Supermarket Income REIT plc

Good morning, and welcome to Supermarket Income REIT's full year results for the 12 months to 30th of June 2024. I'm Ben Green, and I'm joined this morning by Mike Perkins, who's the Finance Director of SUPR; Isabelle Smith, who's our Head of Sustainability; and Rob Abraham, who is the Fund Manager for SUPR.

Before handing over to the team, I'd like to try to summarize the year for you. So it's been a year of strong operational performance.

We've made accretive acquisitions in the U.K. and France, and we're delivering earnings growth for shareholders.

Taking each of the circles in turn, the underlying grocery markets continue to deliver strong growth. Our core tenants are outperforming those markets and the stores that we focus on are capturing an outsized share of that growth.

Moving to the middle circle, with improving market confidence, we've moved from a cautious strategy in the first half of the year where we ran lower leverage to now making selective accretive acquisitions. These include our first strategic transaction outside the U.K., where we've maintained our core focus on strong covenants and omnichannel stores.

Our off-market transaction with Carrefour gave us the opportunity to lock in a better spread to debt than in the U.K. and also for longer.

And then on the right, through all of this, we've positioned SUPR to deliver earnings growth even in a world of prolonged higher interest rates. And of course, we have a lot of upside if interest rates do actually moderate.

On that note, I'm going to hand you over to Mike, who's going to run you through the financials.

Good morning, everyone. I'm pleased to report Supermarket Income REIT's financial results for the year ended 30th of June 2024.

Shown here are the key financial highlights for the year, which I'll take you through in greater detail as we step through the presentation. We reported net rental income of GBP 107 million, adjusted EPS of 6.1p and our dividend was fully covered.

The portfolio was valued independently at GBP 1.8 billion. Our EPRA NTA was 87p, and we reported a loan to value of 37%.

So starting with the income statement. Our portfolio generated net rental income of GBP 107.2 million, representing a 13% increase year-on-year.

And this growth has replaced the income loss following the disposal of our interest in the Sainsbury's joint venture. I'll now take you through the principal drivers of this growth.

In this chart, we provide a bridge in the portfolio passing rents over the 12 months. Investments we have made in both the U.K.

and more recently in France, have contributed GBP 5.2 million and GBP 4.4 million to the rent roll, respectively. An additional GBP 2.9 million of rental growth coming from 22 rent reviews completed in the year, with these reviews being settled 4% ahead of the previous passing rents.

And the passing rent at 30th of June 2024 was GBP 113.1 million, and the investments we've made in the year will provide positive earnings momentum into FY '25. I want to take a moment to highlight our sector-leading metrics on occupancy, rent collection and our gross to net margin.

Our administrative and other expenses were GBP 15.2 million, down 1% year-on-year. And we continue to be vigilant on our cost base and monitor the operational efficiency of the business through its EPRA cost ratio.

And set out on this chart is the EPRA cost ratio across a peer group consisting of FTSE 350-listed REITs. As this chart shows, SUPR has reported a cost ratio of 14.7%, which is an improvement of 80 basis points from the prior year and is one of the lowest in the sector.

We expect our cost ratio to reduce further over the next 12 months as we focus on growing rents and driving operational efficiencies throughout the business. Here, we show the bridge in adjusted earnings over the 12 months.

The sale of the group's interest in the Sainsbury's joint venture portfolio resulted in a reduction in income from joint ventures of 0.9p. We've been proactive in the utilization of these proceeds and a loss of earnings was offset by 0.9p growth in net rental income from acquisitions and rental uplifts.

Our continued drive to achieve operational efficiencies and the decision to fix our cost of debt in a period of greater interest rate uncertainty have resulted in a 0.3p increase from net interest and administrative expenses. So bringing this all together through a combination of accretive acquisitions, operational efficiencies and our hedging strategy, adjusted earnings have increased by 4.4% to 6.1p per share.

