The Impending Dividend Cut Makes Gladstone Land A Prime Short Opportunity

The Short Thesis:

We believe that Gladstone Land (LAND) will suffer near-term capital depreciation as its dividend is cut further than the market expects it to be. Upon the announcement of the lower-than-expected dividend, we believe many of the shareholders will sell in search of better yield, thus dropping the market price. This thesis hinges on 2 points:

1. The dividend will be cut to $0.04 monthly


2. A meaningful portion of shareholders are anticipating a return to $0.12 monthly

The meat of this article will be dedicated to supporting these points. We will follow with an estimation of the magnitude of opportunity along with a discussion of the risks involved in shorting LAND.

Key thesis point #1: the dividend will be cut to $0.04 monthly

LAND's recent dividend history looks like this.

(click to enlarge)

*Data from SNL Financial

The $0.12 dividend that we have seen monthly through most of 2013 has been in place to meet compliance with REIT regulations. LAND recently became a REIT and in doing so is required to pay out 90% of its accumulated earnings from prior years. This was detailed by LAND in a December 3rd press release:

"To date, the company has declared dividends of approximately $7.6 million during 2013, a portion of which relate to the $9.6 million of accumulated earnings and profits from prior years to be paid out by the end of 2013. The dividend declared above represents the final distribution of the company's remaining earnings and profits from prior years. A breakout of the accumulated earnings and profits from prior years and the earnings from 2013 will be reported on a Form 1099 to be provided by the company in January 2014."

Compliance with REIT regulations has been reached with the $0.33 dividend that went ex on 12/16, so beginning in January LAND can go back to its regular dividend of $0.04. The argument for a return to monthly distributions of $0.04 can also be made from a fundamental perspective.

Fundamental justification for our $0.04 monthly dividend projection

In both 2Q13 and 3Q13 LAND reported FFO/share of $0.03, or about $0.12 annualized. Clearly, this does not cover the current $0.12 monthly distributions. In fact, it is not even sufficient to cover the $0.04 monthly distributions that we are proposing. Even with a cut to $0.04, there will be a period in which LAND's FFO payout ratio exceeds 100%. We do believe, however, that in place and future growth will validate such a distribution.

1. On November 20th LAND purchased 1,970 acres of Arizona corn fields.


2. On December 12th Gladstone Land announced the acquisition of 1,898 acres of irrigated farmland suitable for root and field crops.


3. On December 17th, LAND purchased a 60-acre lemon farm.

Given that LAND owned a total of only 1,959 acres as of the third quarter, these acquisitions more than tripled its acreage. Consequently, LAND's FFO/share is expected (by FactSet consensus) to grow to $0.39 in 2014 and $0.50 in 2015.

If the FactSet consensus is right, LAND will clearly be unable to maintain the $0.12 monthly distribution and will just barely be able to handle the $0.04 monthly that we propose. This would suggest a FFO payout of 123% in 2014 and 96% in 2015. Some would argue that such a high payout ratio is ambitious and that the dividend could be cut even further.

To investigate this claim we can look at its longer established affiliate Gladstone Commercial (GOOD). Over the past 9 years its FFO payout has been near or over 100%.

(click to enlarge)

Given that David Gladstone is the chairman of both companies, we believe it is reasonable to anticipate that LAND will be equally ambitious in its FFO payout ratio.

Summary of key thesis point #1

From the standpoint of compliance with REIT regulations, LAND will no longer be required to pay special distributions. Fundamentally, LAND cannot sustain the $0.12 monthly. For these reasons, we believe it is clear that the dividend will be cut to $0.04 each month.

There is little debate over the likelihood that it will get cut. Gladstone Land has made no attempt to hide the fact that these special dividends are done and that distributions will be returning to normal levels. With the public availability of this information, why do we believe the announcement of the cut will negatively surprise the market?

Key thesis point #2: many expect the dividend to remain at the former $0.12 monthly

While the original sources of information, such as SEC filings and Gladstone issued press releases are clear about the temporary nature of the presently high dividend, secondary sources of information are misleading. Most mass information hubs calculate forward yield automatically by extrapolating recent dividends. Allow me to provide some examples. Below is a current (12/24/13) screenshot from Yahoo Finance.

(click to enlarge)

Notice the dividend shown at $1.44 which is the most recent $0.12 monthly payment extrapolated over an entire year. The 8.5% shown is substantially skewed from the actual 2.8% forward yield (based on $0.04 monthly).

The same misinformation is displayed by online brokers such as TD-Ameritrade.

(click to enlarge)

Even professional and highly reputable data sources such as FactSet and SNL Financial show a forward yield of 8.5%.

Why does this matter?

