Supermarket Income REIT plc (SUPR) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Supermarket Income REIT plc investor presentation. [Operator Instructions] I'd also like to remind you that this presentation is being recorded. Before we begin, we would like to submit the following poll, and if you would give that your kind attention, I'm sure the team would be most grateful. And I'd now like to hand over to Robert Abraham and Steve Noble. Good afternoon, sir.

Good afternoon, and thank you for taking the time to join. My name is Steven Noble, Managing Director and Co-founder of Atrato Capital. Atrato Capital is the Investment Adviser to the Supermarket Income REIT, which is the U.K.'s only real estate investment company focused exclusively on investing in U.K. supermarket property. And I'm joined by Rob Abraham, who is the Investment Manager looking after Supermarket Income REIT. Just before we get into the presentation, delighted to announce that we were the winner of the AIC Property Investment Company of the Year award for this year. I just wanted to start today's presentation with a brief introduction with the people behind the funds because it gives you some context as to why we're a specialist in this sector. Just to start with our Chairman, Nick Hewson, he was Co-Founder and CEO of Grantchester and currently serves as a non-executive Director at Redrow, which is one of the largest and leading housebuilders. Vince Prior as well on our Board. Vince was previously the Head of Property at Sainsbury's, and he helped grow Sainsbury's property portfolio from around GBP 7 billion to GBP 12 billion over his 5-year term at Sainsbury's. And on the Atrato side, Ben Green is a Principal and Co-founder of Atrato, and has 20 years of structuring and executing real estate transactions. And Ben's completed over GBP 5 billion (sic) [ GBP 3.5 billion ] of supermarket sale and leasebacks, and we believe Ben has done more sale and leasebacks on supermarkets than anybody else in the U.K. And another name to note there is Justin King. Justin is a Senior Adviser to Atrato. Some of you know that Justin King was Chief Executive of Sainsbury's for 10 years until 2014, and he currently sits as a non-executive Director for Marks & Spencer. Justin loved the idea of what we were doing, and was keen to join us as an adviser. And broadly, we've put this team together to generate a coverage model for our sector. Now, we cover our tenants all the way from Board level, be it John Allan, Chairman of Tesco, right the way down to the individual store manager. And that's designed to give us a deep understanding of the sector, deliver a material information advantage, but at the same time, generate a relationship advantage over our competitors in this space. Now Rob will take you through the portfolio in a lot more detail later on in the presentation. However, I've got some just key numbers that we can take you through for the year -- sorry, I just lost -- the presentation's back now. So highlights there, GBP 1.3 billion is our total assets under management during our financial year ending 30th of June, we saw an 8.5% like-for-like valuation increase in our portfolio. And of our current share price, our dividend, which we increased in line with our inflation-linked rent reviews again this year, to a dividend of 5.94p. And of our current share price, we're currently yielding a dividend yield of 4.9%. And during the financial year, we generated total shareholder returns of 10.9%. You may have seen that since our financial year in June, we closed a highly oversubscribed GBP 200 million equity placing in October, and we're currently in the process of deploying that capital, which currently takes our total assets to GBP 1.5 billion. Just to quickly run you through our financial performance to date. This page illustrates how we've delivered growth for our shareholders and persistently high returns. The chart to the top left shows you the growth in the rental income over the last 5 years as we've built our supermarkets portfolio. And top right, you can see how that enables us to deliver an inflation-linked dividend growth. And we announced earlier this year that we increased our target dividend again to 5.9p, in line with inflation. Bottom left, you can see the aggregate growth in the fund's NTA since our IPO in June 2017 as we've grown the portfolio from GBP 100 million to over GBP 1.4 billion today, at the same time, we continue to grow our NTA, which currently stands at 108p. And finally, bottom right, we can see how we've consistently delivered on our total shareholder return. Now, I'm briefly going to take you through an overview of our investment strategy, and then I'll hand over to Rob to take you through the sector in a bit more detail. So broadly, there's 3 core pillars to our investment strategy, which underlies what we really love about this sector. The first of those pillars is long inflation-linked income. We target leases that provide long unexpired lease terms. Our current portfolio weighted average lease length is 15 years. And obviously, this provides a high degree of certainty of income that also grows with inflation. At the moment, just under 90% of our portfolio is either inflation-linked or has the benefit fixed uplifts. The second pillar to our investment strategy is omnichannel stores, now let me explain that. We target stores that operate as traditional supermarkets, but also as last mile fulfillment hubs for online grocery orders both via home delivery as well as click and collect. Now as more grocery sales go online, how do we, as real estate investors, capture that growth? Well, we do that through acquiring omnichannel stores. And we've got a lot more details around the omnichannel strategy and the economics of omnichannel last mile fulfillment later in this presentation. And the third pillar about what we love about this sector is just site size. One of the benefits of acquiring supermarket properties is the size of the land we acquire alongside the acquisition. On average, our site size is around 10 acres, and we have about a 25% building cover ratio on our site, with the rest being car park. Now what we love about that, of course, is that, that amount of land gives us a lot of optionality to explore asset management opportunities in the future, and that primarily relates to our ability to respond as the needs of our tenants change and the need of how they use the buildings change. Most recently, we've seen the investment in online fulfillment in terms of back of house logistics operations. And again, we're going to take you through that in the presentation a bit later. Just to summarize, as an introduction to what we're seeing in the sector overall, we continue to benefit through strong headwinds. We've seen a persistent uplift in grocery sales and operators have proved highly agile in negotiating the impact of the pandemic and the shift towards online grocery. Now this is leading to record levels of investment in the grocery sector, both in the operators, through some of the buyouts we've seen in this sector, but we're also seeing significant investment in supermarket real estate, which is having a positive impact on yields. As a result, we're seeing a strong property market backdrop with continuous yield compression, and we're seeing plenty of accretive pipeline opportunities. I'm going to hand over to Rob to take you through this section in a bit more detail.