We have declared dividends equaling 6.1p per share, a modest 1% increase year-on-year and was fully covered. Now turning to the balance sheet.

Our portfolio was valued at GBP 1.776 billion, an increase of 5% over the 12 months with the growth in the portfolio from acquisitions being offset by yield expansion. This resulted in EPRA NTA per share of 87p, down 6% from June '23.

Our balance sheet continues to remain robust with the portfolio valuation representing a loan-to-value of 37%. It was a year of 2 halves for valuations.

And shown here is the movement in portfolio value over the 12 months. In the first half, the company invested GBP 36 million into 2 omnichannel supermarkets.

However, property values declined by GBP 54 million due to the impact of higher interest rate expectations and property markets. In the second half, as market expectations on interest rates improved, valuations stabilized, and we took the opportunity to invest GBP 100 million into accretive acquisitions.

Like-for-like valuations were marginally up in the second half and the year-end valuation of GBP 1.776 billion represents a net initial yield of 5.9%. Set out in this chart is the maturity profile of our committed debt facilities.

The group has no major refinancings into FY '26 and the committed facilities are well diversified by lenders and maturities. The quality of our portfolio has helped deliver GBP 275 million of debt refinancing, demonstrating the attractiveness of grocery property in debt markets.

Including post-period end activity, the average maturity is 4 years. Our drawn debt is 100% fixed at an attractive average cost of 3.8%.

And we are pleased to announce that Fitch reaffirmed our BBB+ credit rating with a stable outlook. We're delighted to complete our first bond issuance shortly after the year-end via the private placement of EUR 83 million of new senior unsecured notes.

The proceeds of the issuance were used to refinance euro drawings under an existing revolving credit facility, which have been drawn to fund the acquisition of the Carrefour portfolio. The fixed rate coupon of 4.4% is very attractive relative to the acquisition yield of 6.3%.

And this issuance opens up new financing markets to the company, which will help to support our future growth plans and at the same time, access debt at an attractive all-in cost with longer maturities. I will now pass you over to Isabelle to take you through our sustainability strategy.

Good morning, everyone. I'm Isabelle Smith, Head of Sustainability at Atrato.

I've been at the firm for just over a year now, and I'm very pleased to report on the significant progress we have made in continuing to build out our ESG agenda. This year, the company launched a 3 fresh sustainability strategy aligned to 3 key pillars: climate and environment, tenant and community engagement and responsible business.

These pillars aligned to the UN Sustainable Development goals that the company has identified as most material to the business, and provide a framework for reporting on our sustainability activities. We have also prepared a stand-alone sustainability report, which we have released today alongside the full year results.

Sustainability report outlines our progress against this refreshed strategy and expands on some of the sustainability highlights from the year, including our work on net zero, biodiversity, charitable giving and enhanced sustainability reporting. A key sustainability milestone reached by the company this year has been setting emissions reduction targets, which have been validated and approved by the science-based target initiative.

This includes a commitment to reach net zero emissions by 2050 and 2 underlying targets. The first to reduce Scope 1 and 2 emissions, 42% by 2030.

This near-term target relates to our own direct emissions, for example, from communal areas over which we have operational control. The second, to reduce Scope 1, 2 and 3 emissions 90% by 2050.

This longer-term target incorporates the emissions from our tenants, including from the energy they consume to operate our stores. These targets align with the climate aims of our major tenants, many of whom have set ambitious near-term commitments to reach net zero across their own operations by 2035 in addition to longer-term 2050 science-based targets.

As a result of our tenants' commitments to reduce their own operational emissions, we are directly benefiting from proactive tenant lead investments in upgrading and decarbonizing the store estate. Shown here are a few examples of the types of tenant investments being made, which also reflect the strategic importance of these sites to our tenants.

At our Cheltenham store with only 8 years remaining on the lease, Sainsbury's made a multimillion pound investment to upgrade heating, cooling and refrigeration systems. This activity completed at no cost to SUPR resulted in an EPC upgrade of D2B.

