LANDO - Gladstone Land: A Reliable Monthly Dividend Income Stream

2023-04-10 10:11:34 ET

Summary

• LAND operates in an industry with a persistent and strong tailwind.
• Growing food crops provide a buffer against rising inflation or even a prolonged situation of high inflation in this business.
• The trend of eating more healthy foods - think nuts, berries, and fruits - benefit LAND's tenants as many of them grow these crops.
• Due to increasing farmland scarcity, the value of the land owned by Gladstone has increased over the years.
• The dividends from this monthly dividend payer are not only safe, but it is also at a respectable AFFO yield of 4.32%.

Preamble

Warren Buffett once said when asked why he bought Gillette shares,

It's pleasant to go to bed every night knowing there are 2.5 billion males in the world who have to shave in the morning.

To appropriate the sentiment, I think investors of Gladstone Land Corporation ( LAND ) should go to bed happy every night knowing there are millions of people in the world who enjoy eating pistachios, almonds, strawberries, blueberries, grapes, citrus fruits, and more.

An investment in LAND is not for everyone. However, income-seeking investors should consider this company as the investment thesis for Gladstone Land Corporation is pretty straightforward.

Investment Thesis

LAND operates in an industry with a persistent and strong tailwind - food. Food is something everyone needs, and with the increasing global population, predicting an increasing demand for food is easy. This means there will always be demand for the farmers-tenants' produce. Land suitable for farming is a limited commodity that is not increasing but due to urbanization the amount of available farmland is in fact decreasing. The basic law of decreasing supply and increasing demand makes a food production business a no-brainer. And because of increasing farmland scarcity, the value of the land owned by Gladstone has increased over the years.

The other strong tailwind is the trend of eating more healthy foods - think nuts, berries, and fruits - benefit LAND's tenants as many of them grow these crops.

Growing food crops can also provide a buffer against raising inflation or even a prolonged situation of high inflation in this business; the rising food inflation outpaces the rising costs of food production, which means more money in the farmers' pockets, and that means paying rent is not a problem. Therefore, LAND's business model is resilient to a high-inflationary environment.

Finally, the dividends from this monthly dividend payer are not only safe, but they are also yielding a respectable AFFO yield of 4.32%, paid out at a payout ratio that is the lowest it has ever been.

Now, let's dig into some details.

Business Overview

The straightforward business model is a strength in LAND's favor. LAND gets its income from farmers who rent farmland from them. As most of the leases (72.8%) are structured on a triple-net basis, which means the tenants are responsible for paying all relevant taxes, insurance, maintenance, and other operating costs on the land.

The company describes itself in its 2022 10K as follows,

We are an externally-managed, agricultural REIT that is engaged in the business of owning and leasing farmland . We are not a grower of crops, nor do we typically farm the properties we own. We currently own 169 farms comprised of 115,731 acres across 15 states in the U.S., as well as several farm-related facilities.

The 169 farmlands that it owns are located in these 15 states with the majority in California and Florida.

LAND makes money primarily through leasing the land it owns. It can also recycle the assets by selling some land to free up cash to acquire more desirable land in other areas.

Growing Cash Crops That Fit The Times

According to data from USDA , the United States Department of Agriculture, U.S. fruit and tree nut production value has increased since 1990, and the pace of increase picked up from 2010. The leading fruits produced were grapes, apples, strawberries, and oranges. In addition, tree nuts value rose to record highs of $10 billion starting in 2016, buoyed by strong sales of almonds, walnuts, and pistachios.

Clearly, being healthy and eating healthy has never been more important. That was true then and is even truer now post-pandemic. According to research , Americans are consuming more plant protein like nuts, the kind of crops grown on LAND's farms.

LAND has positioned itself as an attractive option to farmers hoping to cash in on growing these cash crops. In the 2022 10K, LAND's strategic acquisitions of land suitable for growing these desirable crops are obvious,

Our farmland is predominantly concentrated in locations where farmers are able to grow either fresh produce annual row crops (e.g., certain berries and vegetables), which are typically planted and harvested annually, or certain permanent crops (e.g., almonds , blueberries, pistachios, and wine grapes).

Even though the cost of production has gone up in the past three years, due to various reasons like the rising cost of fertilizers and labor, the rising prices of these cash crops will go a long way to offset these rising costs.

