Supermarket Income REIT plc

Good morning all, and welcome to Supermarket Income REIT's half year results webinar. In terms of webinar logistics, I'm reliably informed everybody has the ability to type in questions at any stage before, during or after the presentation.

But you do need to type them in as the webinar doesn't facilitate verbal questions. We'll then do our best to answer these at the end of the presentation.

Moving on to the next slide. So this is Steve Windsor speaking, and I'm joined by Ben Green, Steve Noble and Nat Markham.

Between us, we'd like to take you through the financials, run through our approach to environmental, social and corporate governance and give an update on our renewable energy initiatives. We'll take a look at our current portfolio and the makeup of our rental income.

And finally, we'll leave you with our perspective on the outlook for U.K. grocery.

Next slide, please. The last 12 months have provided a very supportive grocery market backdrop.

The sector continues to be a net beneficiary of changes in consumer habits. We've seen increased investment demand for U.K.

grocery property, and this rotation of capital out of traditional generalist property continues to provide us with a steady supply of high-quality assets. So taking each of these points in turn.

The grocery sector has obviously been a net beneficiary of the COVID pandemic. It's led to a materially increased trading in our stores and, further, to stronger balance sheets for our tenants.

There have been some negatives. For example, our rooftop solar projects have been delayed as our stores have been simply too busy to allow third-party contractors on site.

Increased investment demand for grocery property has led to the beginnings of a positive yield shift in our sector. And despite there being increased demand, the third point on this slide, that of the rotation of capital continues to provide SUPR with attractive opportunities that require high-quality supermarket assets that meet our investment criteria.

Next slide, please. When you look at the U.K.

grocery sector, we think it's useful to bucket the COVID-19 changes in consumer grocery habits into 3 categories: temporary shifts, accelerated trends and permanent changes. The temporary shifts include the bigger basket sizes as we've all tried to minimize the number of trips we make.

They also include the shift of calorie purchase from casual dining to supermarkets. The accelerated trends major on the huge uptake in online grocery.

Online now makes up 14% of all grocery sales in the U.K. And 66% of first-time online grocery shoppers say they expect to continue buying grocery online post pandemic.

The permanent changes relate to the new normal or the future hybrid home office working. A recent YouGov survey reported the majority of office workers expect to work from home at least 2 days a week post pandemic.

Work from home triggers a step change in grocery volumes. In fact, every additional work from home day adds about 7% to that individual's weekly grocery spend.

Next slide, please. Looking at the reporting period to the 31st of December, once again, a period of strong growth for SUPR.

We deployed GBP 315 million, and we were pleased to see our gross assets go through GBP 1 billion. We received 100% of our rents throughout the period.

Moving to these bottom row of circles. The like-for-like valuation increase of our portfolio was up 5.5%.

That, in turn, drove a 3p increase in EPRA NTA to 104p per share. During the period, we increased our dividend by RPI for the third consecutive year and paid interim dividends totaling 2.9p.

That means SUPR continues to throw off a dividend yield of over 5%, backed by inflation-linked assets. I'll now hand you over to Nat to take you through the financials.

Good morning. This morning, I'm going to talk you through the financials for the 6 months ended 31 December 2020 as included in the interim report.

As part of our commitment to maximum transparency, we are going to present 2 sets of figures, the EPRA numbers for the 6 months and a pro forma based upon EPRA principles. On the next slide, we have the income statement overview.

Ordinarily, on this slide, I will be talking you through the comparison between the 6-month period to 31 December 2020 and the same period for 2019. However, as a result of the significant acquisition activity and resulting growth in the period, the figures are more similar to those for the 12 months to 30th of June 2020.

In fact, rental income for the 6 months was 77% of the full year income for the June year-end and was 41% higher than for the 6 months ended at that date. This just demonstrates a huge and rapid growth of the fund.

The impact of the new acquisitions on total rent are set out in detail on the next slide, showing the income movement bridge. Next slide, please.

Here is where we can clearly see that the growth in the period has been driven by acquisitions rather than rent reviews. The portfolio is weighted towards the second half of the financial year in terms of rent review timings, and there were only 3 rent reviews in the period to 31 December.

This, coupled with a very low RPI, means that rent reviews only accounted for GBP 0.1 million of income growth. Given this timing bias, we expect this number to be much more significant in the 6 months to June 2021 with 8 scheduled reviews and a market expectation of higher inflation for this period.