At our Tesco Bristol store with only 7 years to expiry, old heating systems were replaced with new electric heat pump technology. We are now planning an EPC review at the store and expect to see this improve.

At the same time, we've also seen a notable reduction in emissions from the store due to the removal of natural gas. At Waitrose Sudbury, a full store reset was carried out including upgrading refrigeration and installing new energy-efficient lighting.

This activity, again completed at no cost to SUPR resulted in an EPC upgrade from D2C. As these examples highlight, such investments are driving both improvements in energy consumption and also help us see improvements in EPC scores across the portfolio.

We will, therefore, continue to work closely with our tenants to further support the delivery of their decarbonization plans. The short length of leases remaining on these examples also indicates the tenant's long-term commitment to our store.

I will now hand you over to Rob, who will talk about the grocery market and portfolio.

Good morning. I'll first be taking you through why we are so positive on the grocery sector and its future growth.

I'll then update you on our portfolio and investment market activity. U.K.

grocery is a strong growth sector with the total market up 35% since SUPR's IPO in 2017, now standing at GBP 252 billion and achieving growth of 5.8% over the last year. We have also seen online grocery return to growth, achieving GBP 24 billion of sales this year and forecast to grow ahead of the total market.

And of online sales, our 2 largest tenants Tesco's and Sainsbury's have a combined market share of 55%. The discounters are reaching maturity in the U.K.

market. The top chart here shows the total number of Aldi and Lidl stores, which now exceeds 2,000.

But you can see in the bottom chart, the discounter growth has slowed dramatically. As the economics of new store development have been impacted by increased construction costs and a shortage of suitable sites, and this is making existing space increasingly valuable.

Moving on to our key tenants, which have been reporting strong sales growth, with Sainsbury's total sales up 10.3% and Tesco up by 7.7%. And you can see here, it's the type of large-format omnichannel stores that SUPR owns, which have been the strongest growing channel within that, with sales up by 11% in large format stores for Sainsbury's and 8.2% for Tesco.

That strong revenue growth is providing the capital for increased investment into our tenant store estate. In the coming financial year, Sainsbury's forecast capital expenditure is GBP 920 million, whilst Tesco is GBP 1.4 billion.

As Isabelle has already mentioned, much of that will be invested in initiatives such as rooftop solar, electric vehicle charging, energy efficiency and store refurbishment. And as a landlord, we benefit from improvements to our assets at no additional cost.

So across the sector, we are seeing long-term tailwinds for market rental growth. Increased sales, both in-store and online, is improving affordability of rents particularly as large format stores are seeing outsized sales growth.

Whilst the challenges of opening new stores means that existing floor space is becoming increasingly valuable. We believe these factors will combine to drive market rental growth.

And as we explained in our recent note on supermarket rents, we don't think values ERVs have yet reflected the improved rental affordability in our stores. Turning to our portfolio, which we have further grown during the year.

We have 73 supermarkets led to the leading operators in the U.K. and now also France, valued at a 5.9% net initial yield and 93% of our supermarkets are omnichannel.

77% of the portfolio is led to the U.K.' s best operators in Tesco's and Sainsbury's whilst we have deliberately kept our exposure low to the weaker covenants of ASDA and Morrisons.

Now to our investment in France. You can see here how the opportunity ticks the boxes of what we look for when investing in the U.K.

for SUPR. Firstly, French grocery is also a growth market.

Online is growing ahead of the total market whilst that growth is fulfilled through omnichannel stores. At the tenant level, we look for leading operators with strong market share and weighted to those with an investment-grade covenant who are making significant investments into their store estates and online operations.

Whilst our model is relationship-led and so dealing directly with Carrefour was important. So let me just take you through that in a bit more detail.

Starting with French grocery as a strong growth sector, up 20% since 2017. And the French online market has also been permanently enlarged following the pandemic.