Thanks, Steve. So Steve mentioned the persistent uplift in grocery sales. And on the left here, you can see the 9% increase in annual volumes, which is compared to 2019 as the last normal year pre-COVID. But it's important to break that down into its component parts, and it's the online channel that really saw the dramatic growth, up 85%. And the primary driver there, of course, is the change in working patterns and the structural shift to growth to working from home. And then it's through in-store or the omnichannel fulfillment network that the increased demand has primarily been met with volumes in that channel up 110% since 2019. Worth mentioning there that we're focused on acquiring the top trading stores, and omnichannel is a key pillar of the investment strategy, and then it makes sense that through the growth in online sales, that then underpins both property values and also income growth for our portfolio. Now turning to online capacity. So the vast majority of online fulfillment is through the store networks, and there's been a massive growth in demand through online grocery. And that's then, of course, been met by a huge scaling up of online in-store fulfillment capacity since start of the pandemic. So in this graph, you can see that increase in weekly online delivery slot capacity across the individual groceries, with the pre-COVID capacity in the shaded columns and the current capacity in the [ brown ] columns. Looking at the blue column, with the example of Tesco, what's quite impressive here is the amount of additional capacity at a store pick model, up 150%, and Tesco has grown its weekly delivery slots by more than double the size of Ocado's business in that space of time, which might come a bit of a surprise given Ocado's perception as the online specialist. And then you can see it's a similar story for Asda and Sainsbury's, who are driven via store pick fulfillment, and that's something we've seen in our own stores, with the operators adding a number of vans and also dedicated warehousing and fulfillment space for online. And that's in contrast to the pure-play operators like Ocado on the right there, and you can see they found it difficult to add capacity at the same pace in that period. And the message is really quite reinforced by both Asda and Sainsbury's closing 2 of their online fulfillment centers, including probably by [indiscernible] for Sainsbury's during the course of last year. These are often referred to as dark stores. And you would think of it, if ever there was a time to make that model work, it would be in a post-COVID world, but those groceries have decided to instead focus on omnichannel fulfillment. And you can see why from this slide here. So proximity to customers is key, and that's why omnichannel stores are the winning solution. So those that know our story well I'm sure would have seen these maps before. We've got Tesco's distribution map here, and each blue dot is an omnichannel store fulfilling online orders through home delivery to the local neighborhood. And then those red stars -- dots clustered around London, are their online-only fulfillment centers. So these are also known as dark stores. Notably, they are all clustered around London because you need the population density, and also Tesco hasn't opened one of those since 2014. And as I just mentioned, Sainsbury's [indiscernible] were actually seen closing some of theirs last year.

