Supermarket Income REIT plc

Good morning, everyone, and welcome to Super's interim results presentation for the 6 months to the 31st of December 2023. I'm going to make a brief introduction, then hand you over to the team to take you through the financials, the grocery market and the market for supermarket stores.

So there are 3 key messages today underpinning why Super is in such a strong position for its next phase of growth. Omnichannel stores like ours are increasing grocery market share.

Super has low leverage, providing us with growth capacity and we have an accretive acquisition pipeline. So taking those points in turn, we see omnichannel stores continuing to take an outsized share of grocery growth.

This is driven both by our tenants' strong performance but also by the slowdown in discounter store openings. Why is this important?

It's driving rental growth. We're already seeing that growth in lease regear evidence, and Rob will take you through that later in the presentation.

Turning to leverage. We took active steps to reduce risk in 2023.

You may remember that at the start of 2023, we sold our Sainsbury's JV at very attractive levels. We used the majority of the proceeds to pay down debt.

The outlook now for the next 12 months is one of reduced borrowing costs but still elevated Supermarket yields. So now it feels like the right time to be putting capital to work again using the balance sheet flexibility that we have.

We can use our information and relationship advantage in grocery to buy stores with attractive return characteristics and that will help us to grow earnings. I'll now hand you over to Mike Perkins, who joined us in November as the Super CFO, and he'll take you through the financials.

Good morning, everyone. I'm pleased to report Supermarket Income REIT financial results for the 6 months to December 2023.

Detailed here on this slide are the key financial highlights for the period, which I'll take you through in greater detail as we step through the presentation. We reported net rental income of GBP 52.6 million, adjusted EPS of 2.9p, and we are confident in delivering our full year 2024 dividend targets of 6.06p.

Our portfolio was independently valued at GBP 1.7 billion. And as you'll see later on, the impact of the valuation resulted in EPRA NTA per share of 88p.

And post debt refinancing, our loan-to-value is 33%. So turning to the income statement.

We have delivered net rental income of GBP 52.6 million, which represents an increase of 15%. This has been driven by additional rents from new acquisitions, which replaced earnings loss from our joint venture disposal and to rent review uplifts.

In this chart, we provide a bridge in annualized passing rent since June 2023. Over the 6 months, passing rent has increased from GBP 100.6 million to GBP 104.7 million.

And part of this growth was achieved by 2 acquisitions, contributing GBP 2.5 million to rent roll and reflected a blended acquisition net initial yield of 6.5%. A further GBP 1.6 million of growth coming from rent reviews, which were settled on average, 3.6% ahead of the previous passing rent on an annualized basis.

And we're also pleased to report another period of 100% rent collection. Turning back to the income statement.

Administrative and other expenses were GBP 7.6 million, a reduction of 4% over the same period last year. We continue to monitor the operational efficiency of the group through its EPRA cost ratio, which improved by 160 basis points to 15.1%.

Finance expenses were GBP 8.7 million, representing a decrease of 3% versus the prior period. So bringing this all together, we have maintained our adjusted earnings despite operating at a lower leverage.

As you can see at the bottom of this slide, we actively reduced our LTV from 40% in December 2022 to 33% at the period end. The chart above sets out a bridge in adjusted earnings.

The group's divestment of its interest in the Sainsbury's reversion portfolio resulted in a reduction in income from joint ventures of GBP 7.4 million. The loss of earnings was substantially offset by a GBP 6.7 million increase in net rents, driven by accretive acquisitions and rent reviews.

Reductions in both administrative expenses and net financing costs have contributed a further GBP 0.6 billion in earnings. So taking these movements together, the group delivered adjusted earnings of GBP 36.3 million over the 6-month period.

The company paid dividends totaling 3p per share, up 1% and was 0.97x covered by our adjusted earnings. Importantly, the second half of the year will benefit from a full period of rental income from property acquisitions and contractual uplifts across leases subject to review in the 6 months to 2024 -- June 2024, and we remain confident in achieving full year dividend cover.

So turning to the balance sheet. The portfolio was independently valued at GBP 1.675 billion, down 1.1% over the 6 months and 3.2% on a like-for-like basis, which has resulted in EPRA NTA per share of 88p.

