LANDM - Gladstone Land: Farmland Shortage Provides Significant Tailwinds

2023-11-07 00:06:14 ET

Summary

• Gladstone Land specializes in the acquisition and management of farmland and agricultural properties in the United States.
• With the global population expanding and the climate becoming unpredictable, farming becomes more challenging but more valuable too.
• My valuation model implies a potential annual return of 13% from the current price; therefore, I consider LAND a Buy.

Investment Thesis

Gladstone Land Corporation ( LAND ) is a company positioned to capitalize on a potentially concerning but significant trend of the coming decades: the growing demand for food and the shrinking supply.

In this article, we will delve into the company's strategy for harnessing this trend and assess whether the market conditions are conducive to achieving this goal. Finally, I will provide an evaluation to justify why I believe the current stock price offers an investment opportunity.

Business Overview

Gladstone Land is a real estate investment trust ((REIT)) that specializes in the acquisition and management of farmland and agricultural properties in the United States. The company's primary focus is on purchasing farmland, which is then leased to experienced farmers for agricultural production, with the aim of generating rental income from these properties.

Gladstone Land's strategy typically involves acquiring properties suitable for a variety of agricultural purposes, including row crops, fruits, vegetables, and nuts, since these are less of a commodity than foods like corn, wheat, and soy and therefore prices have lower volatility and higher profitability . Through leasing the land to seasoned farmers, the company seeks to establish a consistent income stream. Gladstone Land offers three options to its customers:

1. For farmers who are selling their land: A long-term sale-leaseback transaction that allows them to free up capital to improve their farming operations.
2. For farmers who identify land they want to farm, but not own: The company offers to purchase the farms and rent them to the farmers with flexible lease terms.
3. For sellers who do not farm the land: Offer cash purchase of the land, while either keeping the existing tenant farmers in place or finding new farmers if needed.

This strategic approach has enabled the company to develop a portfolio of high-quality farms, currently comprising 169 farms (which have grown at rates of 26% annually in the last decade) with a total of approximately 116,000 acres across 15 states, all maintaining a 100% occupancy rate.

Relevance of food-producing Land

The world's population has witnessed significant growth in recent decades and is projected to continue expanding , at least until 2050. This growth is primarily driven by developing countries that have experienced improved quality of life, resulting in higher survival rates to reproductive age.

In contrast, the availability of arable land per capita has shown a declining trend and is expected to continue diminishing. This decline is attributed to various factors, including the increasing urbanization of populations, leading to the conversion of rural areas into residential neighborhoods, schools, office buildings, government facilities, and more.

Furthermore, climate change has exacerbated challenges in regions with growing populations, particularly in Africa, Asia, and Latin America. These areas are experiencing rising temperatures and arid conditions, making food production increasingly challenging and therefore quality arable areas , such as those owned by Gladstone, become increasingly valuable .

It comes as no surprise that individuals like Bill Gates are acquiring extensive farmland holdings. Bill Gates owns nearly 270,000 acres (while Gladstone owns 115,000), establishing him as the largest landowner in the U.S. Although the average person may not have the means to acquire such vast land holdings independently, Gladstone Land offers an excellent alternative for gaining exposure to this trend, which shows no sign of resolution.

With the global population continuing to expand and the climate becoming increasingly unpredictable, farming becomes more challenging. As a result, companies engaged in food production or land ownership are expected to become more valuable.

Fragmented Market

Not only is Gladstone Land well-positioned to capitalize on the current trend, but it also operates in a market with highly favorable conditions for continued expansion. According to Statista , the value of farm real estate in the United States exceeds $3 trillion and continues to rise significantly each year. However, this increase in value can be attributed to the fact that individual farms are becoming more valuable. In reality, the number of farms in the United States has been steadily declining over the years, dropping from 2.16 million in 2000 to just 2 million in 2022 . This decline reinforces the idea that the supply of farmland is decreasing while the demand is on the rise.

