Background;

New Zealand Rural Land Co. (NZRLC) is a newly incorporated company that has been formed for the purpose of acquiring rural land across the New Zealand agricultural sector. NZRLC's intended business is to be an agricultural sector landlord only, as it will lease the rural land that it acquires to experienced tenants under long term leases. Tenants will undertake the on-land agricultural operations and pay rental to NZRLC.

NZRLC IPO'ed in December 2020 at $1.25/share raising $75M for the purpose of buying large scale dairy farms in New Zealand. The New Zealand dairy sector has seen an expansion in the past 20 years resulting in large scale corporate farms emerging, more notably in the South Island. NZRLC's first property was purchased in March 2021 and they have been raising equity and adding to their land holdings throughout 2021 and 2022. Notably purchasing 6,350 hectares for approximately $114 million, the vendor having being placed into receivership due to an outbreak of Mycoplasma Bovis disease. They now own 11,710ha of dairy land in the South Island of New Zealand all of which have been bought on very favourable terms due to the lack of competition from other large-scale buyers.

Valuation;

NZRLC has a market cap of NZ$120 million at current price of $1.06/share. Taking book values off their balance sheet from their 2021 annual report and adding in new purchases, their net assets are NZ$151 M. Going further, from my analysis the book value understates the value of NZRLC's net assets by a considerable margin as these assets were purchased under a distressed state with limited buyer competition. The company has recently had its assets appraised by an independent valuer on the 30th June 22 ahead of their annual results which will be released to the market in August. NZRLC put out a market update on 2nd June 22 stating that the discussions with valuers have indicated that based on comparable sales and updated cash-flow assumptions, the valuation of NZRLC's assets are likely to see an increase of 7.50%-9.50% vs June 2021. If you take the lowest increase of 7.50% this will increase the net assets to NZ$166 M or $1.42/share. Current market price is $1.06 per share.

As a New Zealander who owns farmland myself, I see the revised revaluation as still being too low. The total area owned by NZRLC is 11,710ha, all of which is dairy land in the South Island. The book value of this land is $250,400,000 which translates to $21,400/ ha. A recent large scale dairy farm listing in South Canterbury owned by the Ellis-Lea portfolio recently sold for $58,675/ha. I presume this is the top of the market so I will be conservative and estimate that NZL’s properties would be able to command $45,000/ha if sold to a willing and informed buyer. This would translate to an adjusted book value of $526,950,000. Minus the outstanding debt of $97,600,00 leaves an adjusted net asset value of $429,350,000. Outstanding shares of 116,300,000 works out at $3.69/share. Even if my $45,000/ha valuation is too optimistic, (which I genuinely believe it isn't) then there is still a large margin of safety between the current market cap of $121M and the possible $429.3 M.

My estimates are for rental income of $13.2 M in FY23 (balance date 30 June). Looking ahead NZRLC has three yearly, uncapped CPI adjustments written into its lease agreements with their tenants. New Zealand's latest CPI figure on 18th July came in at 7.30%. Therefore, NZRLC should realize a significant and permanent uplift in lease income at renewal intervals in 2024 and 2025 (circa 14% uplift in rental income). Inflation has had an historical positive affect on farmland which should also increase the value of NZRLC's asset values going forward. Obviously, the flipside to this is that interest rates are increasing which will increase the cost of debt for NZRLC. The increase in interest expense going forward will decrease short term FY23 and FY24 forecast cash earnings. Their current net debt/equity % is 57.4%. This debt is in the form of 90-day floating rate loans with RaboBank. From the interim financial report dated 31 Dec 21 there are 3 tranches of debt of $29.5M with rates of 2.38% (expiring 1 Jun-23), 2.68% (expiring 1 Jun 24), 2.98% (expiring 1-Jun 26). They will have a further $9M loan since that date which partly financed their latest acquisition. This brings the total debt to $97.5 M and I have factored in a rate of 6% on this debt which will increase their debt servicing costs to $5.85M in FY23.

So, from $13.2M in rental income, I take away management fees, S, G&A and other exp (total $1.8M) to arrive at operating EBIT of $11.4M. After interest of $5.8M you are left with $5.6M Net profit before tax. NZRLC expects to pay dividends of 5c per share or $5.8M which is a yield of 4.8%. They have used a lower debt servicing cost in their forecast than I have, so with my estimation they will pay $5.1M in dividends or 4.3c/share for a yield of 4.1% all else being equal.

One factor worth considering looking out past FY23 is the strength of the tenants. Can they absorb the increase in rent they are liable to face with CPI adjustments? I have made some basic assumptions using New Zealand industry data.

With NZRLC's income of $13.2M over 11,710ha the rent per ha works out at $1,127.24. This increases to $1,206/ha if it is increased by 7%. Not a material change for the farmer leasing the land.

Assuming the farmers leasing NZRLC's farms can meet the New Zealand average then they run 3.6 cows/ha and produce 456kg of milk solids (MS) per cow which is 1638kg of MS/ha. This year’s milk pay-out forecast from Fonterra (NZ's largest milk processor) is $9.30/kg of MS. This is $15,233.40/ha in revenue for the average farm. The average operating expenses are $6.25/kg MS or $10.237.50/ha. Therefore, operating profit/ha on the average New Zealand dairy farm in FY23 is $4995/ha. Easily enough to cover the cost of the rent increase if current conditions persist. Looking ahead I believe operating cost will increase and the $9.30 milk pay-out may be in jeopardy for the following season which with shrink the average operating profit. Milk powder is a commodity and difficult to forecast but at this stage I expect that NZRLC's tenants are producing above average and without the burden of debt they will be resilient enough to absorb the increased rent. A risk that will need to be regularly re-visited.

Conclusion;

We are in an inflationary environment and a lot of comparisons have been made with the 1970's. There is no denying there are some similarities. Farmland outperformed in the 1970's and is a traditional inflation hedge.

The way I see it, with NZRLC you are getting farmland with a book value of $151M for $120M. Even without the recent revaluation which hasn't been factored in yet you are getting a dollar for 80 cents. When NZRLC reports in August and the book value is adjusted for the new valuation of $166M you will then be getting a dollar for 72 cents. If you take my valuation of $429.3M, which compares their properties to similar New Zealand farmland you are getting a dollar for 28cents. In the meanwhile, you are getting a dividend yield of >4% on your original investment.

Not a bad place to wait out the current uncertainty.

NZRLC presents its annual report FY22 in August. They have already provided a market update stating that their Net asset value will increase materially due to recent revaluation gains. A recent equity raise at $1.05/share has side tracked the market and the price has languished around this level. Their annual result announcement could be the catalyst that lifts the price to its book value. As it only has a market cap of $120M and has only been listed since December 2020 it appears to be flying under the radar her in New Zealand. There are no comparable companies listed on the NZX apart from listed commercial property funds so I believe the market is failing to recognize the value.