The Business Model Is Resilient: The Leases Are Structured For Profit-Sharing

Profit sharing can boost total revenue when crop yields are good and when crop prices are high; it can also provide a buffer during times when yields are poorer or when crop prices are less ideal by giving LAND a cut of the profits.

Factors outside farmers' control that can affect their profits are (1) the prices of their produce (like the low almond prices in recent months that are hurting almond farmers) and (2) bad weather (like drought or hurricane). To factor in the possibility of farmers falling behind on their rent, some leases are structured with a revenue-sharing component called the annual participation rent which is based on the gross crop revenues earned on the farm.

LAND Potentially Provides Better Returns Than Long-Term Bonds In An Inflationary Environment

Income investors are likely to be drawn to LAND because it provides a monthly dividend payout at a dividend yield of 3.26% (AFFO yield of 4.32%) that exceeds that of the S&P 500. It is also reassuring that the company has maintained and grown dividends for eight consecutive years, from $0.36 per share in 2014 to $0.5463 per share in 2022.

The yield on the US 30 Year Treasury bond now is 3.623%, better than LAND's 3.26% dividend yield. However, one can make the case that an investment in LAND is better and maybe even safer.

What do bond investors get? Bond investors get 3.623% on their principal after waiting for 30 years. The principal is guaranteed. That's it.

What is the risk bond investors take? During this 30-year period, if inflation exceeds 3.623%, these bond investors lose out. Obviously, no one can predict the future but there were periods in history where high inflation persisted for many years, like in the 70s, when investors lost 40% of their purchasing power. As recently as 3 April 2023, International Monetary Fund ( IMF ) wrote,

Global inflation is forecast to rise from 4.7 percent in 2021 to 8.8 percent in 2022 but to decline to 6.5 percent in 2023 and to 4.1 percent by 2024 .

Investors should do scenario planning to consider various "what ifs" situations and how the different assets in their portfolio would perform. The IMF forecast of stubbornly high inflation presents one possible scenario, and investors should consider investments that can perform well or at least hold up if the IMF scenario comes close.

LAND is one alternative. Compared to bonds, LAND investors will get these:

a. Monthly dividend payout that has been growing for 9 years;

b. Rental increases yearly provide for an increase in dividends. There are yearly rental escalators built into the leases, adjusted to inflation or standard costs of living;

c. Depending on whether the leases are for agriculture or for farms growing permanent annual row crops, the lease terms are usually short between 3 to 10 years and 7 to 15 years (with options to extend these longer-term leases) respectively. Since the shorter lease duration means LAND is not locked in at a fixed rental yield for decades , unlike the current 30-year bond where investors are locked in at a yield of 3.623%, what that means is when it is time to renew leases LAND can rent the same farmland out at higher rates.

d. LAND owns lots of farmlands, and the value of these farmlands has been rising over the years, land which LAND can sell for a profit and to buy new land.

Of course, capital will not be guaranteed unlike a bond, and that is the risk investors take when they invest in equities.

How Does LAND Attract Good Tenants?

The amount of farmland in the US is decreasing, and with that good, arable farmland is also decreasing.

Farmers have fewer choices when it comes to leasing good farmland. They will be on the lookout for landlords that can give them a good deal because other than good weather, farmers need water and landlords who treat them as partners more than anything else.

Water

To attract tenants with good quality to lease farmland from it, LAND makes itself attractive by investing in water infrastructure to bring water to the tenants, water that LAND sells as well.

In addition, LAND actively seeks to invest in land with water resources. As of February 2023, LAND owns 45,000 acre-feet of bank water acreage foot equivalent to 14.6 billion gallons of water in the ground, mostly in California.

The following is from page 37 of the 2022 10K ,

To date, none of our farms have suffered water shortages due to our wells not being able to reach the aquifers. We continue to seek out opportunities to provide additional sources of water to our farms, such as acquiring supplemental water banked at local water districts or by entering into separate agreements directly with water districts for surface water deliveries. In addition, we are also currently looking into capital improvements on certain of our farms, such as building pipelines to allow for surface water deliveries and building recharge basins on unplanted acres to capture stormwater and allow it to recharge the aquifers below.

Landlords And Tenants As Partners

Two of LAND's tenants are currently behind in their rental payments. Instead of evicting them and getting new farmers, the management is trying to work with them to recover the delayed rental payment, by restructuring the leases to factor in a higher portion of participation rent.

