Supermarket Income REIT plc

Good morning, everyone. Welcome to SUPR's Fifth Annual Results.

I'm going to kick off and then hand over to Haff to take you through financials and then Rob is going to take you through sustainability in the portfolio. Steven will round out with thoughts on the sector.

So in this challenging macroeconomic backdrop, we're very fortunate to be investing in a highly resilient sector. Our investment strategy in grocery property is structurally supported through growth in population and nondiscretionary spending.

Our omnichannel stores form a critical part of the nation's food infrastructure with flexibility to satisfy customers' needs both in-store and online. And of course, our income benefits from inflation-linked rents.

Turning to business highlights. We deployed GBP 597 million and successfully continued to buy long income, which means that despite the passage of time, we maintained our world at 15 years.

We also increased the A2C EPC ratings of our portfolio by 11%. As a result of our transition to the premium list, we also achieved inclusion in the [ FTSE250 ] and EPRA indices.

Today, we're pleased to announce that Sainsbury has agreed to purchase 21 of our JV stores at a very attractive price. This represents a 1.7x multiple on our equity investment.

And we can also update you on debt. Since the balance sheet date, we have entered into swaps to fix 100% of our drawn debt and protect us from further increases in interest rates.

In terms of the financial highlights, at the year-end, we had GBP 1.8 billion of assets, an EPRA NTA of 115p per share, which is a 6.5% increase. We delivered a 7% total shareholder return with dividend cover of 1.08x.

And we're increasing our dividend target for the fifth successive year to 6p per share. So I'll now hand you over to Haff to take you through the financials.

Thank you, Ben. Good morning.

I'm pleased to report the financial results for the year ended 30 of June 2022. Starting with the income statement.

Net rental income was GBP 72.1 million, up 50% from GBP 48 million when compared to last year. Let me now take you through the component parts of that rental income growth in more detail.

On an annualized basis, net rental income increased by GBP 18.4 million following 12 new acquisitions in the period. For existing leases with rent reviews in the year, we achieved uplifts of GBP 2.7 million, representing growth of 3.7% on a like-for-like basis.

Many leases hit the maximum rental caps on their reviews, which is on average 4% for the whole portfolio. During the year, we extended the lease on our Tesco store investor to 15 years, which resulted in a reduction in rent, but led to a material capital gain, which Rob will take you through later in the presentation.

All in all, annualized net rental income stands at GBP 80.2 million and including post balance sheet acquisitions, GBP 90.9 million on a pro forma basis. This slide shows how busy the team have been over the course of the year.

We have broken out each of the acquisitions, showing the rental contribution of the 12 new assets across 6 different operators. Moving back to the income statement overview.

EPRA net income from our joint venture was GBP 12.2 million, up 85% from GBP 6.6 million last year. The main reason for the scale of the increase is that the current year number includes the full year impact of the second JV stake, which, as you may remember, was purchased midway through last year.

Administrative and other expenses have increased by 49% with the growing size of the business. However, as you will see at the bottom of this slide, the EPRA cost ratio has fallen year-on-year and is now 16.5% compared to 16.8% last year.

Finance expenses have increased to GBP 13 million, up 53% from GBP 8.5 million last year. This reflects our additional debt to fund portfolio growth and towards the latter part of the year, the effect of increases in interest rates.

Let me now talk you through the debt in more detail. I've been talking to the numbers as of the year-end, but let me now talk you through the debt as of today.

As Ben has just mentioned, we have hedged 100% of the company's variable debt by entering into interest rate swaps. Together, with our existing fixed rate debt and swaps, the company's drawn debt now has an effective interest rate of 2.6%.

This has a one-off cost of GBP 35.3 million, which will impact EPRA NTA by 2.8p per share, but provides significant protection to the company's future earnings. Not only have we derisked ourselves from further interest rate movements, we also have significant balance sheet flexibility.

We have increased our total facilities to GBP 862 million, of which nearly 50% is now unsecured. At the same time, we have also maintained our average debt maturity at 4 years.

Returning to the income statement. EPRA earnings were up 56% to GBP 57.4 million from GBP 36.8 million last year.

On a per share basis, EPRA EPS was 5.9p compared to 5.6p last year. At the same time, we have improved EPRA dividend cover to 1.08x.

Moving away from the income statement to the statement of financial position. Gross assets stand at GBP 1.8 billion, up 39% from GBP 1.3 billion last year.