We have also included a column which shows the annualized rent for all assets held today, inclusive of those acquired post balance sheet, which totals GBP 55 million. Next slide, please.

Returning back to the income statement overview, this time to focus on earnings. EPRA earnings for the period were GBP 15.5 million.

Moving to the next slide. As with the June numbers, we provided an adjusted version of the EPRA earnings number, which strips out the undistributed profit from joint venture being the underlying income from our investment in the Sainsbury's Reversion Portfolio.

Removing this income reduces EPRA earnings to GBP 12.6 million. The other key figure to highlight here is dividend cover, which has increased from 0.84x to 1.12x on EPRA earnings and from 0.82 to 0.91x on adjusted EPRA basis, both figures showing the positive impact of the new acquisitions on earnings.

Moving on to the next slide. We have again prepared a pro forma income statement which reflects the full year effect of all acquisitions in the period and those acquired post year-end.

This results in an increase in EPRA earnings to GBP 49 million and dividend cover to 1.26x on an unadjusted basis. We have also prepared an adjusted pro forma EPRA earnings figure, again, eliminating the undistributed income from joint ventures, which reduces EPRA earnings by GBP 11.6 million to GBP 37.4 million and dividend cover to 0.95x.

So we are practically fully covered even if you remove the undistributed income from the increased stake in the Sainsbury's Reversion Portfolio. Now moving away from the income statement on to the statement of financial position.

Again, the first thing that stands out on this page is the growth that the fund has gone through in the last 6 months. Investment properties have increased by a total of almost GBP 346 million, resulting from a combination of acquisitions and like-for-like valuation growth of 5.5%, which Steven will take you through in more detail later on in the presentation.

We have also reached that key milestone of gross assets of over GBP 1 billion. You may also note that the value of the investment in joint ventures has increased by GBP 4.9 million rather than the GBP 2.9 million shown on the adjusted EPRA income slide.

The difference of GBP 2 million relates to the gain on investments in the underlying structure, which has already been removed from the unadjusted EPRA earnings figure of GBP 15.5 million. We also want to highlight the upward movement in the EPRA NTA per share, which has increased by 3p per share from 101p as at 30th of June to 104p at 31 December.

We have also prepared a pro forma statement of financial position, which is included within the appendices and shows gross assets of GBP 1.1 billion and an EPRA NTA of 103p. I will talk you through the period movement in NTA on the next slide.

Here, we have separated out the key components of the movement from the end of the last reporting period to 31 December 2020. The key point to highlight here is the positive valuation contribution from both the direct portfolio and within the investment in joint venture, which is more than double the impact of writing back acquisition costs on new purchases.

Moving on to bank financing. We are once again delighted to be able to report that we have further diversified our banking group, adding a new revolving credit facility with Wells Fargo during the period.

As at 31 December, we have total facilities of GBP 464 million and debt drawn of GBP 304 million. Since the period end, we have added another new lending relationship with a revolving credit facility with RBC and Barclays.

The addition of this facility increases our total debt capacity to GBP 614 million. And as at today, we have GBP 168 million undrawn.

Next slide, please. Pleasingly, the impact of adding these new facilities has been to further reduce our interest cost from 2% to 1.9% whilst increasing maturity.

As of today, we have GBP 446 million drawn and have a comfortable headroom on all our banking covenants. I will now pass you over to Ben.

Good morning. I'm going to talk to you about environmental, social and corporate governance, because we want to make a positive contribution to the environment and society while generating positive returns for shareholders.

What do we mean by that? Well, if we turn over the page, you'll see that our broad effort across not just environmental, but also social and corporate governance.

Under environmental, I'll take you through our renewable strategy in a moment. Under social, we've been significant supporters of our chosen charities.

And of course, our tenants, the grocers, play a critical role in supporting the daily needs of the nation. And on governance, we've just been awarded the EPRA Gold mark for the second year in a row.

Turning to the next slide and our tenants, the grocers. As well as the social impact inherent in their businesses, they have some very ambitious corporate targets for carbon neutrality.

That's not surprising when you consider that the grocers consume about 5% of all of the electricity in the U.K. This creates an opportunity for us in renewable energy.

Next slide, please. So what does that mean for SUPR?

We have a unique opportunity to use our relationships with the grocers and the operational platform that we've built in solar. We can use this not only to deploy solar on SUPR's rooftops.

We can also offer to put solar panels on our tenants' freehold stores or even perhaps supply solar from ground-mounted panels. Of course, in each case, we would have a long-term contracted offtake agreement with the grocer.

