Rural Funds shares higher following update and guidance reaffirmation

This morning, Rural Funds Group (ASX:RFF) reaffirmed guidance and announced its intention to increase guarantee to J&F Australia.

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An announcement to the market was made this morning by the agricultural REIT (real estate investment trust) Rural Funds Group (ASX: RFF). This announcement was followed by a discussion webinar to give investors a chance to ask questions directly to management.

Rural Funds shares are currently trading up around 1% today, coming off the back of a large gain yesterday when the broader share market fell. So, what did Rural Funds announce today?

Reaffirmation of guidance

Rural funds reaffirmed its guidance forecast which was made on the 2nd of March. This specifically included:

  • FY20 adjusted funds from operations (AFFO) per unit of 13.5 cents
  • FY20 distributions per unit (DPU) of 10.85 cents, up 4% on the prior year
  • FY21 DPU of 11.28 cents, up 4% on the current year.

Increase of JBS feedlots and guarantee

In August 2018, Rural Funds raised equity to fund JBS feedlots and a $75 million limited guarantee to provide security for J&F Australia Pty Ltd. J&F provides a cattle supply facility for cattle held primarily in these feedlots. This structure meant Rural Funds preserved its REIT status.

Due to expanding business, JBS has requested a larger facility to $100 million, up from the current $75 million. A meeting will be held on the 14 April 2020 to seek approval from Rural Funds unitholders.

This structure may be a bit confusing. However, I will do my best to break it down and explain how Rural Funds Group earns its return from J&F. This return was noted in today's announcement and webinar by management to be an annualised (net of all costs) 10.23%.

This return of the guarantee has been generated through finance income and interest savings.

Finance income

J&F revenue is recognised as finance income which is paid to Rural Funds by JBS on a cost basis. This return is net of all costs paid to Rural Funds Management, for which J&F is a wholly-owned subsidiary and Rural Funds Group is a responsible entity. This means J&F is distinct from Rural Funds Group and is what preserves its REIT status.

Interest savings

Interest savings have been made from a reduction in bank debt. This is thanks to the original $75 million in equity raised in 2018 being used to pay down debt.

New guarantee

The increased guarantee is stated to accrue a similar rate of return as previously seen. An independent expert has assessed the return range to be between 9.68% and 11.21% of the guarantee.

The guarantee is supported by Baybrick who has $3.5 billion in net assets and is a subsidiary of JBS S.A. Meaning, it guarantees the obligations of JBS.

Risk is also diversified further through geographic diversification of the feedlots, with Rural Funds Group having no direct operating risk, consistent with its other assets.

Foolish takeaway

Rural Funds pays its dividends through income received from lease agreements. These leases have a weighted average lease expiry (WALE) of 11.5 years, giving Rural Funds a strong position to continue paying dividends during a recession.

However, this income can only be received if its tenants remain profitable and continue with their contractual obligations. 78% of Rural Funds' tenants are listed and corporate entities such as Treasury Wine Estates Ltd (ASX: TWE) and Select Harvests Limited (ASX: SHV).

In line with this, management expects its lessees to remain profitable as they are producers of a daily requirement – food. Additionally, management noted that exports to China have normalised during the summer crops harvest season.

Motley Fool contributor Michael Tonon 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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