This is a combination of disciplined capital raising deployed into accretive acquisitions coupled with valuation growth. As a result, EPRA NTA per share increased from 108p per share to 115p per share.

At 30 of June, our LTV stood at 19%. Since the balance sheet date, we have invested a further GBP 216 million in 5 new assets and the LTV is now 31%.

As always, we have included a pro forma balance sheet within the appendices. Here, we have separated out the components of the 7p per share movement in EPRA NTA.

Our earnings matched our fully covered dividend. Acquisition costs were 1.4p, predominantly as a result of stamp duty.

We issued equity in October and May at a premium to NAV, generating 3p per share of accretion. Valuation growth in the direct portfolio generated a further 3.2p.

And finally, our joint venture portfolio added 2.5p to EPRA NTA. Moving on to the next slide, you can see that rental growth drove all of the GBP 43 million of valuation uplift.

Meanwhile, yields have remained broadly flat. We have had GBP 18 million of acquisition costs, which, as I said, were predominantly stamp duty, bringing us to a direct portfolio valuation of GBP 1.57 billion.

I'd like to pause for a moment and leave you with a 5-year look back highlighting the overall growth of the company. Alongside this growth, we've also increased our per share returns every year since IPO.

I will now hand it over to Rob, who will talk us through sustainability and the portfolio.

Thanks, Haff. Good morning, everyone.

SUPR and its tenants are committed to sustainability. During the year, we have seen great progress on our EPCs, increasing our A2C ratings by 11% and we now have no E-rated stores.

We've also been making progress on carbon, undertaking our first calculation of baseline emissions across all of our sites. We continue to work on our program to introduce EV charging and rooftop solar to our assets wherever possible.

And this year, we've included TCFD-aligned disclosures in the annual report for the first time. There we go.

SUPR also received an EPRA Gold Governance Award for the first time -- for the fourth year in a row and appointed Frances Davies to the Board. She is an experienced non-executive director and has also been appointed to chair the new ESG Committee.

Turning to our portfolio. Haff has talked you through the numbers as at the 30 of June, while all of my numbers are as at today.

It's been another period of strong growth for the group. We now own 49 supermarkets with a rent roll of over GBP 90 million and gross assets are up GBP 640 million to GBP 1.8 billion.

Our unique portfolio of top trading stores has been compiled through more than 40 individual acquisitions. And as you can see, we have increased diversification, both by geography and tenant with representation across 8 of the U.K.'

s leading and largest grocery operators. 93% of our stores are omnichannel, playing a critical role in the online grocery fulfillment network, and Steven will be taking you through this in more detail.

Our leases offer inflation protection with 81% of rent reviews inflation-linked. And we have given you a full breakdown of rent reviews in the appendix.

I'd like to take you through the value-add transaction at Tesco Lester that Haff mentioned earlier. It's an example of where we're able to drive value for shareholders through our tenant relationships and industry insight.

We bought this store with a short lease, confident of its importance as an omnichannel hub for Tesco. We subsequently agreed to extend the lease to 15 years and convert the rent [indiscernible] to annual RPI.

In this case, we were able to deliver gains of over GBP 14 million in less than 2 years at an IRR of 17%. And in the current environment, we're expecting to see more of these shorter lease opportunities.

Turning to our non-grocery exposure. To remind you, our strategy has always been to target top trading omnichannel supermarkets and we continue to do so.

It is common for these to be located with other retailers and services. And we consider buying these where they complement the supermarket and where a site separation would be suboptimal.

These assets represent 5% of the portfolio. Our non-grocery tenants are highly diversified, operating in a range of sectors, which typically cater to daily essentials and services.

And the location adjacent to the supermarket is highly desirable, driving footfall to the site. Taking a couple of examples, you can see here, top left, very close in Winchester that shows the site with a medical practice.

And top right, Sainsbury's and M&S Foodhall in Glasgow are co-located with a number of tenants, including Costa, McDonald's, Home Bargains and Boots. We have also invested in asset managers with expertise in this space.

As shown by Tesco and Lester, omnichannel real estate is critically important to the operators. And this is again highlighted by Sainsbury's actions in our joint venture investment.

Earlier in the year, Sainsbury's exercised its purchase option over 21 of the 26 stores. And I'm pleased to say that the value for those has now been agreed at just over GBP 1 billion.

The implied value of SUPR stake has increased again from GBP 177 million at 30th of June to GBP 190 million today. And this means we've achieved a money multiple of 1.7x and an IRR of 24%.