Here, we set out the movement in portfolio valuation over the 6-month period. Starting with the bar on the left, the group acquired 2 properties for a combined consideration of GBP 36 million, excluding transaction costs and represented a blended net initial yield of 6.5%.

Now looking at the valuation movement in greater detail. Rental growth in the portfolio contributed to a positive movement of GBP 29 million, which has been offset by an GBP 83 million decline following an outward shift in property yields applied by our property values.

As I mentioned on the previous slides, on a like-for-like basis, the portfolio valuation over the 6 months was down 3.2%, which compares favorably to the MSCI all property capital index, which reported a decline of 4%. In this chart, we provide a bridge in EPR NTA per share since June 2023.

The group reported adjusted earnings of 2.9p and paid interim dividends totaling 3p per share. And the valuation movement, which I discussed in the previous slide resulted in a 4.6p reduction in NTA.

And as at 31st December 2023, our EPRA NTA was 88 per share. Now given the uncertain economic and interest rate outlook for much of 2023, we made the deliberate decision to use some of the proceeds from the sale of the Sainsbury's Virgin portfolio to pay down debt.

As you can see from the chart at the top of this slide, and as previously mentioned, we have reduced LTV from 40% in December 2022 to 33% at the period end. The refinancing of our debt has further increased our significant headroom under both loan-to-value and interest cover covenants.

Our net debt-to-EBITDA ratio remains very strong at 6.1x, and we have low average debt cost of 3.1%. And we're also pleased to announce that Fitch Ratings has reaffirmed the company's BBB+ credit rating with a stable outlook.

Our decision to step back from the investment markets to conserve cash during a period of continued volatility, now provides the group with capacity for deployment into earnings accretive acquisitions. So now looking at the debt book in more detail.

This chart sets out the maturity profile of our loan facilities as at December 2023. Following our debt refinancing in September, 60% of our committed facilities are now unsecured.

In addition, the group has undrawn facilities of GBP 177 million, which includes accordions and an average maturity of 4.1 years, including extension options. And 100% of the group's drawn debt is either fixed or hedged.

And the company has continued to deliver on its sustainability strategy to improve its ESG performance. Our strategy is focused on responsible investments for long-term value and is structured by 3 key pillars: climate and the environment, tenant and community engagement and responsible business.

These 3 pillars represent the most material sustainability issues for the company and are aligned to the UN sustainable development goals, where the company believes it can have the largest possible impacts. And we will report on progress against this strategy and the underlying ESG activities in our year-end sustainability report.

To deliver the company's sustainability strategy, a number of ESG activities are planned for 2024, both at the portfolio and asset level. Following the publication of our first stand-alone sustainability report in September, along with our TCFD compliance annual reports, the company has identified a number of initiatives for 2024.

Starting with portfolio initiatives. These include further enhancing our sustainability reporting, including preparing a transition plan and conducting quantitive TCFD scenario analysis and working with our tenants in developing a nature-related strategy and exploring opportunities for on-site biodiversity pilot projects.

At the asset level, 30% of the portfolio now has electric vehicle charging base installed, and we continue to assess the portfolio for other opportunities with 3 immediate targets identified. In addition, we continue to support our tenants with the rollout of PV rooftop solar, and 20% of the portfolio has been energized at 0 CapEx cost to the company.

These systems provide clean energy directly to the store and demonstrates our tenants' commitment to our sites. And I'll now pass over to Steven, who will take you through the grocery markets.

Good morning. I'll start by discussing some of the really impressive numbers we've seen from the grocery market and our tenants before turning to stores in a bit more detail.

Firstly, the U.K. grocery market is experiencing strong growth.

Since 2017, the grocery market has grown by an impressive 35% to GBP 250 billion today. In other words, GBP 65 billion of growth since we launched the fund in 2017.

And given store rents are a factor of turnover, this growth is highly positive to the reversion value of our portfolio. And we can illustrate that by looking at how this growth is distributed by channel.

This chart shows the breakdown of that GBP 65 billion of growth by channel. Highlighted here in green is the omnichannel segment in which we specialize.

This is the largest growth segment in U.K. Grocery, and this growth has been achieved from existing stores with 1 net new supermarket opening since 2017.