This presents a substantial market opportunity , especially when compared to the size of Gladstone (with its only 170 farms). Another important driver for the company's future growth is the demographics of farm owners. A significant portion of farmers in the U.S. are older individuals, with an average age of 57.5 years , and this average continues to rise each year. This means that the market consists of many retirees who may be increasingly inclined to sell their land, further enhancing the growth prospects for Gladstone Land.

Key Ratios

Thanks to its presence in the expansive market of farmland ownership, Gladstone Land has achieved remarkable revenue growth over the past decade. The company has realized a stunning annual growth rate of 41%, all while maintaining robust Funds From Operations (FFO) margins that consistently hover around 23%.

Despite the company's consistent annual increase in dividend payments by approximately 11%, this growth hasn't translated into higher dividends per share for investors. This is primarily because Gladstone Land has been actively issuing new shares, with a substantial annual issuance rate of 21% since 2013. Such share issuance has the unintended consequence of diluting existing shares, which can impact earnings and ultimately result in lower dividends per share, a factor that potential investors should take into account .

What is quite positive is that Funds From Operations completely cover the dividend distribution. On average, 85% of FFO is paid in dividends .

In the current economic environment, it is crucial for companies to avoid having a substantial amount of debt with near-term maturities. When the time comes to refinance, they may be subject to exorbitant interest rates.

Fortunately, Gladstone Land is well-positioned in this regard. The company maintains a Debt to Equity ratio of 89%, which is considered reasonable for a REIT. Most notably, Gladstone has secured long-term debt arrangements, with an average maturity of 9 years at fixed rates , while its lease terms typically span 6 years. These favorable debt terms are understandable to creditors due to the company's stable business model, and in the event of cash shortages, Gladstone can rely on its substantial land holdings as collateral.

Valuation

In terms of valuation, I will consider several key performance indicators (KPIs). To begin with, the rate of farm acquisitions has shown impressive growth, averaging 26% per year, which is equivalent to acquiring approximately 18 to 20 farms annually. However, it's worth noting that in the first two quarters of 2023 , the company has not announced any new purchases. As a conservative estimate, I will assume that they will acquire only 4 farms this year, with an expectation of 19 farms per year for the subsequent years.

Additionally, revenue per farm has displayed an annual growth rate of 11% over the past decade. This growth trend is anticipated to continue, especially considering that the previous year saw a slight 4% decrease in revenue. This provides a more favorable baseline for future growth prospects. Based on these assumptions, I anticipate an annual revenue growth rate of 19% over the next five years, reasonable compared to the 41% CAGR of the last decade.

I will make the assumption that the company will continue to issue shares at an annual rate of 5%, primarily for financing the acquisition of farms. However, I anticipate that as Gladstone Land gains scale, it will gradually transition towards using cash for such acquisitions.

Applying a conservative estimate of a Funds From Operations (FFO) margin at 27% and a Payout Ratio of 85% , based on the average values observed over the past decade, we can estimate that the company would be paying approximately $1.10 per share in dividends . To achieve a dividend yield of 4% - which aligns with the sector's average according to Seeking Alpha , even though LAND's average is 3% - the stock would need to reach approximately $27 USD by 2027. This implies a potential annual return of 13% from the current share price.

Final Thoughts

It appears that Gladstone Land is in a highly advantageous position. The company benefits from a favorable macro trend with a significant terminal value, while the sector's dynamics align with its successful historical strategy.

Considering the stability of its business, the current valuation appears appealing to me. Therefore, I believe the company is a ' buy '.

However, it's important to note that the company's capital structure is somewhat complex . It includes common shares and Series B to E, likely to attract capital from various types of investors. Each share type comes with different voting rights and dividend distribution characteristics. For instance, Series B shares offer preferential cumulative cash dividends at a rate of 6% per annum. If you wish to delve into the specifics of each Series of shares, you can refer to the annual report on page 109.

This seems to me to be the biggest negative aspect to take into account since it assigns different benefits to each investor and overcomplicates the capital structure in a way that does not seem necessary to me.

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