For the remaining 5 stores, we have agreed a new 15-year lease on 4 of those. And that leaves 1 store to be sold vacant, which makes up only GBP 1 million of SUPR's GBP 190 million investment value and proceeds will be received in March and July next year.

I'll now hand you over to Steven.

Good morning. The U.K.

economic outlook remains uncertain. However, we are fortunate to be in the countercyclical grocery sector where spend is nondiscretionary.

At GBP 130 billion of annual sales, the supermarket channel dominates U.K. grocery.

A staggering 4 out of 5 consumers will visit a supermarket at least once a week, making supermarkets core food infrastructure. However, powerful structural changes are taking place within this channel with a shift towards omnichannel stores that capture the long-term growth in online grocery.

GBP 76 billion of supermarket sales are fulfilled through omnichannel stores. The omnichannel format seamlessly integrates in-store and online fulfillment, combining the largest channel with the fastest-growing channel.

And on this graph, you can see in the blue box, omnichannel store sales are up 13% on a like-for-like basis. The shift towards omnichannel trading translating to growing trading volumes and densities within our stores and as a result, store sales growth is now outpacing contractual rental growth.

This is making our stores ever more affordable for our tenants. Now we continue to produce our yield series for long lease supermarket property.

As a reminder, we compiled this yield series based on all transactions which are representative of our investment market. That is all transactions which have over 10 years unexpired lease terms benefiting from index-linked or fixed uplifts.

Yields in our series were effectively flat at 4.5%. On this graph, we show market-wide investment volumes since 2016.

Now we have near-perfect visibility on this market. And we see every transaction months before it comes to the market.

Despite some commentators stating that there's been a crash in supermarket volumes, we estimate that 2022 will match the same volume seen in previous years. And yes, this graph does include some of the speculation this morning, which we knew about months ago.

The overall size of the U.K. supermarket property sector is around GBP 100 billion.

Our subsector of omnichannel stores gives us an addressable market of around GBP 40 billion. And as you can see in the last 5 years, we've seen over GBP 8 billion of transactional volume.

In addition, the buyback activity by both Tesco's and Sainsbury's is leading to a net contraction of supply, which we believe will be favorable to long-term investment yields. I'll now hand you back to Ben, who's going to finish with an analysis of relative value and our outlook.

Great. So this slide illustrates the impact that inflation has on unlevered returns for typical supermarket property with inflation-linked rental uplifts.

So yes, interest rates are higher. And yes, bond yields like Tesco's have widened in response.

But just look at what happens to our returns in a higher inflation world. If higher inflation persists, then supermarket properties will generate a 12% total return by year 10, whereas the bonds will continue to return their flat yield.

Put another way, if you own inflation-linked leases, your returns improve in a high-interest rate, high-inflation world. This is especially true for us as we've now fixed the interest rates on our financing costs.

So to sum up the outlook, we're investing in a structurally supported sector with absolutely no question at all over demand for our properties. We have highly contracted inflation-linked rents and that underpins valuations and the safe haven status of our asset class.

We have a strong, flexible balance sheet. We've announced today that we're recycling capital from assets in our Sainsbury's JV at extremely attractive levels.

And our strong flexible balance sheet with 100% fixed rate debt will enable us to move quickly when we see accretive acquisition opportunities. And we do expect to see those kinds of opportunities in this kind of market, including assets that we've wanted to buy for years, but just simply haven't been available to us.

So thank you very much for listening this morning. I'll now hand over to questions.

Miranda just beat Jonathan there.

Miranda Cockburn, Panmure. A few questions, if I may.

Firstly, just in terms of firepower, you've said you've got 31% loan-to-value at the moment. And what level would you feel comfortable going to?

I recognize that obviously you've got income or capital coming back from the reversionary portfolio with Sainsbury's as well. But if you could just give us a feel for what you think you can spend at the moment.

The second question was just in terms of the reversionary portfolio. The GBP 190 million, what's the applied valuation yield, if you can sort of work out if there's a number there that you can give us?

And also the 5 stores that you're leasing, is that going to be within the joint venture? So the joint venture is going to continue to hold those 5 stores or is that going to change going forward?

And then, the final question was just you're highlighting, obviously, inflation linkage. So that's 4% for this next year, and you fixed your debt.

But you're indicating only 1% increase in terms of the dividend. And can you just explain the math behind that?

Okay. Why don't I start with the LTV and the dividend, I'll hand to Steven on the JV, if that works.

