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Why Rural Funds (ASX:RFF) is a great ASX dividend share

I think that Rural Funds Group (ASX: RFF) is a great ASX dividend share for both its income growth and diversification for investors.

Rural Funds’ diversification

Rural Funds is a farmland real estate investment trust (REIT). It owns a variety farms including cattle, almonds, vineyards, macadamias and cropping (cotton and sugar).

It’s good to see this level of diversification because it’s hard to say which farm type will deliver the best returns over the coming years.

These farms aren’t just diversified by farm type, but they are also diversified because they’re located across different states and different climates. It’s good that risk is lowered with this diversification.

Not only are the farms themselves diverse and strong, but most of the tenants are large and quality as well. That means they’re likely to keep paying their rent, even if times get tough. Many of them are listed either on the ASX or elsewhere. Some tenants include: JBS, Olam, Treasury Wine Estates Ltd (ASX: TWE), Select Harvests Limited (ASX: SHV) and Australian Agricultural Company Ltd (ASX: AAC).

It’s important to remember that Rural Funds doesn’t take on the operational risks that the tenants do. But Rural Funds does own a large amount of water entitlements that are leased to tenants for them to use. I think that’s a good strategy considering the recent drought issues that the agricultural sector has faced.

The REIT has been adding to its diversification over the years and I think it will become even better over time.

Income growth

A key part of any business delivering market-beating returns these days is the ability to deliver growth. Some ASX tech shares are priced highly, whilst ASX dividend shares are looking a bit wobbly because of their impacted earnings.

Rural Funds is proving that it can continue to deliver rental earnings growth thanks to the way it’s set up.

Its rental contracts have rental indexation growth built into them. That growth is linked to CPI inflation or it’s a fixed 2.5% annual increase, with some contracts having market reviews. These rental increases are a big reason that the ASX dividend share can target an annual 4% increase to the distribution.

Another pillar to the growth of Rural Funds is its investing in productivity improvements. Rural Funds regularly retains some of its rental profit to invest in its farms to improve their productivity. This is particularly useful in a sector like cattle. The improvements can increase the rental income and capital value of the farms.

The final area of growth for Rural Funds is acquisitions. The ASX dividend share can make accretive acquisitions to grow its portfolio and then invest in those acquisitions to be more productive or change the farm type to a better use.

Is the Rural Funds share price a buy today?

Rural Funds is certainly not cheap after rising 15% since the start of August. It offers a FY21 distribution yield of 4.8%. I think that’s a solid starting yield which is projected to grow by 4% per annum for the foreseeable future.

It’s currently trading at a 21% premium to the adjusted net asset value (NAV). But the quality ASX shares with good assets like Goodman Group (ASX: GMG) are trading expensively at the moment because of the ultra low interest rates. I don’t think the premium should put off investors who are more focused on dividend income. 

Rural Funds is one of the few ASX dividend shares that kept growing its dividend/distribution during the difficult COVID-19 crash period. For strong income, I think Rural Funds is one of the best options out there. But there are a few other ASX dividend shares I’m also looking at.

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Returns As of 6th October 2020

Motley Fool contributor Tristan Harrison owns shares of RURALFUNDS STAPLED. The Motley Fool Australia owns shares of and has recommended RURALFUNDS STAPLED and Treasury Wine Estates Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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