And I think just to note, I mean, the core pillar of our investment strategy is we're predominantly targeting those blue dots. It's omnichannel stores that we want to acquire because you can see how it gets -- in this example, Tesco's a complete U.K. coverage network with delivery times. I think their current statistic is that they can hit 90% of the U.K. population within less than a 30-minute drive time.

And so here's how you can see what that's really translated into for the operators. So online is now profitable for these supermarkets. We've seen a massive increase in U.K. online grocery demand, up from 8% to 13%. We've then also seen -- and that also spiked to more like 15% last year. And then that's resulted in a lower cost, rapid scaling up of the installed pick model, and that means that significant economies of scale are being achieved. So then you can see how fulfillment costs are greatly improved as a result for the omnichannel model since 2017. So on the left there, you can see broadly the omnichannel model was similar to that of the fulfillment center model like Ocado on the left-hand side. And actually in now 2021, that cost has reduced dramatically as a result of greater penetration of the market. That means delivery drivers are traveling shorter distances, and therefore, it's now through delivery charges of GBP 5 to GBP 6 that, actually, grocers are recovering almost all of the cost. Whereas Ocado, the Ocado model really needs both population density to work and also market penetration. And I think there's a perception that the Ocado robot-picking model must be much more efficient. But actually, we see pick rates that are broadly similar. Ocado slightly ahead at around 170 items picked per hour, Sainsbury's, though, they're still achieving 160 per hour with the in-store pick model.

And this slide shows you the power of all those blue dots on the previous page. I mean, most of the fulfillment costs for online grocery is in delivery, and you can only solve that by being closer to your customer. And hence, omnichannel is dominating. And as Rob said earlier, we're seeing the likes of Asda and Sainsbury's close dark stores because they want to deliver from traditional supermarkets because you can see the cost benefit right there as utilization increases, economies of scale increases, they can dramatically reduce the delivery costs. Just to give you some numbers, I mean, a man in a van is typically around GBP 17 per hour. And if you're doing 2 deliveries per hour, that delivery charge is costing you GBP 8.50 whereas if you can get back to what is currently the average for the big 4 grocers of 4 deliveries per hour, that reduces your costs to around GBP 4. We have some supermarkets in our portfolio, for example, our most recent acquisition, the Tesco in Colchester, they're currently achieving 6 deliveries per hour. That's their current performance target. And you can see how that drives down the cost of delivery.

So yes, just turning to the store investments. So one of the benefits of our portfolio and owning mission -- what we call mission-critical real estate. So if you think about it from a supermarket's perspective, whether they fulfill in-store or online, they need the stores to achieve sales unlike other sectors where online takes volumes away from the store networks. So that means it's our operators that are making the investment in the stores. So we've got an example here of one of the stores in our portfolio with a dedicated fulfillment center being added to the rear of the warehouse. So we're seeing small extensions, a number of vans being added, drive-through click and collect opportunities. Click and collect has grown as a channel quite considerably as well. And it's just really -- it improves our store's performance. It makes the store more important to that operator. And actually, as a result, it therefore drives rental growth for us. So it's a real positive of owning, as I say, mission-critical real estate.

And I think it's important to note that property market right now just does not differentiate omnichannel stores from non-omnichannel stores. Hence, this is why you need to be a specialist when you're investing in this sector. I mean that additional capacity you see there for all the online fulfillment from 3,000 orders to 7,000, I mean, when you think that that's the weekly increase in capacity and the average online order is GBP 100, that will drive an additional GBP 20 million of sales volume through that store. Now if you think, well, how are rents determined in this sector? Well, rents have always been a factor of turnover. And generally, when rents are set, they're set at around 4% of the store's turnover. So you can see how this online growth through the store will eventually filter through into rental growth. And hence, that's what we love about this sector and focusing predominantly on omnichannel trading stores.

