FPI - Gladstone Land: Farmland And Food A Great Thesis For A Reasonably-Valued REIT

Summary

• Gladstone Land Corporation posted respectable fourth quarter results, which is mostly what we have come to expect from the company.
• The company is likely to slow down on growth compared to what it has done in the past due to rising interest rates.
• The company could be a good way to play rising prices of food and farmland, which will likely be the case over the long term.
• The company raised its distribution by 0.22% QOQ and appears to be easily able to sustain it.
• The company is trading at a slight premium today but the current price is as attractive as it has been for a few years.

On Tuesday, February 21, 2023, farmland real estate investment trust Gladstone Land Corporation ( LAND ) announced its fourth-quarter 2022 earnings results. At first glance, these results were fairly reasonable, as the company beat analysts’ revenue estimates and posted respectable funds from operations. However, the market seemed less than impressed, as LAND stock fell on the first trading day following the earnings release:

The real estate sector as a whole has generally been under pressure over the past year, as the Federal Reserve’s monetary tightening policy has made mortgages much more expensive and theoretically reduced real estate valuations. Gladstone Land has not been spared from the carnage, as the stock is down a whopping 40.45% over the past twelve months. However, the company’s cash flows have held up much better than the poor stock performance would indicate. After all, rents have certainly not gone down over the past year!

However, as I pointed out in a few articles about this company back in 2021, Gladstone Land was considerably overvalued for a while, so this decline had the effect of bringing the stock back down to a more reasonable level and increased the yield. That should make the trust somewhat more appealing to income-focused investors, although it still only has a 3.15% yield, which is not particularly attractive compared to bonds today. However, the company does have some forward growth potential that bonds do not, so let us investigate and see if Gladstone Land could be a good addition to a portfolio today.

Earnings Results Analysis

As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company’s earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Gladstone Land’s fourth-quarter 2022 earnings report :

• Gladstone Land reported total revenue of $24.791 million in the fourth quarter of 2022. This represents a 2.40% increase over the $24.209 million that the company brought in during the previous quarter.
• The company reported funds from operations of $6.355 million during the most recent quarter. This represents a 0.50% decline over the $6.387 million that it reported during the third quarter.
• Gladstone Land acquired five new farms at a total cost of $65.1 million over the course of 2022. This continues its long track record of portfolio growth.
• The company raised its monthly distributions to $0.0459 per common share beginning January 1, 2023. This represents a 0.22% increase over the prior distribution.
• Gladstone Land reported a net loss of $4.806 million during the fourth quarter of 2022. This compares rather unfavorably to the $3.592 million net loss that the company reported in the third quarter of 2022.

It seems certain that the first thing that anyone reading these highlights will notice is that the company’s revenue increased, but its funds from operations and net income declined quarter-over-quarter. This was due to an increase in participation rents received combined with a write-off during the quarter.

First, let us have a look at the participation rent. This is one of the more unique aspects of Gladstone Land’s business, and it is something that improves its attractiveness. In short, the participation rents act almost as revenue-sharing agreements with the farmers that rent Gladstone Land’s farms. The lease that the trust has with the farmers specifies that the company receives a certain percentage of the farm’s revenue from sale of the crops. During the fourth quarter, these participation rents brought in $4.7 million compared to $3.0 million in the third quarter.

That is not surprising, as harvest time for most farms is around the end of the third quarter, so they will be selling much of their crops during the fourth quarter. Thus, these participation rents allow Gladstone Land to benefit when food prices increase, which could be appealing in today’s economic environment. It could also make this company a way for investors to profit from rising food prices without buying a farm or a food processing company. The fact that Gladstone Land also generates revenue from fixed rents charged to its tenants helps to reduce the risk of a decline in food prices and provides protection that we would not have with other ways of playing food prices, which could add to the appeal here.

This potential appeal of the company as a food price inflation play was hinted at by David Gladstone, Chief Executive Officer of Gladstone Land, in the official earnings press release ,

“This fourth quarter capped off a very solid year for us from an operational standpoint, aided by strong participation rent numbers. The recent floods in California brought some much-needed relief to the region and has improved drought conditions significantly, as snowpack levels are two times their 20-year historical averages. Acquisition activity continues to be slow for us, and we expect that to be the case through at least the first half of 2023, as we continue to act conservatively with our capital and be more selective with acquisitions in light of increased interest rates. The overall food segment, and more particularly, the food-at-home segment, both continue to outpace overall inflation. We expect demand for food and crop pricing to continue to stay strong, and we believe our current portfolio is poised to benefit from continued high inflation.”

In short, Mr. Gladstone is specifically referencing the fact that the company collects participation rents from its tenants. Those participation rents should increase along with food prices. Thus, the company should be able to deliver higher profits and cash flows for its shareholders when food prices appreciate. This is something that we should be able to appreciate long-term, as it seems likely that food prices will grow going forward.

As just mentioned, Gladstone Land collects a fixed rent from each of its tenants under the terms of their leases. This works the same way as the rent collected by other real estate investment trusts. The company reports that this amount decreased by $1 million quarter-over-quarter, primarily due to a write-off of $939,000 associated with two tenants and six leases.

The company did not provide any further information about this in the earnings release, nor did it publish any press release about this matter during the fourth quarter. The fact that it was described as a write-off, though, implies that this was a non-cash transaction that we probably do not need to worry much about. That is the stance that I am choosing to take until further clarity is provided by the company.

Farmland Fundamentals

As mentioned a few paragraphs ago, Gladstone Land should be well-positioned to deliver increased profits and cash flows as food prices increase. It seems likely that food prices will increase in the long term and one big reason for this is supply and demand.

