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Here’s why income investors may love Rural Funds (ASX:RFF)

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There are a few reasons why income investors may love Rural Funds Group (ASX: RFF) shares.

What does Rural Funds do?

According to the ASX, Rural Funds has a market capitalisation of $868 million.

Rural Funds is a fairly unique business on the ASX. It’s a real estate investment trust (REIT) that specialises in owning agricultural properties and leasing them out.

Here are some of the reasons why income investors may love Rural investors:

Diversification

Rural Funds has a diversified farm property portfolio. It has a total number of 61 properties. Its farms are spread across a number of different sectors.

It has cattle farms, vineyards, macadamia farms, almond farms and cropping (cotton and sugar).

Those farms are diversified across different states and are in different climactic conditions.

Rural Funds does actually own a significant number of water entitlements for its tenants to use, but it doesn’t carry the operational risks like its tenants do.

Strong financial position and tenant base

One of the main ratios that REITs tell investors about is the gearing ratio, which tells investors about how much debt it has compared to the asset value.

A high gearing ratio suggests that a REIT may be carrying a lot of debt. A low gearing ratio may suggest that a balance sheet is more sustainable.

At 30 June 2020, Rural Funds had a gearing ratio of 29.7%, which it measures as the external borrowings compared to the adjusted net asset value (the adjustment is for the market value of its water entitlements).

It has a high quality tenant base that are in strong financial positions to be able to keep paying rent as it’s due.

Some of its tenants include Treasury Wine Estates Ltd (ASX: TWE), Select Harvests Limited (ASX: SHV), Australian Agricultural Company Ltd (ASX: AAC), Olam and JBS.

Income growth

Income investors may be most interested in the income distribution side of things of Rural Funds.

The farmland REIT aims to increase its distribution by (at least) 4% each year. That is comfortably ahead of the inflation rate.

The distributions are largely supported by two factors.

The first is that Rural Funds has rental increases built into all of its contracts. Plenty of its farms have a fixed 2.5% increase per annum. Most of its other farms have rental increases linked to CPI inflation. There are also occasional market reviews.

The other main way that it is generating rental growth is that it’s investing some of its excess rental profit (adjusted funds from operations – AFFO) into productivity improvements which aims to increase the rent and the value of the farms.

Finally, the REIT occasionally makes acquisitions which can be accretive to earnings per share. It has been busy acquiring cattle farms over the past few years which management indicate has more capital growth potential than other farm types.

Valuation

Rural Funds has an adjusted net asset value (NAV) of $1.94 per unit, which incorporates the most recent independent property valuations, inclusive of water entitlements. Compared to the Rural Funds share price of $2.52, it’s priced at a 30% premium to the adjusted NAV.

It’s guiding a distribution of 11.28 cents for FY21, which translates to a forward distribution yield of 4.5%.

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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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