Gladstone Land Vs. Farmland Partners: Slow And Steady Wins The Race
Summary
- One year ago, LAND and FPI were trading at the same price. One year later, things are different.
- LAND continues to grow at a methodical pace, and a few changes to how they raise capital should provide more stability.
- FPI acquired quickly and is now forced to pause.
- My prediction for the next year.
Just under a year ago, I wrote the article "Gladstone Land Vs. Farmland Partners: The Tortoise And The Hare," comparing Gladstone Land (NASDAQ:LAND) to Farmland Partners (NYSE:FPI). I used the analogy of LAND as the tortoise and FPI as the hare.
At that time, the two were trading at roughly the same price.
Source: Tradingview.com
Since then, LAND has trended upward while FPI has been mostly down. In addition to share price growth, LAND also increased their dividend four times, for a total increase of $0.015/year (2.9%). Will LAND be able to continue their slow and steady growth? Will FPI be able to pull out of their downward spiral?
Same-Property Growth
LAND had a bit of a bumpy year with their renewals. A farm in California that was previously a strawberry farm operated by Dole, was re-leased as a vegetable farm to a different tenant. The reduction in rent from that farm erased gains from the 9 other farms that were renewed, resulting in a net decrease of $166,539 in annual revenues from lease renewals.
Thanks to additional rents from capital improvements, LAND was able to post a modest $320,000 (2.3%) increase in annual revenues from their same-properties. It is encouraging that LAND can continue to grow same-property revenues, even when they lose a significant tenant.
Going into 2018, LAND only has 4.5% of their leases expiring in terms of base rent. Renewals should have little impact on their same-property revenue. Their built in escalators and capital improvements doing the heavy lifting. That means investors can reasonably expect growth to be in the 2-3% range.
FPI has been facing more severe headwinds, with same-property revenues dropping $0.9 million (8%). The decline in rents is something I have been warning investors about since my original FPI article. I have been especially critical of how Mr. Pittman has handled the issue in conference calls, first saying that renewals were only dropping "5%ish" in row crops and would be offset by other areas. In the most recent conference call, he said:
Collin, you had one other thing I just want to address I forget where it was cited, but I know the statistic you preferring to same-store sales calculation for our company 2016 versus 2017 was down around 8%. That is way less than the market priced us at or expected us to experience. If you-- when we came out with guidance last spring, you would read things where people thought we might see 20% or 30% decline in same store sales. 8% is frankly not very much. That is entirely on the basis of basically a grain production only portfolio because remember the way same store sales works it's based on the 2016 era portfolio. That's what you're really measuring against, and in 2016 this company was virtually 100% row crop with relatively high weighting toward the Corn Belt itself. So what you saying -- that none of this surprises us, but it seems to be lost to the market. We experienced 50% reduction in commodity prices and we were experienced an 8% reduction in rents, and almost no reduction in asset values.
I can't speak for other people, but when I previously referred to 20-30% declines, I was speaking solely about the leases being renewed. Since renewals accounted for roughly 1/3rd of the same-property portfolio, the declines must have been 20-30% in order to cause a drop of 8% across the entire same-property portfolio.
I find the way Mr. Pittman frames this as slightly misleading as it seems to imply that all of the leases were renegotiated and rent only dropped 8%. The reality is that the leases renewed last year were by and large written in 2014 (most of these leases have a 3-year term), those written in 2015 and 2016 remained flat because they were not up for negotiation.
Mr. Pittman does have a point in that due to the AFCO merger and other acquisitions, the same-property portfolio is a small portion of the entire portfolio. That is why a 20-30% drop across the renewals ultimately translates to a loss that is less than 2% of total revenue.
The big question is what investors can expect going forward. Last year, I relied on data published by Gary Schnitkey with Farmdoc Daily to estimate the renewals.
Most of FPI's land is going to fall into the "good" to "excellent" category. Since the leases expiring in 2018 were written in 2015, we can expect renewals to be approximately 15% lower.
