Finding Value In Farmland
Our analysis suggests that Farmland Partners (FPI) represents an attractive investment opportunity
We believe FPI has a defensible moat (competitive advantage) in how they acquire land
Farming underpinned the creation of modern civilization, allowing for specialized labor, modern government and much more. That’s my synopsis on the importance of farming from a fascinating book I’m currently reading by Jared Diamond called Guns, Germs, and Steel: The Fates of Human Societies. I highly recommend this read as it will answer questions you never knew you had about how civilizations have transformed over time and can help form a framework for predicting how the world may evolve in the future.
Recently, Aurora Financial Strategies began acquiring shares of a company called Farmland Partners (FPI) for clients in our individual stock strategies. In this blog, I will briefly describe the company and why we see a compelling investment opportunity in its shares.
A Primer on Investing in Farmland
Most aspects of farming are extremely competitive and difficult to invest in. However, farmland has been a popular asset class. In fact, the USDA estimates that farmland represents $1.9T in assets In the US alone. Most investors have a difficult time allocating to the asset class as these are the most common options:
Direct Farmland – Nice asset but not liquid and difficult to buy in the intended amount
Equipment Makers like John Deere – Somewhat related to farmland, but equipment manufacturers are sometimes with landholders for a stake in the value chain
Seed Companies – Dwindling Public Investment Options after Monsanto was purchased by Bayer. Again, these companies also are not the same as investing in the land.
Farm Operations – Need significant scale to be profitable and most need to be active in the business. The profit stream from operating is also somewhat different to that of a landowner.
Farmland Partners (FPI)
Business Description – Farmland Partners owns approximately 156,500 acres of land in 16 states (as of June 2, 2020). That land is primarily rented out to more than 100 different tenants growing 26 different crops.
Moat Description: We focus on companies that we believe have a sustainable competitive advantage aka moat. Farmland Partners primary competitive advantage is structural. They have the ability to issue operating units convertible to common stock in exchange for farmland. This provides the seller liquidity without having to trigger capital gains until they need to access liquidity. As a result, Farmland Partners acquires land at a discount relative to cash buyers that can offer no such tax avoidance option. Should capital gains tax rates increase, the discounts negotiated by farmland partners would likely be increased widening their economic moat. The company as the company scales, they currently have capacity to manage $2-3B in farmland without adding staff. They currently manage about $1.1B in farmland. As a result, a significant portion of the associated revenue should be available as cash flow to distribute to shareholders or to reinvest in new land or capital improvements.
Valuation
We believe the net asset value (NAV) of the company is about $13/share. This is essentially what you could get if you liquidated the company’s assets, paid off all the debts and distribute what is left to shareholders. With shares trading around $10, we see significant opportunity for investors. The NAV is derived from a review of the company’s owned properties, land value trends in the states where the land resides, and comparison data with prevailing discount rates in various states. While there is some variation in land value within each state, we feel comfortable with the roughly $3/share difference as a margin for safety.
When the stock price is close to or higher than the NAV, the company tends to sell new shares of stock into the market raising new capital for purchasing land and expanding the farmland portfolio. However, due to the depressed share price, the company has been selling off land to buy shares of its stock back. This essentially allows them to purchase part of their existing portfolio at a greater discount and increase the NAV for existing shareholders.
Scenario Analysis
Three models were created to simulate various acquisition/dispositions based on where the share price goes in the short term. Based on this modeling exercise, we believe the company should be able to reach an NAV/share of somewhere between $19 and $26 by 2025.
Risks
If the stock price does not recover, management will need to continue to shrink the company to create value for shareholders through arbitrage. There is a risk management does not do this fast enough reducing the ability for value to accrue to shareholders.
Interest rates could rise enough to depress the value of their farmland, especially if driven by inflationary pressures that do not drive up the revenue operators can reasonably expect to generate from the land.
If the actual value of the company’s farmland is materially different from the estimated value, the output of that analysis would lead to a much different conclusion.
Further Reading
https://www.nass.usda.gov/Publications/Todays_Reports/reports/land0820.pdf
In Summary
At Aurora, we are constantly looking for “the right pitch” in our sweet spot where we believe the probabilities are in our favor. This blog represents our thinking at the time of publication. If you are a DIY investor, use this only as a starting point for your research and be sure to do your own due diligence. For questions regarding our individual stock strategies, please reach out to us!
Invest Curiously,
Austin Crites, CFA
Austin Crites is the Chief Investment Officer of Aurora Financial Strategies, a financial advisory firm based out of Kokomo, IN. He can be reached via email at austin@auroramgt.com. Investment Advisory Services are offered through BCGM Wealth Management, LLC, a SEC registered investment adviser. This blog does not constitute advice. This is not an offer to buy or sell securities. Advisor is not licensed in all states. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. BCGM Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Clients may own positions in the securities discussed.