So on the LTV, I mean, we -- I think fundamentally, we feel comfortable still going to our kind of historical range of around 40% loan-to-value. And I guess we feel particularly comfortable with that, as you mentioned, because we're going to have a cash inflow from the JV into 2 tranches next year.

So we've got the optionality of what we do with that cash at that point in March and July, which I think puts us in a really strong, flexible position. And then in terms of the dividend, yes, we think that given the current backdrop, the right thing to do is to be cautious and conservative.

So together with the Board, we decided to put through a more modest increase in dividend this year. And obviously, we'll revisit that again next year.

But fundamentally, our underlying income is largely linked to inflation. I hand you over to Steven on the JV.

Yes. Thanks, Miranda.

So off the purchase price on Page 56, we do breakout the yields on the Sainsbury's reversion portfolio. So you can work that out, but it's roughly around 4.2% was the buyback yield.

And then in respect to the 4 stores where there is a new reversions leased to Sainsbury's, we do have exclusivity to acquire those within the JV, but no decision has been made yet as to whether or not we're going to acquire those stores yet.

John Cahill from Stifel. One question about the hedging.

Obviously, you're now 100% hedged on the drawn debt, but obviously there's plenty to go in terms of getting fully invested. How should we think about what you've done today?

Is it a de facto change in the hedging policy? Can we assume that you'll be broadly speaking looking to hedge all of your debt?

Or is it the case that you will now draw down and go back towards the, I think, 60% was the hedging policy originally?

I think we're going to take it on a kind of drawdown by drawdown basis. And if we think at that time, the right thing to do is to hedge that, then that's what we'll do.

So we'll always have a minimum 60% hedged. I think we're more likely than not going to be a bit higher than that going forward.

And if we think it's attractive to do it, we may hedge 100% of future drawdowns, but we don't want to kind of tie our hands at this point.

Okay. And you're still very happy with the sort of 4 or 5-year, 6 term debt horizon rather than looking to match your debts and the duration on the assets?

Yes. And again, we've got a very open mind to refinancing in the bond market, but we have to pick the right time to do that.

And obviously, with the volatility right now the bond markets aren't the friendliest place to be. So in the medium term, we definitely aspire to term out the debt.

And that's something that we're in close conversations with our lending banks on.

Just on the 5 JV stores. Can you say a little bit on about the ones that have been relet that the basis for the rents that have been agreed and how they compare to the previous rents?

And then in terms of one that's not being relet, maybe you could just give a little bit of color on why [indiscernible] and what you've learned from that, if anything?

Yes, can do. Thanks, Julian.

So in respect to the one that's not been relet, that's going to close. It's just a case that the trading performance of the store relative to the competition, Sainsbury's has taken the decision to close it.

So we'll work with them on monetizing that value in time. In respect of the other 4, it's a new 15-year lease.

That lease is going to be subject to open market rent reviews. The rents have been rebased because you might recall this structure was the securitization, which has been running for 20 years.

The rents have been growing over that period. And the rents have roughly dropped by about 40%, I think, from their passing level, which for Sainsbury's makes them sustainable in their leasehold model.

Those rents have been rebased to being highly affordable relative to the stores trading and then also derisked it from an investment perspective. So in that respect, the decision around letting those has just been about rebasing the rent to making it more appropriate.

But I think as Rob illustrated, with the Lester re-gear as well, what we're seeing is 4% rent turnover is highly affordable for the operators and that's roughly where the stores have been rebased too in the JV structure as well.

I think, just mentioning that when we underwrote the acquisition initially, these were the 5 stores which we had some doubts over and actually we initially underwrote it on the basis of them all being -- going to VP. So actually re-letting them to Sainsbury's is further upside for the -- for our investment.

Tom from Berenberg. I just wanted to get a sense of your views on sort of the outlook for online grocery sales in light of sort of current macro and consumer weakness going forward, just how you're seeing that, please?

Yes. I mean, I think we're seeing online penetration fall back slightly.

And that's partly because customers have to pay for delivery. And they can choose to do the delivery themselves and save that labor cost and save the fuel cost by combining with the journey that they're already doing.

Our kind of long-term conviction is that online penetration will get to kind of around 20%. And I think one of the really powerful things about this omnichannel model is that actually it's incredibly flexible and it doesn't have a lot of fixed cost in it.

So the grocers during the pandemic were able to pivot to a much higher penetration in online incredibly quickly. It's also really easy for them to sort of drop back that resource dedicated to online fairly quickly.