According to the United Nations, the global population will reach nearly ten billion people by 2050. That represents a significant increase from the approximately 7.9 billion people worldwide today:

Naturally, this will require more food to feed more people since food is a necessity for life. However, the amount of acreage available to feed each person is declining. There are a few reasons for this, including the fact that there is only a limited supply of arable land in the world and every year thousands of acres of farmland are converted into suburban uses such as housing developments. In 1960, there was 0.94 acres of farmland for every person on the planet but today that figure has fallen to 0.46 acres. It is currently projected that by 2040, only 0.37 acres of farmland will be available to feed each person:

Thus, the global supply of food will probably get tighter and tighter with the passage of time, even considering the fact that new advances may well improve the productivity of a given acre of farmland. In addition, we have huge numbers of people in the various emerging markets around the world that are getting wealthier and will likely consume greater quantities of food than they do now. All of this will put pressure on food supplies and likely cause prices to increase going forward. That is simple economics.

The fact that farmland is necessary for human life yet is becoming more precious is illustrated in the overall market returns. Over the 2002 to 2022 period, the NCREIF Farmland Index delivered a 12.6% total return, which beat the S&P 500 Index ( SP500 ) over the same period:

Gladstone Land appears to be quite well-positioned to profit from this going forward as it is one of only two farmland-focused real estate investment trusts in the market and its participation rents cause its revenues to increase alongside food prices.

As everyone reading this is no doubt well aware, food prices have increased quite rapidly over the past eighteen months. In fact, the rapid increase in food prices is one of the things that has been forcing many Generation Z members and Millennials to take on second jobs or enter the gig economy in order to obtain the money that they need to feed themselves and their families. However, this is something that has been going on for a long time. In fact, fresh produce prices have been outpacing inflation for more than three decades:

This further builds the case for Gladstone Land as a way to protect yourself against food price inflation. This is because Gladstone Land specifically invests in farms that grow fresh produce such as lettuce, celery, cantaloupe, most berries, peas, tomatoes, and leafy produce. This differentiates it from Farmland Partners ( FPI ), which primarily invests in farms growing grains. As fresh produce prices tend to grow more rapidly than the consumer price index, Gladstone Land should see benefits going forward. Overall, the company’s strategy is a good one and it should have a great deal of appeal for anyone looking to both hedge their consumer exposure to food prices and profit from rising food prices.

Distribution Analysis

One of the reasons why real estate investment trusts, or REITs, are popular among investors is the high yields that they typically possess. Gladstone Land is no exception to this, as its 3.15% current yield is significantly higher than the 1.59% yield of the S&P 500 Index. However, 3.15% is not really enough to impress most income-focused investors today as a government money market fund is currently yielding around 4.20%. However, Gladstone Land has a tendency to increase its distribution in most quarters, including the most recent one. In January, the company raised its monthly distribution by 0.22% to $0.0459 per share. That represents the company’s 29 ^th distribution increase in 32 quarters. The fact that this trust pays its distribution monthly is another bonus as that allows investors that reinvest their distributions to compound their money more rapidly. Investors that are looking for income to use to pay their bills will also likely appreciate the monthly distribution as most of our personal bills and other living expenses are due monthly, so this makes it easier to budget our money.

As is always the case though, it is important that we ensure that the company can actually afford the distribution that it pays out. After all, we do not want the company to be forced to reverse course and cut the distribution since that would both reduce our incomes and most likely cause the stock price to decline.

The usual way that we evaluate a real estate investment trust’s ability to cover its distribution is by looking at its funds from operations. This is a measurement of how much cash a real estate company produces from its core operations in a given period of time. It is similar to cash flow but excludes certain things such as gains or losses from real estate transactions. As stated in the highlights, Gladstone Land reported funds from operations of $6.355 million during the fourth quarter of 2022. This works out to $0.1820 per diluted common share but the distribution is only $0.1377 per share quarterly. Thus, it does appear that Gladstone Land is generating sufficient funds from operations to maintain its distribution at the new level. We should not have to worry too much about any potential problems here.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate a suboptimal return on that asset. A real estate investment trust can be valued much like a closed-end fund. After all, it basically is just a portfolio consisting of real estate as opposed to stocks and bonds. Thus, we want to look at the trust’s net asset value, which is the current market value of all its real estate minus any outstanding debt. This is the amount that the shareholders would theoretically receive if the trust were immediately shut down and liquidated.

Ideally, we want to purchase shares of a real estate investment trust when we can get them at a price that is less than the net asset value. This is because such a scenario implies that we are purchasing the shares for less than they are actually worth. That is unfortunately not the case with Gladstone Land today. The company stated in its conference call that it currently has a net asset value of $17.08 per common share but it currently trades for $17.75 per share. That gives it a 3.93% premium to net asset value at the current price.

Thus, anyone purchasing shares today is paying more for the equity value of the company’s farms than it is worth. However, this is also the lowest premium that this company has had for a few years, and it may be worth paying the premium. Ideally, we want to wait until the price drops under $17 before buying in but that may take a while if it ever happens.

Conclusion

In conclusion, Gladstone Land Corporation’s results were decent but were not really anything incredible. The company showed some of the growth that we have come to expect but the fact that mortgages are much more expensive today than they used to be means that we will probably just seeing this company taking a slow and steady approach to expanding its portfolio for a while. The long-term thesis for both food and farmland is quite strong though and the company should work pretty well as a play on this trend. The valuation is currently better than it has been in several years, so it might be worth picking up some Gladstone Land Corporation shares at the current price.

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