(Pexels; Note – not FPI land)
One of the few industries that appear to be outperforming due to the COVID-19 pandemic is agriculture. With shoppers flooding stores, retail food prices have been rising around the world. Agricultural commodity prices have declined a bit on market liquidity and dollar strength, but if you bought eggs recently, you likely realize prices have skyrocketed or there is a shortage. Consumer demand around the world is higher, and with many not going to work, it is likely that logical issues will cause supply to slow.
Of course, there is also the locust epidemic in Africa, ASF in Asia and now Europe, and export bans all acting to support/lift food prices. Indeed, in times like these where the world is reliant on food producers, it is reasonable for their profits to rise.
I recently wrote about the agricultural commodity trading and processing giant Archer-Daniels-Midland (ADM) in “Archer-Daniels-Midland: A High-Quality, COVID-Resilient Company“. In a similar vein, I’d like to cover the farmland REIT Farmland Partners Inc. (FPI).
Will A Recession Pop the “Farmland Bubble”?
Farmland Partners is unlikely to substantially gain from an expected rise in agricultural prices due to the virus. More importantly, it will certainly not lose because of it. FPI buys land and rents it to farmers, so its bottom line requires farmers to be profitable enough to pay FPI and for farmland to appreciate.
FPI selects land with high soil quality, water availability, competitive tenant environment, access to transportation, and a healthy climate. The company currently owns 158K acres diversified across the U.S., as shown below:
(Source: FPI 10-K 2019)
As you can see, the company is not overly dependent on any one area of the country. If there are an environmental event in one area or a certain crop (i.e., corn) crashes, it is likely that other regions’ revenue will make up for the losses.
The most significant risk to FPI relating to today’s environment is not a drop in revenue but a drop in land values. Given the 3.3 million jobless claim jump on Thursday, it is extremely likely that COVID-19 will spark a severe economic recession. Food demand will likely remain unchanged, if not move higher, which will boost farm profitability, but tighter financing conditions could make land values decline.
As you can see below, farmland values per acre have risen substantially over the past two decades, while agricultural commodity values have been low. Take a look at a chart of U.S. agricultural land values (adjusted to today’s dollars) versus inflation-adjusted agricultural commodity values:
(Data Source: Federal Reserve)
This chart tells us a lot about the agricultural industry today. Real land values have never been this high, while real agricultural commodity values have (almost) never been this low. At first thought, this is a bit paradoxical, as one would think higher agricultural prices = higher land value, since farmers’ profits would rise. That said, the industrialization of farming has boosted yields and thereby reduced agricultural commodity prices while increasing the revenue of most farms, boosting their value.
It appears that the 1970 stagflationary shock boosted both food prices and agricultural land values. If a similar shock occurs, this may happen again. Much of Asia has a food inflation rate above 20% that is likely to soon be exacerbated by the locust invasion in the East Africa/Middle East region and COVID-related transportation difficulties. If the U.S. is a major exporter to fill the gap, U.S. farm rents will likely rise with farmland value.
That said, agricultural land values are very high today and have never been this high. An economic slowdown that hits financing markets would likely bring farm values down. That market is largely impacted by USDA farm loans, which, like far too many loans today, are guaranteed by the full faith and credit of the U.S. government. This program allows people to buy farms at 2-3.5% interest rates. This is likely a major factor contributing to the more recent rise in farm values considering farm debt levels are skyrocketing.
Frankly, there could be a bit of a “farm bubble” very similar to the 2000s property bubble. The root cause is the same: ultra-low rate zero down payment federally guaranteed loans. These loans cause excessive borrowing and, instead of helping farmers, only create price competition among buyers and raise land value accordingly.
Obviously, if the bubble pops and land values decline, it will hurt FPI’s balance sheet. That said, as you’ll see, the company’s balance sheet is strong. More importantly, a drop in farm ownership rates would boost rental demand for FPI.
A Look at FPI’s Financial Situation
FPI is a cheap stock today with a forward price-to-FFO of 10X, which is extremely low for a REIT. As you can see below, this ratio has declined considerably over the past two years:
Usually, this valuation and valuation direction would be a sign that fundamentals are declining. To the contrary, FPI has actually increased funds from operations and book value per share relatively consistently over the past few years:
As you can also see, FPI is trading at a relatively significant discount-to-book of 39%. Remember, the company owns farmland, which does not physically depreciate over time and has actually appreciated over the years (across America), so the stock is trading at a large discount.
Given that FPI has expanded its book value per share and FFO per share and is trading at very low valuation ratios, it would usually imply the company is taking on excessive leverage. However, it has actually lowered its leverage over recent years from both a liabilities-to-assets and EBIT/interest (i.e., TIE) standpoint:
Looking simply at FPI’s numbers, it appears to be undervalued by about 50% and should likely trade closer to $12 with a more reasonable P/FFO of 20X and slightly above book value.
Why Is FPI So Cheap?
While FPI appears to be a stellar buying opportunity, there are obviously reasons it has been trading at such a low valuation. Frankly, I do not believe land valuation risks are high enough to materially impact the company, nor does it seem that the market as a whole is aware of and pricing in these risks.
One reason may be because FPI is in a niche market and has few comparables. REITs rely on investor relations to gain attraction. To be frank, FPI’s is poor, as it lacks up-to-date investor presentations and recently stopped providing its supplemental package. Since it is in a niche that can be easily misunderstood, many would-be investors may avoid the company out of a lack of understanding that would be fixed by improved investor-oriented documents.
There are also allegations of fraud and a corresponding lawsuit war surrounding those allegations that began a year and a half ago. The accuser, Rota Fortunae, claimed FPI uses its mortgage-lending program to make loans to related parties in order to artificially increase revenues. Farmland Partners wrote a point-by-point rebuttal and a lawsuit against what it deems to be a “short and distort” report.
Frankly, I side with Farmland Partners. Its revenue and income per assets appear to be completely normal, and the company’s rebuttal appears to sufficiently demonstrate many allegations were/are false. Obviously, doing your own due diligence is recommended, but I believe the lawsuits will be “litigation upside” for the company, as it appears to be suppressing its share price. It is still not clear when the verdicts will arrive.
Overall, I believe that FPI is a “Buy” with solid upside and strong resiliency in the face of COVID-19 and other negative economic factors today. The REIT has low leverage, has improved FFO per share, and is trading at a discount on both a P/FFO and book value basis. There is some risk that agricultural land is overvalued and due to come down in case financing rates increase, but that is not a major concern as of yet.
Interested In My More-Exclusive Research?
My fellow contributor BOOX research and I run the Core-Satellite Dossier here on Seeking Alpha. The marketplace service provides an array of in-depth portfolios designed using the academically-backed Core-Satellite approach. This involves creating a base long-term portfolio (the core) and generating alpha using unique well-researched tactical trades (the satellite).
As an added benefit, we’re allowing each new member one exclusive pick where they can have us provide in-depth research on any company or ETF they’d like. You can learn about what we can do for you here.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FPI over the next 72 hours. 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.