Well, it has caused LAND to be purchased as a yield play when in reality it is not. In fact, its actual projected forward yield of 2.8% is substantially below the equity REIT average of 4.5%. Some would suggest that investors are sophisticated enough to not fall victim to the aforementioned misinformation and to a large extent this is true. However, it only takes a portion of LAND's investors owning it for the wrong reason for its stock price to take a hit upon the declaration of the lower dividend. Therefore, we must only demonstrate that at least a meaningful portion own LAND for its perceived yield.

Ownership breakdown

*Data from SNL Financial

Given the substantial insider ownership of 42.32%, only 57.68% of shares are floating. Looking deeper, ~58% of float is made up of institutions with the mutual fund subset taking up ~22% of float. The remaining 42% consists primarily of retail investors. Let us examine each type of owner to get a feel for why they buy.

(click to enlarge)

9.37% of outstanding shares, or 16.24% of floating shares are owned by institutions with a high-yield style. This is unusually high for a company with a yield substantially below market average. We suspect that much of the yield style ownership will dissipate upon the announcement of the dividend cut.

The 42% of float that is mostly retail investors

For illustrative purposes we can separate retail investors into a dichotomy consisting of the following categories:

1. Those who are highly informed on the issues they own


2. Those who are "sold" the issues they own

Gladstone Land owners falling into the first category are most likely aware of the impending dividend cut and will not be bothered because they own LAND for its growth potential and stable asset base.

LAND owners falling into the second category, however, may be unaware of the impending dividend cut. These investors are also likely to have bought on the premise of yield as that has been a big selling point to retail investors in 2013. Upon the declaration of the lower dividend, we believe a substantial portion of these investors will vacate their positions.

Given David Gladstone's reputation for holding frequent and successful road shows, there is reason to believe that a material portion of the retail investors fall into the 2nd category: those who were "sold" the position.

Summary of short thesis

Thus far, we have demonstrated a likely decrease in the monthly dividend to $0.04 and that many of LAND's investors are not anticipating this decrease. The graph below details this discrepancy.

(click to enlarge)

When the lower dividend is declared, those who are in LAND for its yield will sell, driving the market price down.

Magnitude of opportunity

To ascertain the magnitude of opportunity in shorting LAND, we must consider the supply and demand dynamics of its shares in the market. Under current conditions, demand comes from both growth and yield investors. Once the dividend is declared, revealing LAND to be a 2.8% yield stock, the demand generated by yield investors will evaporate. Further, new supply will be added by the current yield incented investors wanting to get out. Higher supply and lower demand would certainly drop the price, but how far?

The proposed equilibrium

The new supply of shares would be a substantial portion of the aggregate of the 16.24% of float owned by yield style institutions and the portion of retail investors unaware of the cut. This magnitude of supply is not met by the current aggressive growth investors, so it would likely have to dip to a price that appeals to the larger pool of GARP investors. Therefore, we believe the new equilibrant price would be the "reasonable price" as dictated by the incoming GARP demand. Generally speaking, a PEG of 1 would be considered a reasonable price, so there would certainly be enough demand at the corresponding price.

Assuming FactSet's consensus estimates are correct, LAND will earn $0.39 FFO/share in 2014 and has a 29.31% growth rate the following year. This corresponds to a price of $11.43 for a PEG of 1. In my opinion, this represents the best case scenario for a short and any further price declines would be unlikely. Given the current market price of $16.94 (intraday 12/24/13), a short position in LAND has potential near-term upside of just over 30%.

We must also consider the risks.

Risks and concerns

1. Asymmetric risk/reward: Any short naturally has asymmetric risk in the sense that the maximum gain is 100% (if stock goes to 0) yet the potential loss is infinite. In the case of LAND, I believe the risk is somewhat capped by the nature of the underlying assets. Despite the company's currently high growth rate, farmland lacks the capacity to be explosively profitable. Instead, its desirability comes from the steadiness of cashflows.


2. Management's value-add: David Gladstone and the rest of LAND's management team are highly skilled acquirers, capable of finding great properties at strong cap rates. Consequently, LAND may perform better than the sector's underlying fundamentals would dictate.


3. Farmland value: The NAV of farmland has been rising and is projected to rise further. The rising intrinsic value may justify a higher multiple to some investors.

The Bottom Line

Misinformation along with a relatively less sophisticated investor base are poised to create pricing pressure as the dividend is cut.

Disclosure: 2nd Market Capital and its affiliated accounts are long GOOD. I am personally long GOOD. We are considering initiating a short position in LAND in the next 72 hours. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.

Source: The Impending Dividend Cut Makes Gladstone Land A Prime Short Opportunity

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in LAND over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: The "may initiate a position" and long position disclosures are mutually exclusive by the checkbox. so for clarity, I am long GOOD and may initiate a short position in LAND.

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