So just to give you a brief overview of the portfolio. We've got a carefully selected high-quality portfolio of 35 supermarkets, and these numbers are as our year-end results. We've now, of course, added to the portfolio, but we're at 35 stores at a 4.7% net initial yield and a GBP 1.2 billion portfolio valuation. As I say, we since announced a further 3 acquisitions. Since then, we still -- the portfolio yield is unchanged, but the portfolio valuation is now up to more like GBP 1.4 billion for our direct portfolio. As shown on this -- on the bottom left here, you've got income weighted towards the U.K.'s leading and largest grocery tenants, and that's secured on top trading omnichannel stores, and all of our investments are underwritten by rigorous and detailed financial and property due diligence. Top right, the portfolio is underpinned by long-term leases, so that's got a weighted lease length of 15 years. And bottom right, the portfolio benefits from highly visible rental growth, which is substantially weighted towards index-linked rent reviews, and that provides an attractive blend of compounding income growth over the next 15 years. So all of these factors together, you can see we're delivering on our strategy of building a platform of high-quality supermarket assets, and that provides a strong foundation to our long-term income growth. On this slide, we can just see, really, the benefits now of that growth that we've achieved over the last year or so. Of course, we've got 3 more dots to add to this map as well, but really shows both the tenant and geographical diversification that we're achieving. And no one store in our portfolio is worth more than 5% now of our gross asset value. Just turning to ESG, which is clearly a hot topic at the moment, and we've been making some good progress on ESG initiatives. So in the first column on the left, we've undertaken a materiality assessment and that's to understand the key ESG topics for both management and also other stakeholders. And to complete this, we engaged investors, tenants and employees of the Investment Adviser to understand the issues that are most important to them. And the output is that materiality metric shown here that identifies the top 8 most important items for both stakeholders and the company leadership, and that showed a high level of correlation as to what was considered important. Onto the left column here, EPC scores also attracts a lot of attention. And as you can see, 70% of our portfolio is EPC and above, and we only have one property with an E rating. And also worth mentioning here, coming back to the point on mission-critical real estate and also the fact that our grocers have very ambitious net zero targets, we actually see a lot of investment in our stores, whether that's energy-efficient lighting, refrigeration, that means the EPC scores naturally improve over time as it's in the operator's interest to do so, which is clearly a huge positive of having the tenant base that we do. And then finally, moving on to governance, the company has been awarded an EPRA Gold governance award 2 years in a row, and we've been continuing to work with the Super Board to enhance the governance framework of the company.