That will be offset by rising rents on their specialty crops. Unfortunately, FPI does not provide in-depth breakdowns of what is up for renewal and the current rents. FPI is guiding for 2% growth, that seems a bit optimistic to me, although not completely impossible.
Acquisitions
In 2017, LAND acquired 17 farms for a total purchase price of $131.6 million with annualized straight-line base rent of $7.1 million. LAND maintained their strategy of focusing on fresh produce and specialty crops, achieving cap-rates in the 5% range.
One of the issues that has plagued LAND was the inefficiency of their secondary offerings. When making a secondary offering, their share price would plunge and it would take some time before it recovered. Additionally, the company would get a lump sum of capital that would take months to invest.
Going into 2018, LAND is attempting to make their capital raising more efficient by issuing a continuous offering of Preferred B shares. CEO David Gladstone said:
Over the next five years, we intend to sell some or all of the $150 million allotted for in this offering. We believe this offering will provide the Company with access to the additional capital needed to grow our Company in a way that is not as dilutive to existing common stockholders. Shares of the Series B Preferred Stock will be sold on a ‘reasonable best efforts' basis over a certain period, which should allow us to invest the new capital as the small amounts are received, as opposed to receiving a large amount of capital all at once from a typical offering, which can often create a drag on earnings until the new capital is fully invested. We believe this offering will allow us to continue growing our Company well into the future at a steady rate, which we hope will also lead to increases in the value of our common stock
Through a combination of slowly issuing the new Preferred B and using their ATM program to issue common shares, LAND should be able to avoid having to do any large overnight offerings. That should provide for less dramatic swings in share price and less time between when LAND raises capital and is able to invest that capital.
LAND will continue to acquire new properties at a consistent pace and we can expect them to continue buying similar properties.
FPI has been growing far more aggressively, investing $483.6 million in 2017, including the AFCO merger. 2018 will see a dramatic slowdown for FPI as Pittman says they only have about $20 million in dry powder, which might be used for buybacks. For 2018, new acquisitions will have little to no impact.
Dividends
REIT investors tend to put more emphasis on dividends than most. LAND has been increasing the dividend by small amounts regularly. By the end of 2017, the result was a 5.8% increase year/year. LAND currently pays an annualized dividend of $0.531.
LAND's AFFO payout ratio has crept up from 91.5% in 2016 to 94% in 2017. That payout ratio should come back down as acquisitions from late last year contribute to the bottom line. I have followed and invested in several Gladstone companies, and the unique external structure of the companies allows for very high payout ratios.
One thing I have learned about David, is that he loves dividends, he loves to raise dividends and he will go to extraordinary lengths to avoid cutting them. Including, waiving substantial amounts of fees for the advisory company. Therefore, I am more comfortable with a higher payout ratio than typical.
Anyone investing in LAND should take the time to investigate the other Gladstone companies, Gladstone Commercial (GOOD), Gladstone Investment (GAIN) and Gladstone Capital (GLAD), to ensure they understand the unique relationships.
It is very likely that LAND will have at least a couple of dividend raises again this year.
FPI pays a dividend of $0.51, which is not covered. Their AFFO of $0.36/share fell very short in 2017, and even the high end of their 2018 guidance of $0.44 leaves a significant shortfall.
Publicly, FPI management has been adamant that the dividend will not be cut in 2018. The problem is that the dividend is not going to be covered in 2019 either. With minimal acquisitions in 2018, it is unclear to me how AFFO will grow 16% in 2019, or even by 2020.
Share Price
One number where FPI appears to be a much better value than LAND is in share price. FPI is trading at 18-19x AFFO while LAND is trading at 24-25x AFFO.
In my opinion, both are rather expensive right now, though both have emphasized that their shares are trading at a discount to NAV. I recently wrote an article on why I consider NAV a largely irrelevant metric for REITs.
To be brief, the main appeal of investing in REIT stocks is the income stream. Share price is primarily going to be determined on the size of the income stream, the safety of the income stream and prospects for growth of that income stream. Hence why we obsess over FFO, AFFO and other cash flow metrics. The underlying value of the asset is usually correlated to all of that, but not necessarily perfectly correlated.