And to be clear, that means this growth is achieved to be a like-for-like sales on existing stores just like the ones we own, which is highly positive to the reversion value of our portfolio. In contrast, the second largest growth channel, the discount segment highlighted here in light blue, is substantially driven by 568 new store openings.

And let's look at those new store openings in a bit more detail. On this graph, we illustrate the historical store openings from the discounters.

As you can see, there's a slowdown in the rate of new stores from both Aldi and Lidl, driven by higher development costs, a lack of sites and in turn, lower returns from new stores, evidence that this segment may be reaching its market share maturity. Turning back to omnichannel.

In these 2 graphs, we show the total revenue growth versus larger format stores for both Sainsbury's and Tesco. Whilst U.K.

total growth has been very strong, what's more impressive is the larger format stores have outpaced that growth, up 10.8% and 9.3%, respectively, further evidence on how the omnichannel strategy is driving increased volumes for our talents. And this is delivering a significant shift in our tenant's market share, as shown here, capturing ground on all other grocers over the last 6 months.

80% of Super's portfolio is let to Tesco's and Sainsbury's. In contrast, the market share for Aldi has actually decreased as the growth of new store opening is slow.

And putting all of this together, this growth is highly positive to market rents and the reversion of our portfolio, which we're going to take you through in a bit more detail shortly. Turning to stores.

This image is our Sainsbury store in Ashford. It's a top-performing omnichannel store for Sainsbury's, which generates annual sales in excess of GBP 100 million, and we wanted to show how that revenue is generated to illustrate the versatility and resourcefulness of these assets.

Typically, 60% is generated in store. Their size supporting the full range serving around 10,000 customers a week.

And we're seeing growing momentum behind the larger weekly shops. 10% is generated from Essentials, school supplies, pharmacies and fuels with food to go and EV charging, offering significant growth potential.

And of course, 30% is now online. Optimal locations for last mile delivery with the full range enabling profitable online fulfillment via both home delivery as well as click-and-collect.

And let's pause on the growing value from the online channel. 90% of the U.K.

population is less than 35 minutes from an omnichannel store, which now fulfills over 80% of the online grocery market. And the grocers are increasingly leveraging the power of this last mile proximity.

For example, 70% of Argos' annual sales are collected at a Sainsbury store, becoming the largest click-and-collect platform in the U.K., and the majority of the Argos range can now be ordered and collected same day from a store, becoming an alternative to Amazon. And Tesco's has also been leveraging its proximity by expanding its Whoosh delivery service from more stores now covering over 60% of the U.K.

population. And this demonstrates how important our stores are to our tenant strategy and how that growth will be positive to the long-term value of our portfolio.

I'll now hand over to Rob to take you through the investment market in a bit more detail.

Good morning. I'll be taking you through the investment market for supermarket property in more detail.

As was the case of the property sector as a whole, supermarket yields widened in the final quarter of 2023, shown here with the gold line, the MSCI index reporting 6.4% net initial yield. And at these levels, supermarkets provide strong relative value compared to all property in blue and logistics to gray line.

While Super's portfolio was not immune to the yield shift, the high quality of its assets means that the portfolio yield at 5.8% remains inside the yield reported by MSCI, which is very much an average of the whole market, including weaker performing stores as well as sub-investment-grade covenants. And it's the strong relative value along with its defensive characteristics that means Supermarket property investment volumes have remained strong, achieving a record of GBP 2.1 billion in 2023, over half of which was driven by operators' said leaseback activity, of which Asda was the largest at GBP 650 million.

We have also seen an active investment market so far this year with increased competition for assets, suggesting that the market has found a floor and supporting the case for a tightening of yields in 2024 as investors look to a low prospective cost of debt. As sector specialists, we have full visibility of the market.

And I'll now take you through where we have been seeing these investment volumes, along with case studies for each of the 4 distinct strategies for investors in supermarket property. Firstly, long-lease assets led to investment-grade covenants, which are being targeted by unlevered institutional investors.

For example, Sainsbury's in Chadwell Heath, which was acquired by Abrdn, with the recently regeared 15-year inflation-linked lease pricing at 5.25%, highlighting the yields achieved for long leases to the strongest tenants. Then there are the regear opportunities where the covenant strength remains but the leases are shorter in length.