I'm going to give you a quick update and take you through, for those who are new to it, our joint venture portfolio. I'll take you through the details shortly, but big picture to this because it is quite complicated is that we effectively acquired an interest very cheaply on a portfolio of stores, 26 in total, which had a 2-year lease to Sainsbury's. Now, our conviction at the time that we entered into the joint venture was that Sainsbury's wanted these stores for the long term. That's what's happening. And when we exit, we'll exit with a benefit of a 20-year lease to Sainsbury's, and that will be positive to the NTA of Super. Just a quick overview of the detail, the structure. It has 26 Sainsbury's stores. We have a 25% interest in that structure with our joint venture partner, British Airways, who also own 25%, and the other holding is held by Sainsbury's itself. Our running return on this joint venture, our annual return, is 11% per annum. Now our investment will monetize in 2023 in 2 ways, either Sainsbury's buying back those stores or entering into a lease renewal on the stores in the portfolio. In September, Sainsbury's exercised its option to buy back 13 of the stores, and Sainsbury's has an option to purchase a further 10 stores, which it can exercise between December and January. Now we expect Sainsbury's will exercise most of those purchase options. As I said, we'll then receive the sales proceeds in around mid-2023. And as I said before, the option price for Sainsbury's, the price they have to effectively buy those stores, assumes a fresh 20-year lease to Sainsbury's. And given yields on 20-year supermarkets have tightened materially, this will be positive for the NTA at Super. Now, the current leases will continue on all the stores until that date in 2023, so we have continued to earn our 11% running return on that joint venture. And the full impact of Sainsbury's exercising the purchase options, well, that will come through most likely in our half year results in December, which we'll announce around March. And then because if the remaining options are not exercised until January on those other 10 stores, it will probably come through in our results announcements in June 2022. Just quickly take you through debt. I mean it's one of the things we love about the fund is that we believe we have one of the lowest cost of debt in the real estate sector. So broadly, we target leverage of between 30% to 40% over the long term. Our running interest cost or debt cost is around 1.9%. As I said, we think we're one of the lowest in the sector. And primarily that makes sense because we have very strong tenants within our portfolio, and we have the benefit of very long-dated leases. We do operate a secure funding structure. You can see there's some traditional clearing banks as well as German banks who provide our underlying debt, and we're also in the process of exploring other options for our debt financing, which includes moving to potentially an unsecured funding model on the capital markets, which will give us a bit more duration on our debt term. Currently, unsecured debt term is 4 years. I just wanted to take you through the supermarket sector in a bit more detail. It's frustrating for us not to have a representative transactional yield series in the market. And what do I mean by that? Well, I mean yields on stores that are in our target market. Predominantly omnichannel, long lease lengths with the benefit fixed or inflation-linked uplifts. So as a result of that, we've been tracking individual transaction since 2016 that represent our investment market. And in the graph you see here, we've highlighted all transactions, which are representative of that investment market. Ten years unexpired lease term benefiting from index for inflation uplifts. Now please note, this is the whole market, not just our transactions. Now, this allows us to create a yield series. Effectively, this is the line of best fit for all those transactions. And as you can see, investment yields have been tightening from 5.3% in 2016 to 4.5% today, illustrating the impact of valuation increases from growing investment demand in this sector. By the way, this data is available on our website for anybody who wants to go on and download it. Now one of the other things we love about this sector is we can show you the differential between supermarket property yields and bond yields. And when we add the yield on Tesco's corporate bonds, as shown here in blue, we can see that despite the yield shift we're seeing on supermarket property, the relative value from supermarket real estate have significantly improved since we launched the fund back in 2017. So on a risk-adjusted basis, our investment strategy has never looked so compelling. You can also see here on this graph, on the left, we've got vendors of supermarket and on the right, we've got purchases. You can see over the last 3 years on the total column, there's been over GBP 5 billion of supermarket transactions taking place. And what we're seeing is a rotation of capital from a generalist investor base to specialists. You'll see many generalist property investors in that vendor column as well as some more traditional institutional funds, open-ended funds on that list, making good hunting grounds for acquisitions for us, primarily as they're forced to sell either due to a rebalancing of their portfolio. And it is crazy, but sometimes still put supermarkets in a retail asset classification. And others who have been [ for sellers ] primarily in order to produce liquidity into their open-ended fund structures. Now on the other side, you can see the buyers on that -- within the supermarket investment space. One thing to point out there, the ultimate insider, Tesco's. Obviously, they've seen that previous yield graph that I showed you, and they're well aware of the relative value of borrowing in order to buy back supermarkets. And hence, they have been participating in the market, but they tend to quietly participate in the market rather than doing any kind of large-scale buybacks because of the obvious impact that, that would have on investment values. And other names to note there, Realty Income, which is a large U.S. specialist REIT, which has been a big buyer as well as some other specialist names there such as LondonMetric as well as BlackRock. Again, evidence of this rotation of capital out of generalist funds into specialist investment sectors. Now in many ways, as Rob's noted, 2021 has been an exceptional year for U.K. grocery and private equity players have obviously been attracted to buyouts within the sector. And it's not hard to understand that given the mission-critical nature of grocery assets, the significant real estate [ backing ] within their portfolios, the sector still has considerable freehold real estate values. The businesses are highly cash generative. They're very agile in terms of their overall business model. And of course, all the big 4 have a dominant online market share, which is relatively unique. Now how do we think about all of this M&A activity within the market? Well, firstly, grocery real estate, it's core food infrastructure. Our asset selection is absolutely critical in this space, and we use our information and relationship advantages, which I spoke to you about on the start of this presentation, in acquiring high-quality stores with growing sales, both in-store as well as online. Now that provides a strong foundation to long-term income and capital growth at the asset level. And in addition, we don't expect this buyout activity, which is taking place, to have any kind of disruptive impact on the supply and demand dynamics within the market because we don't expect to see significant sale leaseback volumes of supermarket real estate given the low cost of debt finance in the sector. As you've seen previously, debt is far more cheaper than property yields when it comes to financing for any private equity buyers in this space. And just to sum up before we move to questions. I mean the sector itself has a lot of favorable tailwinds. We've seen sustained grocery sales growth. The initial jump we've seen because of the pandemic, that's continuing, and that's a reflection of the structural shifts we've seen in working habits with people working from home more. Omnichannel real estate has now established itself as key to the online grocers' omnichannel and online model. Currently, the omnichannel model fulfills over 80% of all U.K. online grocery orders. And if we take Ocado out of those numbers as the only pure-play online grocer, that number actually jumps to 90% of online grocers. We're going to come out with more news on the Sainsbury's joint venture in January as we will see the impact of their final option exercise date on the remaining 10 properties. And broad brush, as we expect higher inflation to feed through into the U.K. economy, we think that's highly favorable for our investment story because primarily the grocers have been very efficient in passing through any inflation cost pressure in their supply chain. And of course, that filters through eventually to ERVs and rental growth in this sector. At that point, I think we'll stop and we'll turn to Q&A time.