So it's a very different model. It's having huge, high CapEx, fixed assets, which only do online.

For Tesco's, if somebody goes from being an online customer to an in-store customer, they're still capturing that within their business. And so that's why we like that model so much.

There's a question online from James Carswell at Peel Hunt. So asking about the rents on the new Sainsbury's leases on the 4 stores.

So I think we're happy to say they're about GBP 12 to GBP 14 a square foot. As we said, we viewed all of that as upside because we'd underwritten them as vacant properties.

And so that also looks highly affordable for Sainsbury's. Justin at Numis asking whether we can offer any color on why Sainsbury's is buying stores from us and selling them to -- selling stores to LXi at the same time.

And I'm sure it's question everyone is asking and it's one we can't really shed any light on unfortunately. That's the way they've chosen to fund the buyback from us.

I think we feel like we've done a really good deal. It looks like LXi have done a really good deal, too.

Unfortunately, we couldn't be part of the buy side because we were also selling at the same time. So that transaction wasn't offered to us.

That does in Australia as well. It's just the attractiveness of the asset class.

So we do think we're going to see more new entrants coming into the supermarket sector potentially, given the nature of the characteristics here, which is the inflation protection, countercyclical market, very highly defensive assets.

Yes. And sorry, and James also asked a question about yields in our space in general.

I mean, I think for all the reasons we've discussed, we think that supermarket property is a highly defensive sector, particularly in this kind of environment. And actually, with higher inflation, our assets are actually going to generate higher returns for our investors.

And hopefully, I guess, the other transaction announced today, the LXi one, just shows how attractive this is as a defensive asset class. We're not naive.

So it seems likely that the broader market moves may impact yields in our space as well, but we think that's going to be by much less. And of course, we've got lots of balance sheet flexibility.

We've fixed our debt. And so we're in a really good position if that was to happen.

Sorry, just a quick one. Just wondering, do you think kind of in the current cost of living crisis and more people using food banks and stuff like that and silly prices being seen for some food items that there might come pressure for operators to not pass through as much cost increases to help people with cost of living?

Yes. I mean, I guess it's -- I was just sort of thinking back to some commentary that Justin King gave because he's obviously a much better expert on actually running a grocery store than I am.

And the way he describes is that growth -- that the supermarket operators, their job is to minimize the amount of inflation that the suppliers try to pass through to customers, because ultimately most of the inflation is coming from the supply chain, it's not coming from the supermarkets. Supermarkets are running on relatively thin margins.

And so they seemed to be doing that fairly well when you look at the latest Kantar numbers. They're not passing through the full amount of inflation.

And that's as a result of them keeping costs under control on their side through the supply chain. And I think it's worth noting that, obviously, in this kind of environment, the inflation on our leases is actually much less than the rest of the inflation they're experiencing.

And so our rents are getting more affordable. And that's got to be positive for long-term values in our space.

[indiscernible] from Liberum Capital. Just a follow-on question to that.

I mean, outside of the supply chain, rising energy costs are impacting grocers quite significantly. Just your comments around the sensitivities to affordability ratios and where you see that progressing over the next year?

I'd like to say that one. I mean, the largest component cost for the grocers is labor as well as the stuff they buy and like you said energy.

But as Ben mentioned, rent turnovers are made around 3.9% in our portfolio at the moment. So it is incredibly low.

And when we look at where the grocers aren't going to be immune to the cost pressures coming through in terms of short-term profitability, but nevertheless, they are passing that down through to customers and the stores and the rents remain highly affordable. In terms of energy cost itself, we're just seeing enormous investment going into energy efficiency.

I mean, Rob, do you want to talk to solar and the kind of EV charging, et cetera, that we're seeing going through?

Yes. Obviously, our tenants have all got big sustainability commitments and we're seeing that across our portfolio.

They're actually fairly agnostic, whether the store's freehold or leasehold, they'll invest in them in the same manner. So we've got our own programs looking to roll-out solar across as many of our sites as possible.

We've also just made good progress on EV charging. So we're in the kind of final stages of our plans to roll out EV charging to 6 more sites.

So yes, it's absolutely top for our agenda and certainly for our tenants as well. So we're making good progress.

All of that is combining to reducing our overall cost footprint on energy as they take it away from the grid and start focusing more around onsite generation.

Great. Well, if that's it, thank you very much, everyone.

Really appreciate you coming this morning. And very happy to chat further over a coffee if you have time.

Thank you.