The problem with relying on NAV as a guide to share price is that NAV can only be realized by selling the property. In general, REITs are not in the business of flipping properties. When they sell a property, their cash flow is reduced until they buy another one.
Neither of these companies has done any significant selling, and it is unlikely that they would. The value to investors like us lies in the ongoing cash flows.
The possible exception would be some kind of liquidation. Which is not going to happen anytime soon for LAND. There was some interesting discussion in the recent conference call for FPI that leads me to believe it might not be completely out of the question in a few years if the public market continues to discount the stock.
The problem with using NAV for liquidation is that the process takes time, sometimes years. Especially when you are dealing with property that has a very limited pool of potential buyers. Meanwhile, the REIT shrinks and the efficiencies of scale dissipate. Debt holders and preferred shareholders will be paid first and common shareholders are likely to receive significantly less than the theoretical NAV.
A buyout of the entire portfolio is a quicker possibility, but anyone purchasing the whole thing would only do so at a discount to their NAV calculations. At the end of the day, NAV is unlikely to protect common shareholders from any losses. Investors looking to capitalize on property value growth should look at the preferred shares.
Trade War
Another potential risk that could be brewing in 2018 is the prospect of a trade war. With grains being one of the most significant exports for the US, it is likely that they could be a target for retaliatory tariffs. That would certainly be bad news for US grain prices, adding to the downward pressures that already exist.
LAND is significantly more insulated from such issues since the majority of their crops are sold domestically. FPI's high exposure to corn and soybeans means that their tenants would be hit harder.
It is difficult to measure the potential impact. Given the inconsistent nature of farming, farmers are always prepared to absorb a bad year or two, it comes with the industry. FPI will probably not feel the effects unless it turns into a multi-year thing, although the share price might reflect it much sooner.
I will leave it to the reader to determine the likelihood of a significant trade war. I do not pretend to have an idea of what Trump or Congress will do.
Conclusion
One year later, the tortoise has continued growing at a consistent pace, while the hare has stopped to take some breaths.
LAND soundly beat FPI in same-property growth and dividend growth in 2017, LAND will easily do so again in 2018. FPI had a substantially higher level of acquisitions in 2017, but with little dry powder and no easy way to access capital, LAND will almost certainly have a higher level of acquisitions in 2018.
When I wrote about the two companies last year, they were trading at the same price. LAND has continued to increase, while FPI has continued to trend downward. I fully expect that trend to continue in 2018.
In 2018, LAND should be almost boring in a very good way, making acquisitions throughout the year that are very similar to their current portfolio and avoiding the dramatic drops from overnight offerings experienced in the past.
FPI will need to find a way to cover their dividend, sooner or later. If management is to be believed, it will not be sooner. Either cash flow has to grow, or the dividend has to be cut. I do not see how cash flow grows substantially enough.
While FPI is substantially cheaper, I believe that LAND remains the superior investment.
This article was written by
Beyond Saving is a professional in commercial real estate providing research on REITs with a focus on properties being acquired and sold by REITs. He shares investment ideas with the understanding that the quality and value of the real estate purchased by a REIT serves as a significant catalyst for future pricing.
Beyond Saving contributes to the investing group Learn more.Analyst’s Disclosure: I am/we are long LAND, GAIN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (39)
Thank you for posting this thoughtful analysis. I have sometimes wondered about the apparent time correlation between the FPI / AFCO merger and the FPI / LAND stock price divergence (as in your Figure 1). In particular I wonder if a large percentage of the original AFCO owners who suddenly found themselves as FPI owners might have sold their FPI and bought LAND. My reasoning is that AFCO was, in many ways, more similar to LAND than to FPI. Perhaps most of the original AFCO owners have now exited FPI and are now LAND owners. What are your thoughts on that?
Thanks again for the nice article.
-Hawkeye7.
Farm girl, daughter of a farm girl, and very long-time organic gardener. I know whereof I speak.