That's great. Robert, Steve, thank you very much indeed for updating investors this afternoon. [Operator Instructions] Robert, Steve, we did enable investors to presubmit questions. We received a question ahead of today's event, which, if I may, start off with. It reads as follows. What are your plans with regard to shorter lease assets within the portfolio?

I can start with that. We've only got a few short leased assets in the portfolio, primarily our investment. What's underlying the investment story is the regear potential on those assets. I mean, again, what we're fundamentally underwriting is the trading performance of the store. And therefore, when we do experience investment opportunities on shorter-dated leases, they can obviously be acquired at high yields, primarily because of the uncertainty around the regear lease. However, our underwriting is designed to evaluate the trading performance of that store. We know when traditionally rent turnover ratios exists. So we can kind of work out where we think that regear rental needs to be. And when we've got a high conviction that, that adds a lot of value to shareholders, we will buy shorter-dated lease assets. I think the best example of that is the returns we're currently making on our joint venture investment. That was a short-dated lease portfolio to Sainsbury's. It was too big for us to take as a whole, so we did it as a joint venture with British Airways' pension scheme, but that's proving to be quite valuable to shareholders. We always maintain a weighted average lease length in and around 15 years. So when we see opportunities at the shorter end of the curve, that will be very much based on value growth. But then that will get balanced by buying longer-dated leases to make sure we maintain predominantly a waiting of around 15 years in lease length.

That's great. [Operator Instructions] And thank you, firstly, to all the questions that have been submitted by investors. And perhaps if I may, if I could just hand back to you to read out the questions and give a response where it's appropriate to do so, and then I'll pick up from you at the end.

Sure. No problem. [indiscernible] and I'll put Rob on the spot for these ones. So if we take the first question from Simon S., a quick question. I noted that your last acquisition in [indiscernible] was a 4% net initial yield. And that is -- rent review has just happened. I thought [ 4.25 ] was key price, so interesting about the [indiscernible] store. Rob, do you want to take that?

Yes. So this one, we really like. It's got a large omnichannel operation store, and off the top of my head, there was 12 to 14 vans operating in actually what was a relatively small catchment distance by drive times. But within a 15-minute drive time at that store, there are 1 million people, so a huge opportunity for online sales. And there weren't any other Sainsbury's stores doing anything like that for more like 30 minutes. So clearly, that kind of store has a large catchment and that provides an opportunity for future sales growth. And then also, I'd just comment on the 4% net initial yield that we reported, we always report based on standard purchasing costs which stands at the market at 6.8%. This was actually an acquisition of a corporate vehicle, so the purchase costs were much lower, and therefore, the actual yield to Super was more like 4.2% to 4.25%. So yes, absolutely in line with what we're seeing elsewhere, but good question and well spotted.