You will also note here that 80% of online in France is Click & Collect, which is, of course, fulfilled through stores. Carrefour also complements our portfolio weighting to strong tenant covenants with annual sales of over EUR 100 billion, it is the seventh largest grocer in the world ahead of Tesco in ninth, and it has a BBB investment grade credit rating.

Similarly, to our existing tenants, online by our omnichannel stores is core to Carrefour strategy, with a CapEx investment program into its global online operations of over EUR 3 billion and a target to triple its online sales by 2026. The 2 markets are also similarly concentrated with a small number of dominant operators.

And in each market, the top 6 operators are well over 80% of the total market. Now to the EUR 75 million off-market transaction with Carrefour acquired at a net initial yield of 6.3%, which is accretive to the 4.4% cost of debt, the portfolio includes 17 strong trading omnichannel stores, which achieve attractive returns.

We agreed long lease terms of 12 years and low rents of EUR 7 per square foot, which produces a highly affordable rent turnover of 2.1%. An example of the stores acquired in the portfolio is in Abbeville in Northern France.

Carrefour have operated from this site for over 50 years, and it ticks the boxes of our investment strategy as a strong trading omnichannel store with a dedicated drive-thru for online fulfillment. Now to the investment market.

Supermarket profit in the U.K. has remained highly liquid with over GBP 2 billion transacted during the period.

However, breaking that down, you can see that for the first time in many years, almost half of the volume has been from ASDA, Morrisons and Waitrose directly selling stores and leasing them back. But with those transactions now completed, we are not expecting further supply of new assets.

In the context of that reduced supply going forward, I'll take you through how we think about SUPR's addressable market. On the left-hand side here, we have long lease investment -- sorry, long lease opportunities in the U.K.

to investment grade and also sub-investment-grade tenants, which would either not deliver earnings growth or dilute covenant strength. So that's why our recent primary opportunity set has been in Europe and regear opportunities.

Looking first to Europe and particularly the Carrefour transaction, which has broadened SUPR's investment opportunities with a strong covenant and attractive market characteristics whilst generating even greater earnings accretion than similar opportunities in the U.K. through the lower cost of debt.

These enhanced returns make Carrefour and the broader European opportunity highly attractive for SUPR. However, before doing more, we will be consulting with shareholders.

The regear opportunities in the U.K. are lead to the investment-grade tenant covenant of Tesco's and Sainsbury's and a strong performing stores with lease terms of around 10 years and are, in some cases, over rented.

These can be acquired at yields of around 7%, which is accretive to earnings. An example of this is the store in Stoke that we acquired in March of this year.

This is an acquisition, which ticks all the boxes to SUPR's investment strategy led to the strong Tesco covenant with an 11-year remaining lease term and annual inflation-linked rent reviews. The strong trading site produces over GBP 52 million a year of annual revenue for Tesco, whilst acts as an online hub with 5 home delivery vans.

We continue to see attractive pipeline opportunities to drive earnings growth for acquisitions. I'll now hand you back to Ben.

Thank you. So after 24 months of pretty challenging conditions, we're seeing a much more positive macro backdrop and that's coupled with the continuing strong performance of the grocery sector, our tenants and our omnichannel stores.

As Rob explained, and as we set out in our research piece earlier on in the year, we see a lot of upside in U.K. grocery market rents, and that just simply isn't reflected yet in our valuations.

And finally, we continue with our discipline around capital allocation decisions. We evaluate investments against both their ability to drive earnings growth and total returns.

And those decisions include not only potential acquisitions, but also recycling of capital where we see value. So in conclusion, we're feeling very confident about the outlook for SUPR.

So I'd like to open up to questions now. Thank you very much, everyone.

Miranda Cockburn, Berenberg. Just firstly, in terms of acquisitions, 37% loan-to-value, where would you feel comfortable with taking that to?

So yes, look, I think our long-term target has always been 30% to 40%. I think in the near term, we'd probably be comfortable going up to the upper range of that.