These stores will typically have been the original sale and leasebacks of Tesco's and Sainsbury's in the early 2000s. The example here is a strong trading omnichannel Tesco store in Edinburgh, which is over-rented and with a 7-year remaining lease term, which priced at a yield of 7.6%, with opportunistic approach at ICG taking advantage of a seller under pressure in the second half of 2023.

If this store were to come to market today, we would expect to see both strong demand and pricing. The next set of opportunities in the market are where there are weaker covenants of Asda, Morrisons and Waitrose, undertaking sale and leaseback transactions, which has generated strong interest from institutions.

This was evident in the Asda sale and leaseback, which had 4 credible bidders for the whole portfolio with U.S. triple net lease specialist Realty Income, acquiring the 26 stores for GBP 650 million at a 6.5% net initial yield.

Lastly, we have the secondary assets, which are led to the same noninvestment-grade covenants where assets are over rented or of lower quality with opportunistic purchases attracted by yields of 8% plus. Morrisons, Gloucester is a good example here, which was acquired by a private investor at an 8.8% net initial yield with 15 years remaining on its inflation-linked lease.

In terms of acquisition opportunities for Super, we are looking to deploy yields, which are accretive to earnings, whilst also maintaining the tenant covenant strength. So as shown here, of these opportunities, we see the strongest value for Super in regears.

We're a sector specialist, we are able to underwrite the risk better than others, whilst the yields ensure that acquisitions support our ability to grow Super's dividend. But as mentioned, we have seen increased interest for supermarket properties since the start of the year with operators also buying back stores.

And so we expect there to be increased competition for these assets. Turning to our portfolio, which we will be looking to grow in the coming year from the current 55 stores, which is weighted towards Tescos and Sainsbury's and of which 93% are omnichannel.

Bottom right of this page, you can see that Super's portfolio rents remain highly affordable at an average of 3.8% of store turnover. And we are seeing evidence in the market away from Super's portfolio that demonstrates higher rents being agreed on lease regears for strong performing stores in line with higher store revenues.

You can see here starting rents of GBP 26 per square foot and above, but importantly, at 4% of store turnover, which is the benchmark for affordability. And in the case of the Sainsbury's store in North London, our rent to turnover of over 5% was agreed at GBP 35 per square foot for a lease time of 20 years.

Again, this evidence supports the affordability of rents in the super portfolio at an average of GBP 23 per square foot and 3.8% rent turnover. Finally, and as I've already mentioned, we see supermarket property providing strong relative value at current pricing.

Returns are shown compared to 10-year gilts on the left and also Tesco bonds, with property producing a 12% levered IRR, which we view as particularly attractive when you consider that 78% of Super's leases are inflation-linked. 80% of the portfolio is led to Tesco's and Sainsbury's and that we have had 100% occupancy and rent collection since IPO.

I'll now hand you back to Ben.

So to conclude, we have an investment strategy, which is underpinned by growth in the grocery sector. Super has a strong balance sheet with highly visible, highly contracted cash flows.

And we've got accretive acquisition opportunities where we can deliver earnings growth using our balance sheet flexibility. Super delivers secure income and highly attractive total returns.

So thank you, everybody. I would now like to open up to questions.

[indiscernible] from Berenberg. A couple of questions.

Firstly, you've obviously got capacity now to make some acquisitions. Can you give an indication of how much you'd be happy to spend and where you'd like to see the loan-to-value reach?

And then the second question, the 3.8%, what was it, rent turnover. When you look at it and break down, I mean, obviously, that's on average.

When you look at your portfolio at the moment, what percentage would you say is over rented versus underented, just to give an indication?

Sure. So I take the -- on the acquisitions, I think the policy has always been to not exceed 40% loan to value.

And I think we feel, given the backdrop now and the greater certainty around long-term rates, I think we feel comfortable being closer to 40%, but probably not quite that high. And that would give us, what, a couple of hundred million of acquisition capacity.

And then on 3.8%, mean, obviously, we have a distribution around the 4%. I think our view is that actually -- the -- well, I think our underlying view is that we see stronger rental growth probably than the real estate market does.

And so I think we'd argue that much less of our portfolio is overrented in the long term than people think. And -- but I think the distribution is pretty much kind of 50-50 around the 4%.