We'll take the next question from David H. Other than inflationary growth in acquisitions, do you see the possibility of your own property development such as warehousing for online deliveries as well as new supermarkets? I'll let Rob take the development side. But look, broadly, one of the things that's great about investing in this sector is the sale and leaseback model, when they were originally done by the operators, they put 25-year leases on them, and they were FRI leases, what's known as fully repairing and insuring. So actually, we have no servicing and any investment that the operators wish to do on the site, they do that themselves. So it's almost as if your tenant is paying for the refurbishment and any enhancements to the underlying real estate. I mean that's very convenient for us as a landlord. So the example we took you through in the presentation, the Sainsbury's store down in [ Firmdale ], the enhancement to the online delivery and the additional capacity was all funded and paid for by Sainsbury's. And we have to consent as a landlord, and of course, that's something we're delighted to do. It will add to sales in the store, and that will eventually be able to [ improve ] the rents over the long term. So primarily, investment in the stores are covered by the operator. In terms of looking forward to the development pipeline, we don't see too much, Rob. I don't think that's core to our focus.

Yes. And what I'd say there is the economic upside from development has certainly been eroded in recent times. They're typically a smaller format and, therefore, smaller lot sizes. And so there's a number of parties who are participating in that. But one thing you don't really see very often anymore is large format supermarkets and certainly, the omnichannel stores. And actually, one of the things we really like about our portfolio is the strong and long trading history. So we can point to, quite often, operators being in place for 30, 40, 50 years, and the catchment [ suited them ]. There's a large population and therefore, the trading is very strong. It gives you much greater conviction on what the potential will be at the end of that lease. With a new build store, you don't have that. And as I say, there's not really the economic upside for doing it. So we don't see that having a large role in our portfolio. But it's not to -- never say never, but it certainly isn't going to become a material part of the business for us.

Next question from David H. Pre-COVID, it seems that supermarkets were willing to turn away from much larger stores. Is this still the case? And how are you handling that regarding the portfolio? I mean I can take that one. David, it's a good question. I mean you're right. There was a perception that stores were too big. And I think that was right when online grocery demand was very low. However, the store pick and the omnichannel model for the grocers has always been core to their thinking. And they told us very early on that, look, as demand grows, we will need the additional space for the additional capacity to online fulfillment. They always knew that the economics of online are a factor of bringing down the delivery costs, and that's only done through proximity to customers. So when you think about the delivery or the logistics challenge of grocery, it is incredibly complicated. You've got maybe 30, 40 different products to deliver, potentially 3 different temperature zones. You can't shove it in the letter box or stick it behind the bin when your customer's out. You have to hit a 1-hour delivery window. And because of the logistics challenge, that generates costs that's only solved through proximity to your customer, and having the additional capacity in the real estate through larger stores enables them to operate a last mile omnichannel fulfillment model which is now profitable, which gives them a strategic advantage in the U.K. and which has enabled them to capture an online market share, which is greater than the physical market share. Now if you think about any other sector, where the incumbent has a dominant online market share as well as a dominant physical share, I find it hard to find other comparable sectors. Usually, physical stores are hit quite hard by the likes of Amazon. And that model kind of works from centralized fulfillment if you can shove it behind the letterbox or stick it in the bin -- or behind the bin, but very different with groceries. Regarding the future, I mean, you saw all those blue dots for Tesco's. They probably -- well, we think they've got the capacity they need across the U.K. for their large stores, so we don't expect to see many large stores being built. That just adds to the scarcity of the additional [ stock ]. The types of new build supermarkets we're going to see are probably going to be smaller, and they're just infill pockets of demand that they can't cover for their existing stores then.

And just to touch on that, on the large format. So one of our recent acquisitions was a Tesco in Prescot, and that's 140,000-square foot store. So it absolutely ticks that box of the large format that quite often we get the question as to what the future of those stores look like. And our acquisition, we entered into a new 15-year lease with Tesco. So we redid that store to an annual CPI lease, a 0.4% rent reviews. So the absolute conviction from Tesco that they still see a big role for these stores in their network and it was operating 14, 15 vans in the local area. Very dense population, big online trading. So yes, absolutely a key part of their strategy still.

