I recently invested some of my tax refund into an S&P/ASX 300 Index (ASX: XKO) share that I believe is undervalued and can deliver solid long-term returns. That stock was Rural Funds Group (ASX: RFF).
I've been a fan and shareholder of this company for many years. Between March 2017 (when I wrote about being happy to hold the stock forever) and January 2022, the Rural Funds share price climbed 80% and delivered plenty of pleasing passive income.
But, the Rural Funds share price is now back to the same level it was over six years ago. It has fallen by around 40% since its peak in January 2022, which I think makes it cheap today.
Rural Funds owns farms across different sectors, including cattle, wine, almonds, and macadamias. Those farms are spread across different Australian states and climactic conditions, which is useful for diversification.
Why I'm contrarian about this ASX 300 share
I think we can find buying opportunities among companies and sectors investors have become fearful of.
It's understandable that the real estate investment trust (REIT) sector has seen a sell-off – higher interest rates hurt the value of assets, and the cost of debt has increased. Most REITs have a sizeable amount of debt on their books.
Rural Funds does have debt. However, what's important to me is that it has hedged much of this debt at a relatively low fixed interest rate. For FY24, the company has hedged $432 million at a weighted average hedge rate of 2.83%, and for FY25, it has hedged $493 million at a weighted average hedge rate of 2.8%.
For FY24, around two-thirds of the debt has been hedged and fixed, so the company has lowered the medium-term pain of higher interest rates. Rental income can keep growing during this time, and Rural Funds can complete its large farm developments.
Based on today's low Rural Funds share price, I think the company is attractive for whatever happens next.
If interest rates stay higher for longer due to persistent inflation, then Rural Funds' rental income can keep growing – a substantial portion of rental agreements are linked to CPI inflation. Stronger rent could help support farm values.
If inflation falls, interest rates should drop, and lower interest rates should also be positive for farm values.
Either way, I think Rural Funds shares are undervalued when considering the longer-term prospects of the ASX 300 share.
Rural Funds' passive income
I think the long term looks positive for the Rural Funds share price, and in the short term, I'm attracted to the stock's appealing passive income.
While the company isn't offering a larger payout in FY24 compared to FY23, the projected distribution still represents a very good yield. Moving forward, Rural Funds still intends to grow its annual distribution by 4% per annum, and hopefully it can return to growth sooner rather than later.
In FY24, Rural Funds is expected to pay a distribution per unit of 11.73 cents. This would mean a distribution yield of around 6.5% based on the current share price, though I managed to invest with a forward yield of just over 6.6%. With the low Rural Funds share price and the attractive yield, I think the stock has a good chance of outperforming the S&P/ASX 200 Index (ASX: XJO) over the next three years.
