Gladstone Land (LAND, NASDAQ) DATE: 26-05-2014
Recommendation: BUY, PT $15
Gladstone is a company that functions as a professionally managed portfolio of farm land and the structures built on those lands. Its revenue therefore stems from the income on the leases of those properties. It currently owns 21 farms of which 8 are located in California and 6 are located in Florida. The remaining properties are spread out over Oregon, Arizona and Michigan. These properties are leased out to either corporate or independent farmers. The company has been in existence since 1997, but has been operating under the current model since 2004. In January 2013 the company went public through an IPO which brought in 51 million USD after listing expenses. The company has used those funds since to acquire more farmland and recently has obtained an expansion of its existing loan facility to 100 million USD with the same objective. Due to its REIT status the company has been presented mostly as a dividend play, but might as well be classified as a leveraged bet on price appreciation of farmland in the US.
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The media is full of stories about rising food prices as a result of an ever increasing population. The U.N. Intergovernmental panel on Climate Change makes a number of stark warnings regarding food insecurity and food shortages in their most recent report. For a company that gets in now and acquires land at the current prices this trend will support the valuation of the properties over time and may lead to some significant capital gains in the future when properties are sold off. At the same time, as land prices go up, so does the rental revenue Gladstone can command on the properties. In that sense, this company caters to both investors interested in current income in the form of quarterly or monthly distributions of the rental income, as well as to those interested in long term appreciation through the increase in value of the properties in the portfolio.
The investment returns for farmland over the past 20 years are impressive and show a clear acceleration over the past 6 years…
…while volatility for the same period is modest compared to other asset classes:
Companies in this sector would therefore be an interesting addition to an investment portfolio due to its low correlation with other asset classes.
David Gladstone is the CEO and founder of the company. He has a background in the leveraged buy-out fund industry and mezzanine debt finance. During his career he also managed Allied Capital Commercial Corporation, a publicly traded REIT that invested in real estate loans to SME’s. He holds an MBA from Harvard and is 71 years old.
Terry Brubaker is the COO and has been with the company for 13 years. Before joining the company Mr. Brubaker has held executive roles at a number of companies, none of them related to Gladstone’s industry. He also holds an MBA from Harvard and is 69 years old.
Danielle Jones is the companies CFO since 2008. She is a licensed CPA and has previously worked in the accounting team for Avalon Bay Communities for 2 years. This company is also a publicly traded REIT aimed at investing in the high quality apartment segment in the US. Ms Jones is 35 years old.
Bill Reiman functions as the managing director of the company and has joined 10 months ago. Before Gladstone he has been managing a variety of agricultural businesses.
Gladstone's board is further made up of 6 independent directors, 5 of which have degrees from Harvard and the remaining one from Yale.
Overall the management of the company seems to be experienced in the area that Gladstone Land specialized and most definitely has the required management skills to run the company. One would almost wonder whether the current composition of the senior management and directors is perhaps a tad heavy for an investment company with just under 80 million USD in assets and around 60 employees. However, the employees of the company are actually employed by Gladstone management corporation which manages three other business, 2 of which focus on supplying a mix of debt and equity financing to SME’s and one which is another REIT that owns industrial, commercial and retail real property and makes commercial mortgage loans. Gladstone in summary consists of 4 separate venture capital/ private equity style businesses (all listed on NASDAQ under GLAD, GOOD, and GAIN) which are managed by largely the same team of people.
Investors pay for the management of the portfolio through a 2% of the assets under management base management fee and may additionally pay incentive fees if certain targets are achieved by management. The way this basically works is that when the return (as measured by FFO) exceeds a hurdle rate of 1.75% in any quarter (7% annualized), all of that return goes to the management until the next hurdle of 2.1875% (8.75% annualized) is reached. Of anything that is earned in excess of that, 20% goes to management and the rest to the shareholders.