We've highlighted some of the characteristics of these kinds of investments in the middle box on this slide. But to summarize, it's a win-win because we can deploy capital for SUPR, perhaps GBP 20 million per annum, and exceed SUPR's normal targeted returns.

And meanwhile, we have a happy grocer, because they source clean energy at competitive rates. I'll now hand you over to Steven to take you through SUPR's portfolio.

Thank you. In the following pages, I'll be taking you through the fundamentals of our current portfolio, but I wanted to start on our valuation.

Page 21, please. As Nat mentioned earlier, we wanted to give you more details of the direct portfolio valuation increase during the period.

On this graph, we've broken down the component parts of our net valuation increase for the 6 months. On a like-for-like basis, our portfolio increased by 5.5%, reflecting predominantly a valuation yield shift in our direct portfolio from 5% to 4.7%, and we're really pleased that the like-for-like valuation movement has more than offset the transaction costs from growing our portfolio by GBP 315 million during the period.

Next page, please. Nat has taken you through the numbers as of the 31st of December.

And now in the following pages, I'll be taking you through our current portfolio as of today, which includes all our post-balance sheet events. The portfolio, as of today, consists of 53 stores under management, of which 27 are directly owned, with 26 stores in the Sainsbury's Reversion Portfolio.

In the pie chart, you can see our current portfolio valuation split by tenant, which includes the net value of the Sainsbury's Reversions Portfolio. And just to note, in the appendix, we've also provided a split of our rental income by tenant, and we've also shown the rental income split with the Sainsbury's Reversion Portfolio, both on a gross and a net rental basis.

The current value of the portfolio as of today is GBP 1.1 billion, and the map on the right shows you the level of geographical diversification within our portfolio. Next page, please.

Let me take you through how we think about nonfood assets in the portfolio. Across our portfolio of 53 stores, only 5 have nonfood assets.

We never directly target nonfood assets. However, sometimes buying nonfood assets unlocks the Supermarket acquisition.

And when we do that, the nonfood component falls into 3 main categories, being store redevelopment, site repurposing or site control. Store redevelopment is where the nonfood component plays an important part in the redevelopment plan for the store, such as the Tescos we acquired in Leicester, where the nonfood will be knocked down as part of the overall redevelopment.

Site repurposing is where we plan to convert the nonfood component into food use or quick service restaurant use, such as the Sainsbury's store we acquired in Newcastle. And finally, control, where it's important to obtain 100% control of the site, such as our Morrisons in Wisbech, Sainsbury's in Bangor and the Sainsbury's store in Hessle.

Sometimes, it's not easy to subdivide these sites, and the store will want 100% control of the car parking arrangements. Taking Sainsbury's as an example, Sainsbury's used to our own Homebase.

And as per the picture on the right, our Sainsbury's store in Bangor, we often see Homebase units adjoining the Sainsbury's store, and that comes part of the package. In total, the nonfood component represents 2.4% of our portfolio.

Next page, please. This page illustrates the core elements of our portfolio, split by investment category.

I won't take you through all the details now. But to reiterate, the nonfood component represents 2.4% of our overall portfolio.

And with a yield of 10%, it generates 4.7% of the overall portfolio rent. Next page, please.

On this graph, we've broken out our current direct Supermarkets portfolio by lease maturity date. As you can see, over 50% of our portfolio is in the 15- to 20-year maturity range, and our weighted average lease length is 16 years.

We'll always maintain a portfolio weighted towards longer-dated lease maturities. However, we do see capital upside opportunities from assets with short-term maturities of, say, less than 8 years.

And combined with our strong relationships with the operators, that provides us with an information advantage. And we may, in the future, choose to capitalize on such opportunities.

However, we will always maintain a balanced maturity profile and one which is weighted towards longer lease lengths. Next page, please.

And finally, on this graph, we've broken out our current direct portfolio by rent review structure. As you can see, 86% of our rent is inflation linked, of which 79% is linked to RPI and 7% to CPIH.

I'll now hand back to Steve Windsor.

Thanks, Steve. So that just leaves me to wrap up with our thoughts on the outlook for U.K grocery.

We go to Page 28, please. The pandemic continues to provide positive tailwinds for U.K.

grocery. As we discussed at the start, there might be temporary shifts, accelerated trends or permanent changes.

The last 12 months has led to a significant strengthening of our tenants' balance sheet, which should, in time, lead to improved valuations of their rental cash flows. The new normal bodes well for grocery.