Ben, I'll probably just do that [indiscernible]. I think if you take the examples I had on the screen, we are seeing those regear rents at GBP 26, GBP 27 a square foot.

If you look at kind of market rental index, it will tell you market rents at GBP 20, maybe GBP 22 a square foot. But the point for us there is regear rents don't count as evidence towards that data.

And we are seeing that regear rents that shows you 4% at higher rent per square foot. But that will not, as I say, can be included when you see a value as ERV number?

Tom Musson at Goldman Sachs. Just a question on EPRA like-for-like net rental income was 2.5% in the period.

Your caps are sort of averaging, I think, around 4%. So I think it implies the period, not all leases were hitting the caps.

If that's right, is it fair to think that for the full year, we could actually see that like-for-like net rental income number accelerate slightly.

Yes. So I think we had a slide in the deck, looking at the growth in passing rent over the period.

And the average annualized rent reviews in the period was 3.6% up in previous passing versus our sort of weighted average cap across the portfolio of 4% and the floor of 1%. So sort of close to the cap in the period.

And as I mentioned, we've got probably approximately 1/4 of the portfolio subject to review in the second half where we expect to see some further rental growth.

So you're right, we should catch up in the second half of the year, and that's the difference between 3.6% and the totals, which averages about 2%. Because we've got to catch up in the second half.

Got it. And then just on rooftop solar, I think there was an asset you mentioned in the report that for that went from EPC C to B as a result.

Was there any associated valuation benefit that you could identify from that upgrade at all?

Yes, not at this moment. But I think what we might see over time is if stores are not of the kind of sufficient minimum level, that might be where you see valuations mark down.

So rather than kind of a valuation premium, it become more of a discount. But we've not really seen that yet.

I think it's probably too early to say when the legislation hasn't been settled, how it's going to apply to long leases, commercial buildings. But I think the net positive for us is 0 cost to us as a landlord.

Our tenants are really committed to sustainability. So we see these works, not just rooftop solar, but kind of store fit-outs, still refresh programs that improve the sustainability of the buildings, but at 0 cost to Super.

Denese Newton from Stifel. Just thinking about your acquisitions.

And obviously, they start to make sense if you have sort of positive yield spreads over financing costs, and that's -- and you're confident that's stabilized. You said that there were some transactions in Q1 that are getting done now that weren't getting done in Q4.

I just wonder if there's more detail on where they sit in your sort of table of investment opportunities. Are those the sort of things that you're looking at?

Or are those sorts of transactions included in that was getting done in Q4 last year?

I should take this one. So there was one really good example of the store that was under offer and went under offer in Q3 last year.

It was one of the shorter lease regear type opportunities. And that had got under offer, the deal fell over in Q4.

It came back to market in January. And when it went under offer in Q3, Q4 last year, there was only one bidder so they were getting a discounted price.

It came back to the market in January. There were 4 bidders for that store.

There were -- it went under offer, and there were a couple of overbids after that. So -- and of course, they went under offer at a tighter price than had been agreed late last year.

So I think we've just seen that kind of shift since the start of this year with that increased interest where some of the stores where the market was perhaps a bit risk off, looking at shorter leases, over-rent, there is now more demand coming back in. But as I mentioned, that's where we see the opportunity as well.

I've got a couple of questions online. I can address.

So from [ Shore ] Capital asking our view of portfolio ERV. I think the answer to that is we think we're slightly under-rented on average.

So you can extrapolate from we think the right rent turnover is 4%, and we're about 3.8% at the moment. So I can't do that math in my head, but it's quite simple math to do.

And then 2 opposing but related questions. One is what are we thinking about issuing equity?

And the other one is what are we thinking about buying back shares. So clearly, issuing equity is not in the cards anytime soon.

We're very just focused on driving shareholder value and driving earnings. And then on share buybacks, capital allocation and discipline is a constant conversation with the Board.

And at the moment, we see more value for shareholders in deploying our balance sheet flexibility and acquiring attractive acquisitions. Should the discount widen materially then I'm sure that discussion might change.

But as I say, it's something we consider every board meeting. If there aren't any more questions, we can wrap up there.

Thank you very much for your time.