I view this fee structure as aggressive as it both takes a chunk out of the assets under management and charges investors a substantial fee on the performance in excess of 7%. At the same time, it does align the incentives of management with shareholders.
Gladstone Land follows a very straightforward model that involves cycles of raising capital and subsequently deploying the cash by purchasing farm land and the structures on it as well as making typical improvements to the farmland assets such as irrigation systems, warehouses and cooling facilities. As mentioned, Gladstone land currently owns 21 farms which it leases out. The rental income is a simple function of the number of properties owned, but over time as the price of farm land goes up, so will the rent that Gladstone receives. The key thing for Gladstone is therefore to maximize the spread between the cost of capital and the rental yield on the properties they own.
The following graph shows the average cropland value over the period 2004 until 2013.
source: USDA-NASS august 2, 2013
The data shows a clear uptrend of the value of the land over the past decade. Whether this trend will continue is obviously not known, but that there will be healthy demand for high quality farm land in the near term future seems almost certain.
The data on farm properties show a similar trend with the prices roughly doubling over the past 10 years.
source: USDA-NASS august 2, 2013
Let’s take a closer look at the rental yield before delving into the cost of capital. Gladstone received 1.495 million USD in the 1st quarter of 2014 on assets listed in its books at a value of 75.65 million USD. This works out to an annualized yield of 7.6%. Given that 2 of its most expensive properties were acquired before the year 2000, I am inclined to believe this yield calculation is somewhat overstated as the book values of those properties does not accurately reflect their true value.
Cost of Capital
The cost of capital for Gladstone is reasonable because its properties serve as collateral under its debt arrangement. It can therefore leverage quite aggressively at a modest cost of 3.5% on amounts drawn. Gladstone had 48 million USD in equity as per March 31 of this year and liabilities in the amount of 43.6 million USD. With the increase in borrowing capacity, they may increase their debt by approximately 84 million USD which would give them total buying power of 97 million USD given their current cash position of 13.5 million USD. The historical track record of its share price is too short to reliably calculate a Beta for this company.
Financial performance and position
The historical track record for the company is relatively short and not very relevant considering the significant changes the company has gone through recently. Nevertheless, it provides us with an insight into the rental yield that can be expected in this sector.
The name of the game for this type of company is scale though, which is illustrated by the subdued results for the 1st quarter which is mostly due to administrative expenses and fees associated with making the acquisition. These are “eating up” a large part of the rental revenues. As the portfolio gets larger, these expenses will become smaller in comparison. For that reason, we will focus our attention for now on trying to understand what the company will look like once the dry powder it gained access through with its new debt facility has been fully put to work.
As the company's expenses are directly related to the investments it makes and the fixed costs are low, the cash burn is low when there is little activity. Running out of cash is therefore not a big concern for this type of company. Rental income to debt servicing cost is the more relevant criteria, and assuming that the company would not lease out any properties at rates significantly lower than the historical yield, there is little of concern to investors in this area.
Use of leverage
The recently attracted loan and credit line will be put to work by acquiring farm properties and serve as working capital. The 100 million USD note carries an interest of 3.5% on amounts drawn and will run for 15 years. However, the note replaces a prior mortgage financing which was fully used in the amount of 45 million USD. The new note therefore increases the lending capacity for the company by 75 million.
If the company would elect to fully draw the loan (and we should expect the company to do so), total debt would roughly amount to 125 million USD. Given the current stockholder’s equity, its debt to equity ratio works out to roughly 2.5. While this would be high for some companies, in the real estate investment industry, this is normal industry practice which does not go to say that it does not carry risks.
The company is in its infant stage and the number of properties is relatively limited. With that comes concentration risk both from the counterparty perspective as well as geographically.
Of the 21 farms the company owns, 8 are located in California. Those 8 farms also bring in 67% of the revenue. While this percentage is down from 87%, it is still significant and in the event of a draught or other severe weather conditions in this area it could significantly impact the companies’ ability to collect the lease payments on its properties. In terms of credit risk, 2 of the farms are rented out to the same tenant and the rent on these properties amount to 47.2% of the total rental income for the first quarter. Again, while this percentage is down from the previous quarter and it may be expected that this percentage will further decrease as the portfolio decreases, it is still a risk for the moment.
Aside from these risks, a final risk to consider is the illiquidity of the assets in the portfolio. Agricultural land and farms are difficult to sell, especially in the event of a bankruptcy by the previous tenant.
Applying a simple net-asset value calculation to the company yield a valuation of roughly 48 million USD implying a price to book ratio of 1.57 given its current market cap of roughly 75 million USD. However, in its latest 10-Q filing, the company discloses the current fair value of its properties as provided by third party appraisals. The value of its 21 properties according to this appraised values totals $120 million. Adding in the other assets the company owns and subtracting the current borrowings values the company around $91 million or roughly $14 a share.
Based on our financial forecast for the company’s future rental income and the increased interest expense due to the drawdown of its new loan we forecast earnings for the company for this year $0.62., assuming that the company would need the rest of the year to make the acquisitions using its new debt facility. For the years after 2014 we have assumed the company would have fully deployed the available capital and is able to lease all acquired properties out. Based on these assumptions we forecast the following EPS data for the period 2014-2017:
Share and Per Share Data:
(Loss) earnings per weighted average common share - basic and diluted
One can clearly see the scale effects on the financial projections after 2014 when the loan would be drawn and put to work. Based on this forecast, Gladstone would be trading at roughly 12 times forward P/E. Investors can expect a decent dividend yield from this company given that is has elected to be classified as a REIT, and it currently pays 3% yield. Under the REIT regime, entities are required to pay out 90% of their REIT taxable income. Investors can therefore expect the distributable earnings for this company to go up significantly over the next 2 years and should reach $0.24 per quarter for next year, which works out to approximately 7.5% yield, up from its current 3% yield.
In terms of comps, there are few companies out there who do the exact same thing. One company that comes to mind is Farmland Partners, although their portfolio holds land and farms in different parts of the USA, predominantly Illinois. Since this is also a young company, and it is not making any noteworthy profit, a valuation comparison is not very useful.
Despite the significant use of leverage, the risk profile of this company is modest. Investors are essentially investing in a diversified portfolio of farmland in the United States. With the expansion of its portfolio, concentration risks should move into the background, and yields should be more stable. At a forward P/E of 12, Gladstone is not cheap, but this company can function as a defensive play that will provide a strong yield while giving the investor the chance at profiting from increases in land prices in the US over the long term.
While listed at $15 a little over a year ago, Gladstone is trading at $11.64 at the time of writing. The price drop may not be over, but at the current valuation Gladstone is starting to get very attractive given its NAV of $14. We also believe the market may not yet appreciate the impact of the new debt facility. Once the company starts receiving the benefits from expanding the portfolio I believe the market will reward the company with a higher share price.
Gladstone is a good stock to diversify the portfolio in the alternative asset area. While I would not recommend a sizeable position in a company this small, it is a useful addition to almost any portfolio due to its low correlation with traditional assets such as stocks and bonds.
I would recommend buying the stock at current price levels and see a medium term target price of $15 representing an upside of 30%.
About the author: This article is written by Vincent Groenewoud. Vincent lives and works in Hong Kong and works the finance industry there. He is a CFA charterholder and holds university degrees in Finance and Accounting from Maastricht University.
 Source: NCREIF (2013), FACTSET
 Source: http://www.reuters.com/finance/stocks/companyOfficers?symbol=LAND.OQ
 FFO, as defined by NAREIT, is net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property and impairment losses on property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. The Company defines pre-tax funds from operations ("Pre-tax FFO") as FFO plus the provision for income taxes.
 Form 10-Q quarterly report for the period ended March 31 2014 http://www.sec.gov/Archives/edgar/data/1495240/000119312514182482/d702273d10q.htm