That would kind of broadly be around GBP 100 million to GBP 150 million of acquisitions. And really, it's about being selective targeting the earnings accretion, but maintaining the asset quality.

And then are you seeing more opportunities in France rather than the U.K. at the moment?

I mean as we said that the U.K. opportunity set is, I think, going to be a bit smaller going forward.

And we just see a lot of relative value in France and Continental Europe. As we've said, we need to talk to shareholders to make sure that everyone comes with us on that journey because we see a lot of value, but we probably need to amend the investment policy.

So that's a discussion we'll be having during the roadshow.

And then just finally, just on the hedging. Can you just remind us when the key hedges run off over the next year or so?

Yes. So as I said, 100% fixed at the moment, the first hedge rolls off in January 2026.

So we don't anticipate any negativity from interest rate movements in the coming year. And positive signs that interest rates coming down, we expect to see some of future earnings growth.

John Cahill from Stifel. A couple of questions.

And the first one on the EPRA cost ratio. Obviously, you've had a sustained period where you've managed to get that lower and lower and lower.

How far can you really go with that? I mean are we talking sort of 12%, 13%, not to [indiscernible], but is that the kind of region where you would expect to get to?

Yes. I think, as we said, 14.7% is already one of the lowest cost ratios in the sector.

We will be continuing to target further cost reductions where we can and our stated target being the lowest or having the lowest separate cost ratio among the externally managed listed REITs is our target.

Great. And then on the opportunity in France and Europe, if the U.K.

is roughly GBP 100 billion of supermarkets, 20% is owned by third parties. What does that look like in France and any other countries you may have looked at?

Yes, should I go with that one? So I think the point with the French market is it's similarities to the U.K., but the difference there is actually a lot of the stores still sit on operator balance sheet.

We think there's the sale and leaseback opportunity as we've proven with Carrefour that perhaps doesn't exist in the U.K. where Tesco's and Sainsbury's are buying back.

So that's why there's definitely a scale opportunity. I think in terms of kind of other countries, it would be where we see those kind of same characteristics.

As Ben said, it's something we'll be looking to discuss with investors on the roadshow to get that kind of support for it.

Yes. So it's kind of the overall size of -- the overall value of supermarkets is bigger.

It's kind of hard to say exactly what the addressable opportunity is because a lot of the opportunities may come from direct sale and leaseback transactions. And so those are going to be sort of situational rather than something where you can say these ones are already owned by third parties and they may come to the market.

And is it at the moment just to focus on France? Or is there without naming it, are you looking elsewhere too?

Yes, we look at selective other strong European jurisdictions. But again, that's a discussion we need to have with shareholders, where it will be led by relative value and seeing stronger -- a better opportunity to deliver returns and grow earnings.

This is Sam [indiscernible]. I've just done some back of the envelope math, so do correct me if my numbers are wrong.

But just looking at your sort of annualized rent of GBP 113 million, so GBP 6 million above your 2024 reported number and your [indiscernible] cost of debt sort of 3.8% seems to be about GBP 26 million. It's about GBP 10 million above where it was in 2024.

So how confident are you on getting earnings growth and hitting that higher dividend target of [indiscernible] in 2025 given the headwinds from debt costs seem to be a little bit higher than the tailwinds from the increased portfolio size?

Yes. So I think, as Mike said, first hedge rolls in January '26, but thereafter, there's, I think, probably 4 years is the longest hedge roughly from today.

So there will be a gradual unwind of that debt cost. In that time, we've, of course, got contractual rental uplifts on the portfolio, 80% of which is inflation linked.

So that provides an offset, but then also we've got the opportunity to make earnings accretive acquisitions, roughly, it's broadly kind of 150 basis points ahead of the cost of debt. So that gives you an indication of the earnings accretion.

So we're confident that by the time the hedge is all unwind, if you look at where long-term rates or forecast to be that we can fully offset that increase in the cost of debt to kind of maintain a sustainable growing dividend.

