their market cap. This sounds very high but how much value do these buybacks truly generate?

When other companies announce a 10% buyback the math is clear. That should give an 11% (1/0.9-1) uplift to EPS etc. As such, the buyback should strongly move the shares higher as most companies are valued on an earnings basis. The main difference between Apple announcing a buyback and FPI doing so is that Apple finances its buyback out of its excess cash flow whereas FPI needs to sell productive assets as all their excess cash flow gets eaten up by their dividend. As I see FPI as an asset play I am mostly interested in how much NAV/share really moves higher due to the buybacks.

I will take the end of 2022 figures from above table and then look at what impact those asset sales and buybacks have.

Year-end 2022 equity value: $594m plus $300m uplift to market value of farms --> $894m. 54.32m shares outstanding leads to a NAV of $16.45.

They already bought back 2.64m shares for about $27m. If I now assume they can buy back another $28m of shares at an average price of $11 that would add another 2.54m shares. Overall share count would be reduced by 5.185m. Not quite 10% as I stick to mid range of their buyback guidance.

How does this change NAV/share? Selling farms at fair value simply increases the cash balance at the expense of land on the trued up balance sheet (it will increase stated book value though as that is shown at cost). Paying down debt is also just an exchange of cash vs. a reduced liability. However buying back stock will reduce the overall equity as well as shares outstanding. The new NAV/share calculation is as follows:

NAV/share=($894m-$55m)/(54.32m-5.185m)=$17.07

This is a somewhat sobering outcome. Buying back more than 9% of shares which would normally increase EPS by 10% for other companies increases NAV/share just by a lowly 3.8%. This much more muted effect of buybacks is because we look at it from a NAV perspective and not from an earnings perspective and from an earnings perspective it would still underwhelm as FPI has to sell productive assets to achieve this.

There is one more thing about buybacks. The bigger the buyback the stronger the effect. If you buy back 10% of shares you increase earnings by 11%. If you buy back 20% you already increase it by 25% ((1/0.8)-1) and so on. This is also true with NAV/share accretion when buying at a discount. Thus it is important to look whether FPI management might be willing to continue selling assets to buy back shares over and above what they have already announced. I already showed that so far they were selling hardly any specialty crop farms. I believe that by year end and going into next year they could continue to dispose of farms to buy back stock at deep discounts. What did management say about this?

As a business, we've always said that we're not emotionally tied to any farm. So if someone makes an offer you can't refuse even for a farm we love we would, of course, sell it.

We will continue to buy back stock until we have closed the gap between what we believe is the fair value of our stock and the price it's trading at.

When asked about whether there is a limit to buybacks they said this:

But the way I look at it is the cheapest farmland on the planet today is our stock and we're in this to make money for our investors. And so if I can buy our farms for, call it, $0.30 less than they're worth and I can -- on a dollar -- 30% discount kind of numbers, why shouldn't we? And that's -- business is buying farmland inexpensively and the cheapest the farmland out there is our stock by miles. So that's what we're really doing. As far as your question, we're not trying to go out of business. I mean, the team here and me, in particular, we built this business, we founded this business. But we're not too proud to aggressively buyback our stock and we think it's trading at a discount

This is the advantage of having an internally managed REIT. As management does not get compensated for sheer size as it is normally the case with externally managed REITs they are also willing to shrink the company if it makes sense. What would the math look like if they were to sell another $100m in farms by end of next year and if they could buy another 5m shares for $55m?

NAV/share=($894-$55m-$55m)/(54.32m-5.185m-5m)=$784m/44.135m=$17.76

Now we are already talking about an 8% uplift in NAV only due to buybacks and selling in total about $200m of their $1.4bn portfolio.

In my last article I provided an expected return table over the next 8 years ranging from 9.9% to 12.8% for my base cases. Price is pretty much unchanged since then and it therefore remains valid. I believe an aggressive buyback program could easily add another 1%-point longer-term. However, there is now also the possibility that together with a more aggressive disposal program we will also get a closing of the discount. If we were to take the above case with a NAV of $17.76 by year end 2024 and assume the discount narrows to 20% that would give a price target of $14.21 or 35% upside plus dividend by year end 2024. FPI traded at that level as recently as October of last year.

I do believe the impact on cash flows from those disposals is manageable. They mentioned cap rates as low as 3.2% in their calls. Specialty farms and water challenged farms likely go for higher cap rates. But they can use it to repay the highest rate parts of their indebtedness which currently are their variable rate facilities.

They will also save dividend payments on the bought back stock. Overall it should still have a slightly negative impact on their overall cash flows once they get to the higher cap rate farms but nothing too serious.

Risks

I believe those sales and gains achieved have reduced the risk inherent in my NAV estimate. In my last article I also pointed out what I perceive as my biggest risk:

I think the biggest risk of investing in FPI right now is that the stock does nothing for a couple of years and then gets taken out on the cheap by private equity or a management buyout leading to poor overall returns.

I think this risk has been somewhat diminished by recent management actions. By showing real transactions in the market that validate the value in their assets, by clearly communicating to the market that they are undervalued and by buying back their stock aggressively, they do what they can to change FPI's perception in the market and hopefully we get a re-rating sooner rather than later.

That said, given that they were that active in the market with buybacks it makes me wonder who else is actually showing interest in FPI and buying them. Plus, a smaller market cap due to buybacks also reduces the likelihood of inclusion in relevant indices and decreases institutional interest.

Summary

The main news item of their Q1 results was not their results but the progress FPI made in their asset disposal program and how aggressively they have already moved on the buyback front.

I view this as a positive for my investment case. Their disposals and corresponding gains on sale validates my $16/share NAV estimate and should provide the market with more confidence when valuing FPI.

Buybacks are accretive but much less so on a NAV/share basis than one might initially assume. Nevertheless, FPI management was handed lemons with the big discount at which their stock trades and they now try their best to make lemonade of it. I believe buybacks could add another 1% to my expected return over the next years. Ideally, a re-rating happens within the next two years leading to much higher IRRs.

I stay positive on FPI as an asset play and I view management's actions very positively. Overall, FPI has notched up on my personal conviction scale and even though I very much like cash right now I just added to my existing position.

If you found this article helpful please give it a like. If you have questions or remarks please comment below. I would love to hear from you. Many thanks!

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