Bell Potter revised yesterday their RFF 12mo target price to...

Bell Potter revised yesterday their RFF 12mo target price to $2.75 (was $2.95).

Rural Funds Group (RFF) - Inflation and interest

Funding costs and asset values
We have reviewed assumptions around funding costs and asset values. Noting:
Higher funding costs on the debt portfolio: We have reviewed our forecasts in light of the recent interest rate movements, downgrading FY23-24e AFFO forecasts to reflect a higher cost of funding. RFF provides details of the hedged position on its debt portfolio, with ~40% of forecast average debt effectively financed at 2.61-3.06% over FY23-26e. In the residual unhedged portfolio, we have upwardly revised our cost of debt assumptions to reflect movements in forward rates.

Continued upward movements in peer asset values: RFF’s 1H22 NAV was $2.00pu with a market adjusted NAV of $2.20pu. Since then we have seen a ~30% upward revaluation in the NAV of AAC and an indication by SHV of an expected ~39% uplift in the market value of its almond orchards and processing assets.

Rent review mechanisms: We note that at 1H22 ~39% of the portfolio had CPI indexation linked escalators in the rental contracts and that ~44% had market rent reviews built into the agreement, which is an important in the context of the above.
We have raised our funding cost assumptions on the unhedged component of the debt as well as inflation drivers in indexed agreements, resulting in AFFO downgrades of 3% in FY23e and 5% in FY24e. In light of sector wide compression our target price is moderated to $2.75pu (prev. $2.95pu), largely on a higher ascribed discount rate.

Investment view: Retain Hold rating
There has been a sector wide derating in REIT investments, with the AREIT index having fallen ~22% since Apr’22, RFF has not been immune to this sell off but a relative outperformer (down ~17% over the same time frame). We retain our Hold, rating though note the more favourable value dynamic emerging. RFF has a track record of creating value through asset development activities in horticulture and cattle, which is where new funds are being deployed. In addition we have seen upward movements in valuations in these segments, noting the benefit this could be to RFF in outward years as market review mechanisms occur.