The ASX dividend stock Rural Funds Group (ASX: RFF) looks like a leading passive income opportunity, in my opinion.
Rural Funds is a real estate investment trust (REIT) that provides exposure to the farming sector. It owns various farms across the country and is exposed to industries such as almonds, macadamias, cattle, cropping, and vineyards.
I don't expect huge capital from this investment, but at its current level, I believe it could deliver an excellent income stream. Let's dig in.
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Passive income potential from the ASX dividend stock
Commercial property has the potential to deliver both long-term capital growth and pay good distributions.
Rural Funds generates rental profits from its high-quality tenants, including Select Harvests Ltd (ASX: SHV), Olam, JBS and Treasury Wine Estates Ltd (ASX: TWE).
The ASX dividend stock is investing in its farms, including creating macadamia farms and boosting the productivity of some locations (such as improving water access). This increases the underlying value of those farms and can unlock stronger rental profits over time.
Rural Funds currently pays an annual distribution per unit of 11.73 cents. That works out to be a distribution yield of 5.75%. Its longer-term goal is to increase its annual distribution by 4% per annum when rental profits allow.
Cheaper valuation
When an ASX dividend stock's valuation falls, it boosts the potential passive income yield. As shown on the chart below, the Rural Funds share price is down 36% since January 2022.
At 31 December 2023, the business stated its underlying net asset value (NAV) per unit was $3.07 as it benefited from independently revalued assets, primarily in the cattle and macadamia sectors.
The current Rural Funds share price is trading at a 34% discount to this value, so it appears to be trading at an appealing price.
Rural Funds suggests there are two reasons for this large discount: higher interest rates and no growth of net rental profit during this period, partly due to the pain of higher interest rates.
In a recent newsletter, the REIT explained why its rental profit – called adjusted funds from operations (AFFO) – could rise. Firstly, the bulk of its macadamia orchard and cotton farm developments are now well-advanced and long-term leases have been signed. Secondly, the ASX dividend stock said:
The most significant way that RFF will increase AFFO is through the rental indexation mechanisms contained in its leases. The mechanisms vary between leases, but generally speaking, leases contain indexation of around 2.5% per annum with periodic reviews to market value or simple indexation at the rate of the CPI.
… Rents have indexation mechanisms, which combine with the capital growth in assets to provide an excellent inflation hedge and good long-term total returns. A number of assets are undergoing development and will be added to this pool, while assets that cannot deliver satisfactory returns may be sold.
I think this business has an appealing future and could be one to watch for the long term.