As we talked about, grocery stands to be a big beneficiary from any increased work from home. And finally, the future model of grocery has arrived and it's omnichannel.

In fact, we've seen nearly 20 years of online penetration growth in a matter of months. The entire grocery industry has had to nail online fulfillment and quickly.

It's really important to understand that the grocers have all now converged on omnichannel stores being the future model of grocery. And as you all know, omnichannel stores form a key component of SUPR's investment strategy.

On that note, we'll conclude and open up for questions. As a reminder, if you haven't already, you need to type in your question.

That then appears on our screen, and we'll do our best to answer them. What we might do, to give everyone a chance to input those questions, is go to the questions we have already.

[Operator Instructions] Okay. Great.

So first question coming in from John Cahill at Stifel. Could you please talk about the timing of the unwinding of the Sainsbury's Reversion Portfolio?

Can we assume the discussions are likely to start this year or next? And Ben will answer that one.

John, yes, it was always our plan to try to acquire the second stake in the Sainsbury's Reversion Portfolio. Now clearly, we've been successful in doing that.

That's now turned that discussion into a bilateral negotiation with Sainsbury's. So we're expecting substantive discussions to start quite soon there.

Clearly, there's no time pressure, particularly because the transaction runs till 2023. So yes, we can't really predict when we're going to kind of sort of reach the end of that discussion, but we do expect to start some substantive discussions with Sainsbury's very soon.

So I'll take the question from Miranda around the acquisition pipeline and what that looks like at present. I mean I think we're continuing to see a lot of attractive opportunities in the market as this rotation of capital that we've described continues.

There are traditional holders of these assets looking for liquidity. They're not specialists in the space.

And so we are logical buyers of those assets. I mean we still have balance sheet flexibility, as Nat's illustrated on our banking financing slides.

But at the same time, we are looking to continue to grow the company, so we'll act opportunistically.

Thank you, Ben. Next one comes in from Julian Livingston-Booth at RBC.

Given the decline in yield in your valuation, should we expect acquisition yields to decline in a similar way? To what extent could plans to buy properties with a shorter WAULT offset this?

Yes. I mean we -- clearly, we've seen this hardening of yields in the sector, particularly around the longer-dated assets.

And as you've, I think, identified in your question, a really good way of us maintaining our target portfolio acquisition yield is to buy some shorter-dated assets. I think the interesting thing around the shorter leased assets is that's where our information advantage really plays to our strength, because the owners of those assets are not typically specialists in grocery property.

So we have a very big information advantage in understanding what's going to happen at the end of that lease. And clearly, if it's a strong trading omnichannel store, we're in a position to have a really good view of what the end game is going to be.

I mean to make it clear, we also pass on an awful lot of assets where we're not comfortable about what would happen at the end of the lease. So yes, I think we want to maintain that balanced maturity profile.

So we will continue to buy longer-dated assets, but we may well offset that with some shorter WAULT assets.

Next question from James Carswell of Peel Hunt. Are you expecting further yield compression over the next 6 to 12 months?

Are you seeing increased competition for assets? And are new entrants coming to the market?

I mean clearly, it's hard to predict yield compression. I mean we just keep looking for quality assets, which deliver good value for SUPR.

But yields in the supermarket space and perhaps our valuation do still seem somewhat wide compared to other similar assets. In terms of competition for assets, the main competition is from Realty Income and from Tesco themselves.

And you'll remember that Tescos have a program of buying back stores over the coming years. So those are the main 2.

Otherwise, it tends to be people going for sort of one store here and there, and we've, I think, been quite successful in allowing them to go for the stores that we didn't want to purchase. So we have very few regretted misses, but we do keep seeing people coming into the market who want to buy one to add to their generalist property portfolio.

So a question here from an investor. Omnichannel, is there any near-term prospect of home delivery being decently profitable?

Probably one for Steve Noble.

Thanks. Yes.

I think what we're seeing is that the cost of online fulfillment has come down considerably during the course of the pandemic. So the increase in demand has resulted in economies of scale now coming through channel fulfillment, especially in the store pick area.

And as the orders go up, they are able to spread the cost over a much greater order range. And remember, most of the cost is in the home delivery.

And certainly, on the store pick model, we're now seeing much larger drops per hour being done by the supermarket operators. So we think, overall, the cost has come down by about 50% to 60%, and that's now bringing it firmly within the profitability range.