The following was what CEO David Gladstone had to say about one of the tenants who was behind in his payments.

The grower in Michigan, so a couple of things with this one. From an operational standpoint, he has made good money on our farms. However, he had a kind of a medical emergency earlier in the year. He was on -- in ICU for several months and that led to a slow -- we didn't put much pressure on him during that time because of his situation and he also might -- we think he also overextended himself in terms of just expanding its operations too quickly. So just put them in a little cash crunch. But we are working with both of these tenants to try to get caught up with payments. But until we have a clear path forward, both these -- both -- revenue from both all of these leases will be recognized on a cash basis and we will just recognize it when the cash comes in.

If I am a farmer looking to lease land, and between a landlord who goes by the book 100% or one who shows compassion and sees me as a partner, I will be inclined to choose the latter.

Valuation

Page 56 of the 2022 annual report states the following:

To provide our stockholders with an estimate of the fair value of our real estate assets, we intend to estimate the fair value of our farms and farm-related properties and provide an estimated net asset value ("NAV") on a quarterly basis. NAV is a non-GAAP, supplemental measure of financial position of an equity REIT and is calculated as total equity, adjusted for the increase or decrease in fair value of our real estate assets and long-term borrowings (including any preferred stock required to be treated as debt for GAAP purposes) relative to their respective cost bases. Further, we calculate NAV per common share by dividing NAV by our total common shares outstanding (consisting of our common stock and OP Units held by non-controlling limited partners).

As of 31 December 2022, the calculated NAV of LAND's common stock stood at $17.08 per share. As of close on 7 April 2023, LAND's stock price was at $16.79.

The current blended P/AFFO is 23.54; the trailing twelve-month P/AFFO is 23.16.

Even after I removed anomalies from the calculation of the normal P/AFFO, and considered LAND's normal P/AFFO between January 2015 and December 2019/ LAND's normal P/AFFO for that period is 22.59. These figures (current blended P/AFFO, trailing twelve-month P/AFFO, and the adjusted P/AFFO between 2015 and 2019) are close to LAND's P/AFFO over the past four to eight years, suggesting that LAND could be trading at fair value now.

If LAND continues to trade at around a P/AFFO of 22.50 and grows the AFFO at 4.88%, LAND could potentially return 6.11% in 4 years.

Risks And Considerations

Expiring Leases

Of the 113 leases, 8 are expiring in 2023 and a total of 29 are expiring within the next three years. The 8 leases that are expiring in 2023 represent 10% of 2022's total lease revenue, and the 29 leases represent 27.2% of LAND's 2022's total lease revenues. It will be a problem if LAND cannot renew these leases.

The company does not provide lease renewal rates. However, based on the occupancy rate data that I gathered from the annual reports from 2016 to 2022, I would say that the management was able to either renew the leases on all the expiring leases, and when they could not they were able to find new tenants to take over, maintaining a 100% occupancy rate every year.

Higher Interest Rates Affect REITs

LAND is classified as a REIT, and to grow it needs to keep acquiring new farmland. With interest rates at all-time highs, it does not make sense for LAND to take on debt to acquire more farmland.

The CEO had the following to say about this during Q4 2022 earnings call ,

As we have mentioned in the past couple of calls, acquisition activities remained slower for us than in the past as we continue to be much more selective in the type of farms we are looking at. Higher interest rates also impact the level of returns we can be able to achieve on any new acquisition. That too will pass.

With inflation and interest rates continue to rise and the risk of recession becoming more likely, we believe it's a good time to be much more selective with our capital.

While a higher interest rate environment is not welcomed, one must remember that threats and opportunities come hand in hand.

In the Q3 2022 earnings call , the CEO said,

The biggest problem right now is that there's a lot of inflation that's going on. And it's really hard for all of these people to make ends meet when they find out that all the expenses they have to pay out in order to grow something have gone up dramatically. So, the other problem, of course, is that water costs have gone through the roof.

In other words, the imminent threat of recession coupled with a high interest rate environment presents acquisition opportunities at favorable rates. The CEO continued,

... the recession has probably sent more people to go out and find out how much of their farms are worth. And I think we'll have plenty of farms that will come our way . And the real question is, can we make them work for us in terms of accretion to our shareholders so we can keep increasing the dividend. I think we will, but there's no guarantees in life. And if it lasts against us, it won't be for long. It would be for six months or so and then people will realize that they've got to pay more in order to get the land that they want to keep growing.

