Is the Rural Funds Group (ASX: RFF) share price a buy for its dividend yield?
An overview of Rural Funds
Rural Funds is an agricultural real estate investment trust (REIT). That means it owns commercial properties that are leased out and generate rental income.
Specifically, Rural Funds owns a variety of farmland properties across five sectors: cattle, vineyards, almonds, macadamias and cropping (sugar and cotton).
It has 22 cattle properties, seven vineyards, 23 cropping properties, six macadamia properties and three almond properties. These properties are spread across a variety of states and climactic conditions for diversification.
The split between the income sources isn't even. Rural Funds has provided an estimate for its FY21 revenue. Around 45% is expected to come from almonds, 36% from cattle, 6% from vineyards, 6% from cropping, 2% from macadamias and 6% from 'other'.
Rural Funds has rental indexation built in to all of its contracts with tenants. The rental increases are largely either a fixed 2.5% increase with market reviews, or linked to CPI inflation.
More than three quarters of revenue from Rural Funds' tenants are large farming enterprises such as JBS, Select Harvests Limited (ASX: SHV), Olam, Australian Agricultural Company Ltd (ASX: AAC), Queensland Cotton, Treasury Wine Estates Ltd (ASX: TWE) and Stone Axe.
How is income generated for shareholders?
The REIT receives rental income from its tenants. The farmland REIT then pays for all of the operating expenses of the farms that Rural Funds pays like insurance cost recoveries, as well as other expenses like ASX fees, bank fees, audit fees, bank interest and so on.
What's left is called AFFO.
'AFFO' which stands for adjusted funds from operations (AFFO). This is a financial metric used in the REIT sector to measure available cashflow from operations (the adjustment relates to a non-cash tax expense).
Rural Funds pays its distribution from the AFFO. In FY20 it generated 13.5 cents of AFFO per unit/share. It allowed Rural Funds to pay a distribution of 10.85 cents per unit, which was a 4% increase despite COVID-19.
The REIT aims to grow its distribution by 4% per annum for investors, which is funded by excess AFFO generation.
What's the prediction for FY21?
In FY21 Rural Funds is expecting to make 11.7 cents of AFFO per unit and the distribution is expected to be 11.28 cents, which is in line with its 4% growth target. That represents a payout ratio of 96.4%.
The AFFO is expected to decrease as funds are re-invested into macadamia orchard developments which are expected to produce higher income when leased.
Maryborough macadamia plantings are to commence in late FY21. The REIT said that it will take several years to fully develop Maryborough and Rockhampton properties. In the meantime, the majority of the Maryborough farms are expected to be leased as cropping operations (primarily sugar cane) whilst Rockhampton assets are expected to be leased as cattle properties.
At the current Rural Funds share price, that means it has a FY21 distribution yield of 4.7%.
Is the Rural Funds share price a buy for dividends?
Rural Funds is currently rated as a buy by Motley Fool's Dividend Investor's Edward Vesely and the pick has performed well since the first buy recommendation in August 2017 when the share price was $1.64.
In FY20, its adjusted net asset value per unit – the underlying 'book' value per unit – grew by 8% to $1.94. That means the current share price is valued at a 24% premium to the adjusted NAV.