Some of the operators themselves came out in their Christmas quarterly updates talking about the profitability of the channel. And we ourselves are coming out with research shortly with a more focus around online profitability.

Follow up on the online topic for Rob Joynson, Exane. Do you have a view on where online food retail penetration falls back to post the pandemic?

I think most of the operators think it does come off slightly post the pandemic. But I think certainly, the demand profiles that we're seeing and the announcements coming from the operators themselves is that it is expected that more people will work from home, which makes them more naturally inclined to use online and home deliveries.

And it is becoming an institutionalized part of their shopping behavior. So although there's expected to be maybe a small turn off once we come out of a lockdown scenario, we nevertheless think the channel will continue to grow over the long term.

Thank you. Next one is an over-rented question.

Are you happy rental charge on your properties is still market rent and there is no risk of over-renting? It's probably one for Ben.

I think we're quite explicit that there is some over-renting in the portfolio. That obviously varies store by store.

And the key for us is a, the credit strength of the tenant in paying that rent for the term of the lease, which drives very strong returns. But also then accurately underwriting the reversionary rent, so the rent at the point that the lease gets extended.

And that's all about understanding store trading. And if you understand those 2 elements, then SUPR delivers very strong returns even with the reduction in rent at the end of the leases.

And one from Jefferies, Andrew Gill. Could you detail the yield compression across the portfolio, please?

Was there yield compression across the board? Or was it largely driven by the prime omnichannel assets?

Probably one for Steve Noble.

Yes. Generally, across the Supermarket's direct portfolio, it's generally even across all assets.

There's no kind of specific categorization towards the omnichannel stores and also on the indirect portfolio or the Sainsbury's Reversion Portfolio, although there's only 3 years left to run. We're seeing a similar compression.

In the presentation pack, we do break out the yields by the core investment category, but it's been fairly even across the portfolio.

Next one from Tom Horne at Berenberg. Could you please outline how you expect the balance sheet to look going forward?

What you expect LTVs to get to, given the current acquisition trajectory? One for Ben.

Yes. I think there are a couple of questions along these lines.

So pro forma LTV is around 42% now. As Nat outlined, we've still got quite a bit of balance sheet capacity to use.

And so we could make further acquisitions with our current bank capacity. In the long term, we expect to run LTVs in the high 30s.

Our policy's 30% to 40%, yes, and we're always interested in acting opportunistically when we see strong acquisition opportunities.

Great. And there's a question here, which I think probably was answered in the presentation, but just to reiterate.

So the question is number of recent acquisitions have involved additional retail. What's the plan to reduce or remove them from the portfolio?

So there's kind of 3 categories to those. We either plan to knock them down completely.

We plan to repurpose them into food or quick service restaurants. Or thirdly, sometimes they're just co-located, and so we'll own the whole.

But it is only in total, 2.4% of the portfolio, so very small. Next one comes from Martyn King at Edison.

Can you discuss the current pipeline of acquisitions and their acquisition yields?

It's Ben. I mean as you know, we always maintain a very long pipeline of target assets.

We've got an idea of a lot of the assets that we'd like to ultimately own in the U.K. because we have a database of all of the supermarkets in the U.K., which are on leases.

I don't think we can talk, for confidentiality reasons, about specific assets, but the broad shape of that pipeline is that it sort of -- it's in line with our average yield target of sort of between 4.75% and 5% on average. As we mentioned earlier on, we'll maintain that average yield to some extent by targeting a mix of longer-dated assets on tighter yields and some shorter-dated assets where actually we see quite a lot of potential capital upside because of that information advantage that I talked about.

And Colm, could be -- I think we answered your question, but was there a divergence in your compression achieved across operators? Did certain operators outperform?

So the simple answer, Colm, is no. Again, we think there should be based on the actual balance sheet strengths of the underlying operators.

We've done a similar answer to the omnichannel question. Valuers don't really attribute any additional value to omnichannel even though we think they should, and they don't really attribute value across the various operators when we think they should.

So it is a fairly flat yield compression that we ourselves would differentiate. And final question comes from Richard Philbin.

Are there any opportunities outside the U.K. that you're exploring?

That's an easy one. That's a no.

So no. So definitely, U.K.

focused, and we're looking to continue to diversify the portfolio around the U.K. as we grow.

I think that concludes everybody's questions. Thank you all very much for taking the time to listen this morning.

The team here, as always, is available for follow-up questions directly. And happy to provide further information as you need it.

So thank you again, and we'll let you get on with your mornings. Goodbye.