... it's just one of those undefined times when you can't make a bet work, you probably get the same kind of risk reward if you just went to Las Vegas and put a number amount of money on red and see whether you win or not. But it's better for us to wait and not put a lot of money out in times that are very, very difficult to predict.

And LAND can afford to wait for interest rates to come down. LAND has a healthy $61.1 million in cash and cash equivalents at the end of 2022, and an operating cash flow of $43.8 million, both at the highest they have ever been in their history. And since LAND's current AFFO payout ratio is just 75.6%, which is much lower than at any point in time in its history of paying out dividends, this means that it has room to increase dividends without needing to do anything drastic like issue shares at depressed prices or borrowing money at elevated interest rates.

Higher Interest Rates Affect Interest Expenses

This is something REITs investors have to take note of because if a company's existing debt carries a high percentage of variable interest rate, the increase in interest expense will reduce the company's ability to pay out dividends and make acquisitions.

LAND is not in such a position. CFO Lewis said in the Q4 2022 earnings call,

Over 99.8% of our borrowings are currently at fixed rates and on a weighted average basis, these rates are fixed at 3.26% for another five years.

Geographical Concentration Risks

California and Florida are responsible for the vast majority (84.%) of LAND's lease revenue.

There were some initial efforts to diversify geographically, from 2016 to 2018, when the concentration of the revenue from California dropped from 56.8% to 46.5%. However, the numbers clearly show that management has changed its mind and has instead doubled down on California and Florida. Being concentrated in two regions definitely carry heightened risks. The risk section of the 2022 annual report has this to say,

The effects of climate change may be more significant along coastlines, such as in the California coastal areas where we partially focus our acquisition efforts, due to rising sea levels resulting from melting of polar ice caps, which could result in increased risk of coastal erosion, flooding, degradation in the availability and quality of groundwater aquifers, and expanding agricultural weed and pest populations.

At the same time, California has a unique climate that makes it suitable for growing the kind of crops that LAND farmers are growing, mainly nuts and berries. Acretrader describes California as the best place in all of the US for growing crops,

In terms of farm income, California leads all other U.S. states and produces the largest variety of commodities in the nation . It is only one of five agricultural regions in the world with a Mediterranean-growing climate that allows farmers to grow such a large variety of crops, including some that aren't grown anywhere else in the nation. California produces the vast majority of specialty crops such as almonds, walnuts, apricots, dates, and figs grown in the U.S. and in some cases, the world.

Florida on the other hand is an attractive place for citrus fruit farmers. The state produces more than 70% of the US's citrus products, ranks first globally in terms of grapefruit production, and second in orange juice production globally.

Better rewards come with more risks. Investors in LAND will have to trust the management to manage adverse situations well, which it had done so in the past, and continue to grow the dividends and the AFFO over the long term.

Conclusion

An investment in Gladstone Land is not about getting a 10x return in a few years. LAND is not a dividend growth investor's dream with just a 5.71% average dividend growth rate since 2015, a growth rate that has slowed to 1.16% from 2022 to 2023, and the forward dividend growth rate is expected to be just 0.98%. LAND is also not a value investor's target for buying excellent assets at low prices.

However, LAND is an investment that income investors should consider. It pays an above-average dividend yield of 3.26%, and AFFO yield of 4.32%. It has been growing dividends for the past eight years and management is committed to paying the monthly dividends. And at the current AFFO payout ratio of 75.6%, the lowest in its history, LAND is more than capable of raising dividends comfortably.

As an income vehicle, LAND may do better than long-term bonds due to the way its leases are structured, and the fact that it raises its dividends every year. And the assets that LAND hold - the land and the aquifers - increase in value over time.

Buying LAND a year ago when the blended P/AFFO then of 58.32 was more than twice its normal blended P/AFFO would not have been a good investment. LAND is still not cheap now but it has corrected to its historical normal blended P/AFFO of around 22-23, and starting a position in LAND now can make sense so long as investors have the expectation that the current negative sentiments towards the entire REITs may further depress the stock price.

I do not yet own shares of LAND but when I do, I know that I can sleep well at night knowing there is always someone around the world snacking on some healthy pistachios, blueberries, strawberries, almonds, and more.

For further details see:

Gladstone Land: A Reliable Monthly Dividend Income Stream