FPI - Farmland Partners: Unique Business But Pricey

2023-07-20 10:59:19 ET

Summary

• Farmland Partners, a company that invests in and manages farms, enjoys many benefits such as low vacancy, low turnover, stable revenues and high quality assets.
• The company plans to increase productivity by using more technology, sustainability techniques, better tools and possibly AI. However, the stock is currently considered pricey, with a dividend yield of 1.84%, significantly lower than its historical average of 4%.
• The company sells for almost 20% premium over its book value and 50+ times its funds from operations.
• This is a good company that's priced for perfection. Investors should wait for a better entry point.

We all have to eat food to survive and almost all of the food we eat comes from farms one way or another, yet not many people are invested in farms. This is because they don't have many options to invest in this particular sector. While farmlands in the US represent a combined value of $3 trillion, less than 1% of farmland in the country is owned by institutions which means this is the least institutionally owned sub-sector of real estate.

Farmland Partners ( FPI ) is a unique business that invests in farms many of which the company internally manages. The company's business also includes developing or fixing farms and selling them for a profit. The company manages a total of 194,700 acres in 19 states growing 26 types of crops but its holdings change pretty frequently as it acquires and sells assets.

For example, the company sold $16.2 million worth of land in May and it sold another $19.9 million worth of land in June for a profit. The sale in May had a price tag that was 24% above the book value of assets sold and the sale in June had a 26% premium. So far this year, the company sold $52.4 million of farmland and booked profit of $12.8 million from these sales.

Apart from managing its own farms, the company also has about 100 tenants who rent land from the company and grow their own crops. FPI's rent revenues have two components. These are fixed component and variable component. The fixed component is the base rent which is due every year right before planting season. The variable component is due after crops are harvested and sold and depend on how much profit a farm obtains from those crops. Basically farmers pay FPI a fixed rent plus a portion of their profits. This allows the company to benefit from uptrends in food prices but it could also result in lower revenues when commodity prices crash. The company also receives revenues from solar panels and wind turbines located within its farms but this makes up a small percentage of its total revenues.

The company enjoys pretty consistent and predictable revenues as its current vacancy rate sits at 0% which means all of the company's farms are actively contributing to its top line. The company seems to be good at finding tenants that stick around and produce for many years which is an advantage. Apart from the company's vacancy rates being at historically low levels, the company's turnover rate is also very low, indicating that farmers are making long term contracts and staying for a long time, not to mention the company is good at finding new tenants in those rare times when one of their tenants leave. A great majority of FPI's farms had the same tenant for many years.

Having the same tenant over many years provides several advantages. First, it helps the company to achieve consistency in its rental income. Second, it allows the company to focus its resources on productive things instead of seeking new tenants. Third, if a farmer is staying in the same land for a long time they are gaining experience growing things in that particular land since every land is unique and takes some time getting used to. Fourth, farmers rarely stay in the same land for long unless that land is really working out for them in terms of productivity. FPI having tenants stay for long periods of time means that it must have some good quality land.

In the long term, the company's plan includes using more technology, sustainability techniques, better tools and possibly AI to increase productivity of each farm so that its farms can produce not only higher quantities but also higher qualities of crops. Better efficiencies should result in better margins and better prices when they eventually sell that farm. This is similar to a residential investor buying a house, fixing it up, upgrading its features and selling it for a profit.

Having said this, the stock looks pretty pricey right now. Since FPI is officially a REIT, it must distribute at least 90% of its profits in dividends. The company's current dividend yield of 1.84% is significantly lower than its historical average of 4%. Notice that the dividend yield dropped sharply in 2020 partially because the company cut its dividends but also because its overall price rose so much due to its assets climbing in value since we saw a very strong real estate market across the board with the exception of a few sub-sectors such as offices. Most people invest in REITs mostly for dividends and this company's current yield seems low, especially when you consider the fact that you can get a risk-free 5.25% yield from treasuries.

Since REITs are a special class of investment, they are typically meant to be priced with a metric called P/FFO (price to fund from operations) instead of the traditional P/E. This stock looks very pricey in this particular metric as analysts expect it to earn 23 cents, 24 cents and 25 cents respectively for the next 3 years. This would give the company a forward P/FFO ratio of 56, 55 and 52 for the next 3 years respectively. This is a very high valuation even for a niche player in a unique sector when most REITs currently trade for about 13 times their FFO.

The company trades for about 1.2 times its book value but this could have been much higher if its book value didn't jump in value after 2020 as its farm assets appreciated significantly along with most real estate assets at the time. Since most of book value in REITs come from their real estate assets, you want them to trade at a level near or below 1.0 of their book value in order to get a good deal out of them. Currently, FPI is selling for a 19.8% premium against its book value which is lower than where it was a couple years ago but significantly higher than where it was 3-4 years ago.

I could tolerate this kind of valuation if the company was rapidly growing its revenues and profits but its growth rate in recent years have been stable but not very rapid. In the last 5 years, FPI's revenues grew by a combined 18% and its net income grew by a 15%, indicating low single digit average annual growth rate and this is before inflation. The company would have posted no growth in the last 5 years if we stripped away the effects of inflation.

FPI is a well-run company in a niche industry that enjoys many benefits such as low turnover rate, low vacancy rate and high quality farmland. The company's management is also very active in finding ways to improve their efficiency and quality of their assets. Having said this, the company is priced for perfection with its high P/FFO multiple and its low dividend yield isn't making it an attractive investment for me. If a REIT isn't offering a high yield it should at least offer a nice dividend growth but FPI isn't offering this either. I would add this stock in my watchlist and wait until it gets to a more reasonable valuation (possibly 1.0 times its book value) and start buying at that level.

For further details see: