A Farmland REIT

Why are there no (or no major) REITs built on farmland? There are REITs constructed around timber, healthcare property, malls, almost any other type of property, but no major farmland REITs. I’ve seen farmland purchased by limited partnerships, pension plans, and private equity funds, but I have yet to see a major REIT presence in agriculture.

For a long time, I have toyed with this idea, and for many years I assumed it was because there wasn’t a demand (as well as "compliance" problems noted below). However, with the price of farmland skyrocketing (see the December 15, 2011 WSJ article A Bubble Down on the Farm?) now would seem the ideal time to create such a REIT. Note, I say “ideal” time from a product marketing perspective – the capital should be easy to raise. I do not say “ideal” time from an investment perspective – anytime an investment is hitting all time highs, commanding interest from major publications like the WSJ, and the topic of cocktail conversation, the value boat has likely sailed. With all that fanfare, a Google search revealing only a handful of potential farmland REITs is perplexing.

Again, although I’m not championing a farmland REIT at current valuation levels – I think the idea has long-term merit / viability. Perhaps we can hash out the details of how to construct one now and be prepared for down the road when/if farmland becomes a good value – you know, when we bang our heads against the wall to raise capital in a great out of favor value investment. 

 A few bullet points on how I think a farmland REIT could be structured:

• Focus on a geographically and seasonally advantageous product – wheat for instance (or more broadly, small grains). The wheat belt runs from central Texas up through the western Midwest and on into the Canadian prairies. The life cycle of wheat, particularly harvesting, follows the same south to north progression, with harvest beginning in Texas (late May) and running sequentially north until early September at the Canadian border. More so than other commodities like corn, soybeans, or cotton, wheat follows a sequential progression north, ideal for exploiting economies of scale. 
• Although REITs are typically rent takers, whereby they simply own and lease their properties (be they malls or condominiums) to end users, economies of scale can be realized by an operating subsidiary. Under the REIT Modernization Act of 1999, a REIT can own 100% of a taxable subsidiary that provides service to tenants and others. In other words, a REIT could buy up acres strategically located at intervals throughout the wheat belt, lease the acres back to a local farmer, and provide an operating subsidiary that furnishes labor, equipment, and ancillary services back to the lessee. 
• In modern agriculture, (most) farmers are price-takers. A REIT operation acknowledges this and instead puts the focus on what can be controlled – costs. Spreading costs around through geographic diversification, higher equipment utilization, and buying/selling power. 
• Equipment and technology costs are the biggest single line item expense for most modern farms. A REIT that could provide well maintained, modern machinery in a timely and cost efficient manner that could save precious pennies per bushel (think of a more focused version of machinerylink.com).
• It is estimated that 40% of farmers in the U.S. are 55 years old or older. Some of those operators may not be ready to retire, but they are ready for some “help.” These farmers are good managers, but they are looking to transition their careers toward more of a management role. They may not have family interested in farming, are sick of trying to find reliable seasonal help, and they would like a partner. A sale leaseback with these operators would likely prove ideal. 
• Of course, we can’t ignore FSA payments. We can argue whether they are good or bad, but they are a fact of modern agricultural life. Although the REIT would be cash leasing the ground to individual farmers who would be charged with complying with regulations and staying under payment cap levels, the link to the REITs operating subsidiary may be deemed material and thus cause for loss of payments. Just throwing out numbers, but if somewhere between 5 – 30% of top line farm revenue comes from the USDA, loss of this revenue would be catastrophic to a REIT model. 

Again, all of the above is just theorizing on the merits of the business model itself, not whether it is a good investment opportunity today. Also, I haven’t set pencil to paper (or in my case, cursor to excel spreadsheet) to see about the financial feasibility of such an enterprise. Finally, I have no direct knowledge of the legality and/or insurability of such an operation.

Bottom-line, I haven’t talked myself out the idea that a farmland REIT could be an efficient and margin improving business structure. I don’t think now is a good time to invest in a farmland REIT, but structured correctly, it could be a good way to apply the Wal-Mart model to another highly competitive business.

And yes, I talked about destroying the American farm, building up corporate agriculture, mimicking Wal-Mart, and how much revenue farmers receive from Uncle Sam all in one article. That should be enough to get me banned from the Farmers Union for life. Enjoy!

Harvest Investor © 2011. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.

Ceres Global Ag Corp. (TSE:CRP): Follow-up

Just over a month ago I posted my Ceres Global Ag (TSE:CRP) analysis. At that time, the stock was trading at $6.50 per share and trailing 12 month EPS for operating subsidiary Riverland Ag was $0.56. Since that time, the share price has dropped to $4.99 and Riverland's trailing 12 month EPS is now only $0.45 thanks to a muted $0.08 per share earnings in the 2nd quarter.

I could tell you that this was all foreseen in my stellar analysis and that my decision to pass on CRP shares in November (due to lack of a margin of safety) was sheer brilliance, but I think I’d rather stick with the truth – dumb luck is a beautiful thing.

The 2nd quarter P&L numbers were ugly. Revenues were off significantly “as a result of lower overall facility utilization” due to “active delivery against future contracts in the spring wheat market.” Negative operating leverage (I see Wall Street analysts use this phrase all the time – must make you sound smarter than just saying “fixed costs”) turned the poor revenue showing into a bottom line loss. Although this is concerning, I remain optimistic that CRP (or Riverland more specifically) can garner EBIT per bushel of capacity of $0.29-0.37 long-term. If CRP converted itself to being a storage only company (no more merchandising or company owned inventory), it should be able to command $0.02/bu. per month in storage. With no cost of sales and the ability to cut SG&A costs to the bone, CRP should be able to earn $0.20/bu. in EBIT annually ($0.24 in revenue, $0.04 in SG&A which is roughly half of current) – just as a passive storage company. As an active merchandiser, I see no reason that the company can’t move back to $0.29-0.37 EBIT per bushel range over time.

Although I am optimistic about the long-term prospects of CRP, the income statement still doesn’t provide a margin of safety in my opinion. The balance sheet, however, is more intriguing. At this point I am more interested in CRP as a Benjamin Graham “Bargain Issue,” better known today as a “net-net” stock. A bargain issue is defined as a company that “sells for less than the company’s net working capital alone, after deducting all prior obligations.” In the case of CRP:

CRP (Data as of 9/30/11 unless noted)
Total Current Assets:	$240,034,011
-          Derivatives*	$1,985,558
-          Income taxes recoverable*	$1,612,766
-          Total Liabilities	$151,317,348
Net Working Capital:	$85,228,003
Shares Outstanding:	14,970,823
Net Working Capital per Share:	$5.69
Current Share Price (12/7/11):	$4.99
Upside to Net Working Capital:	14.0%

*(Derivatives and Income Taxes Recoverable are excluded as the cash value of these are unknown).

With the sell-off in CRP shares, the stock trades at a discount of $0.70 per share to its net working capital. This analysis assumes no value in the company's ~55 million bushels of storage capacity. In other words, CRP is effectively worth more dead than alive. The cash, inventory, and accounts receivable could be converted to cash, pay off all of the company's liabilities, and have enough remaining to give each shareholder $0.70/share and whatever the 14 elevators would bring in an open market sale ($2/share if the elevators could be sold for $0.55/bushel – roughly half of what CRP management feels is fair value for elevator capacity). In that sort of liquidation scenario, our $4.99 investment would return $2.70 in profit – a not too shabby return of ~55%.

Now before we all go out and buy Gordon Gekko shirts and become corporate raiders, I’m actually not advocating a liquidation of CRP. As I noted above, I think the company can return to profitability. As I am not in the business of going “active” on a company, I’m content to buy some shares and wait for the market to realize that CRP is trading for less than its net working capital. If anyone out there is an activist investor or if the folks at Front Street Capital (the hedge fund that manages CRP) want to talk about liquidating to realize value, I’m more than happy to coattail to a 55%+ return (I’m even open to taking a 10% finder’s fee for the outstanding investment banking advice I’m providing in this post).

Of course, this isn’t a firm net-net idea. We’re only trading at a 12% discount, well below the 1/3rd discount advocated by Benjamin Graham. Also, its an individual idea when net-net stocks typically work best as a basket investment – where you buy a portfolio of all available net-nets for diversification. Finally, CRP’s current assets are dominated by grain inventories. Inventories are the least liquid and hardest to value of all liquid assets.

However, given the long-term viability of CRP’s asset base (grain elevators), its historic profitability, and the fact that management owns 21% of outstanding shares, I’m open to initiating a position at these levels. Average in on weakness. Target $5.69 for an initial upside review point.

Anyone see gaps in my logic or reason to be more cautious on CRP shares?

Full Disclosure: Long CRP (TSE:CRP)

Harvest Investor © 2011. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.