And [indiscernible] is that before hedges or after hedges roll off?

That is an average of our cost of debt. So as Rob mentioned, the hedging profile, the cost of debt incrementally increases until the hedges unwind.

So the 3.8% is an average from the balance sheet date to when the hedges roll off.

Justin Bell from Deutsche Numis. I just had a couple of questions.

Firstly, on Slide 39 and 40, where you outlined the primary opportunity set as being for regear opportunities or in Europe? -- flipping that around, might we expect to see some disposal activity on the -- some of the dryer longer-lived assets in the low 5 yields.

Obviously, you mentioned you've got a bit of room on the debt to see opportunities to spend?

Yes, it's an interesting [indiscernible] some of the longer-term -- longer leased assets sort of not only add to the kind of vault of the portfolio, which is attractive and the quality of the portfolio, but actually, the long-term total returns are quite attractive. It's just that at the front end, they're not so accretive to earnings.

So it's always sort of trying to balance those 2 pieces. But we are actively looking at capital recycling across the portfolio where we think there is value.

And the second question was, obviously, a debate you've had a lot over the years about over renting, and I see kind of welcome disclosure, which I haven't seen before in these results of the [indiscernible] yields being about 70 basis points below the initial yield. And you argued that the value of average is undercooking it and you expect to kind of outperform that.

Are there any kind of examples coming up or opportunities where we might be able to sort of see evidence of you outperforming on a regear versus what the valuers have issued?

Yes. I mean the -- we have actually done some regears through acquisitions where we've hit 4% rent turnover, but annoyingly, they're not counted as evidence for the values because they don't include regears in their evidence, which is very frustrating.

So we're very confident based on 2 Tesco stores that we've done and really the exit from the Sainsbury's JV was also really -- the value there was kind of pinned on a 4% rent to turnover rent. And annoyingly, none of that counts as evidenced to the value.

So we think we've created market evidence that's relevant. It just doesn't come through in the valuations.

I'd probably just add to that as well. Our shortest supermarket lease is about 6 years.

So we're not really kind of in any hurry to regear those, but we've seen certainly in our interims and our supermarket rents, we have spoken to some of the regears we've seen elsewhere in the market away from our portfolio, which are at rents of GBP 26, GBP 27 a square foot for 15-year leases, which will be at 4% rent to turnover. So the larger format, strong performing stores, the type of kit that we own, regearing at rents that are materially higher than where a value as ERV would be.

And as Ben says, they're not treated as evidence, but it just gives us a huge amount of confidence when we regear our stores, they will be well ahead of the value as ERV.

Sorry, let me just check online.

Martyn King, Edison. Just on the cost efficiencies, Mike are you talking about trying to peg the nonmanager fee costs, avoiding raises there?

Or is it something you can seize it?

Yes. I think just all of our third-party suppliers, we will be looking to review those contracts where we can and make cost efficiencies where applicable.

So it would just be a review of all of our third-party suppliers. And so we've demonstrated in the year that sort of 80 basis points of EPRA cost ratio improvement, and we want to see that improve further with the growth in rental income and cost savings.

[indiscernible]. Assuming you do carry on and grow in France, have you got a preference for diversifying the covenant there or are you happy to grow with Carrefour, for example?

Yes. I mean, I think long term, we'd like to diversify.

Short term, we haven't really got very much Carrefour yet, so we wouldn't be averse to doing another transaction with Carrefour. And I think sort of interestingly, we've -- I think, benefited from being concentrated on Tesco's and Sainsbury's over recent years, but it does hold us back in few areas like the Fitch rating.

They'd much rather see us have a bit of diversification. We obviously only want to diversify into very strong covenants, and it gives us the opportunity to do that.

I don't think we've got any questions online unless [indiscernible] to say something weird, okay. If there aren't any more questions in the room, I'd just like to say thank you very much for your time this morning.

Really appreciate it. And we'll be around for coffee afterwards if you are there.

Thank you.