The Kaizen Capital allegations are directed at RFM in its capacity as manager for RFP. They are incoherent and confused. Unfortunately they have been given potency by the AFR’s reporting.
RFP is the tenant of RFF’s poultry assets. The sale of the RFP leased assets is contingent on tomorrow’s RFP unitholder vote. If the vote fails, RFP will likely seek rent relief from RFF which could impact RFF’s earnings.
This is not a forum to discuss RFP so I will exercise restraint, other than to say that winding up RFP is not in the best interest of RFM who stands to lose management fees. They are doing this because it presents value to unitholders in excess of the status-quo.
Transferring value to RFF
RFF was formed in 2014 following the merger between chicken, wine and almond funds managed by RFM.
Details here: https://www.asx.com.au/asxpdf/20140212/pdf/42mp3tp2v46g4r.pdf
In summary, the chicken fund investors agreed to:
- keep the chicken growing operations to be held via shares in RFP
- receive 35% of shares in a diversified REIT (RFF) in exchange for:
- vending its property to RFF at a value of ~$99m,
- signing a lease with RFF at commencing rent of $10.15m, indexing at 2.25% p.a. (the same rate of increase as the underlying growing contracts with Baiada)
Similar deals were agreed with the wine and almond fund investors.
Since then, almonds and wine have outperformed while poultry has underperformed. Capitalisation rates for real estate assets have also firmed, causing land values to increase. Meanwhile, the chicken growing operations have not performed as well. However, those chicken fund investors who now hold both RFP and RFF shares have still done very well as the chart below shows.
It is incorrect to say that value has transferred from RFP to RFF. Such a statement ignores the contribution that almonds and wine made to RFF. It also ignores the risk profile of a farming operation vs. agricultural real estate.
Investors in RFF have subscribed for the latter – they not entitled to the surplus gains of farming during the good times and are protected from losses by the tenant during the bad times.
Investors like Kaizen who bought into RFP after the above transactions subscribed for the former – have not done so well but it was the risk they took as a price they found to be compelling.
Today’s rent
The starting rent in 2014 was set at a 10% yield. Since then, RFP rent has escalated in accordance with the lease agreement. Depreciation has caused the asset value to fall each year. That is how you get to 14% yield – no magic.
This is typical of “infrastructure predominant” assets as per RFM’s description. Yields are higher to compensate for falling asset values.
If RFF maintained rents at 10% yield, the rent would fall each year due to depreciation. In FY19, that would be a $0.7m fall in rent. Why would any landlord accept falling rents and falling asset values every year?
The comparison to yields on almonds, cattle, cotton and vineyards is irrelevant due to this distinction.
Rent review and the conflict of interest between RFP andRFF
In recent times, RFP made requests to RFF to provide concessions. Concessions have been granted in response to the difficult farming environment experienced by RFP.
As a shareholder in RFP, I want lower rent from my landlord.
As a shareholder in RFF, I do not want to lower rents charged to my tenant.
Nothing special here – this conflict is typical between all landlords and tenants.
The report correctly identifies that RFP has the right to request a rent review in the event of a material permanent change in the chicken growing gross margin.
This is not a right to a rent reduction. At best, it may be construed as a market rent review.
ProTen’s agreement to purchase the real estate and the chicken growing business at a premium to the current book valuation is strong evidence to suggest that both the rent and the book value are at market. RFP just isn’t at the right scale – a market rent review looks through this.
See table below for concessions granted in FY19
See below for RFM’s view on this issue.
Transferring $64m of value to ProTen
1. RFP doesn’t have the capital to invest $136.5m into CAPEX and farms
2. ProTen does – it takes on the risk and is entitled to the returns
3. For Proten to achieve $64m uplift, the new assets need to be valued at $200m. Someone would need to pay a 7.5% yield on depreciating chicken farm assets and a 13.3x EBITDA multiple on the chicken growing business (For reference, Inghams trades on 7.9x EBITDA and is much larger than RFP)
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