A question from Phil G., just an information question. Please, can you confirm what is the weighted average cap percentage for inflation-linked rent increases? That's easy. We're currently 4%, Phil, is the cap on our inflation. We're floored at 0, some of our leases are floored at 1%, with an average 4% cap. And who are the non-food tenants? Good question. I mean non-food is a very small part of our overall portfolio. It's around 3% in terms of value. Obviously, when we acquire a really good trading supermarket, there's sometimes non-grocery operators that are on the site, enhance the on-site offer. Predominantly, our tenants on the non-food portfolio is Homebase. That makes sense because Homebase used to be owned by Sainsbury's, so you tend to find them colocated on sites. B&Q is another name, B&M are one of the tenants in our non-food portfolio. It is small. We don't directly target non -- what we call non-grocery operators, but sometimes they come as part of the site acquisition. And, of course, controlling the site is what's important for us. So where we think site control is incredibly important to the long-term operation of the supermarket, it's advantageous to make sure we control the whole site rather than just acquire the supermarket element, not acquire the non-food element and end up on some car park sharing arrangement. Obviously, that limits our flexibility if the operators come to us and say they want to do more investment in online. They want more of the logistics operation. We want to make sure we control that. So hence, we acquired the non-grocery element at the same time. A question from David H. on ESG. This is a good question, actually, very topical question. Yes. In the private residential sector, escalating requirements, legislations coming into place, which do not let landlords rent out property under a C EPC grade. Are there the same restrictions on your portfolio? How are we handling that refurbish sale? Rob?

Yes. So again, very topical. So there's a government consultation on at the moment, and -- but yes, absolutely, it looks like that's the way things are moving to, and there will be a minimum requirement to achieve a B. As I mentioned earlier in the presentation, we benefit -- or we're fortunate that our tenants are first and foremost so committed to the net zero agenda themselves, but also that they make significant investments in their own store estates as they are so mission-critical, so there's an ongoing program of investment. And we see many examples in our portfolio of stores that were previously scored an E improving to a B and we've not had to do anything. That said, we have done a review of our entire portfolio, and we see the estimated cost of -- if we had to incur it, if it was incurred by the tenants, the estimated cost to achieving compliance and getting every store to a B would be around GBP 8 million. So in the context of a GBP 1.4 billion portfolio now, we don't see that as a material sum. And as I say, we think over time, our EPC scores will continue to improve on the estate.

A good question from Matt P., and I'll add Paul H. to this as well. Do you see small store [ Urban Express ] delivery models such as [indiscernible] disrupting the omnichannel supermarket? And a follow-on question from Paul. Any development on the urban fulfillment centers Tesco's alluded to? Two great questions, linked. So in terms of the Urban Express model, no. Simply, we don't see that as a threat to the omnichannel market. That's incredibly niche. It's designed towards a particular demographic, predominantly London. I think if you talk to a lot of them, they'll say most of their sales are ARPUs and desserts, stuff that's kind of very impulse buy purchase when it's not convenient to go to a store. We don't think it's a growth model. It certainly doesn't have the same kind of strategic advantage that you think the likes of Tesco's and Sainsbury's has to have by being able to offer a full range grocery product line across nearly all of the U.K. and the amount of capacity that they can offer as well as driving down the overall fulfillment costs to the level they have, I just can't see the smaller operators competing with that. And of course, where that market is disruptive on a localized level, predominantly in London, where the operators are already responding to that either through their partnerships with the likes of Deliveroo or Just Eat or alternatively introducing their own 1-hour delivery service. But it will be very, very niche. And urban fulfillment centers, good question. Tesco's are [ putting up a fight ] at the moment, they've got a program to install about 20 to 25 over the next 5 years. Though interim, we expect to see this kind of mechanicalized fulfillment going into the back of house of supermarkets, and probably on all those blue dots that we showed you on the previous page. It will take time to install it. It does provide additional capacity to what they currently have, so I think the speed and timing of moving from a manual paper operation to an automated one will largely depend upon how quickly online grocery grows. If we continue to see an acceleration of growth, you'll see an acceleration of the investment into urbanized fulfillment in-store in order to get the productivity and capacity benefits. If online continues to grow relatively slowly, I think it would take a lot longer to install. But it is something we think we'll see over the longer term. And we're really excited about it, by the way, we love PropTech. And when you look at the additional capacity that they can generate through the store as well as the additional fulfillment, for landlords like us, it just adds to the value of the asset because it will increase the overall sales capacity of that asset. Just looking at another question. Specialist funds segment, it means that your share price is depressed a little. [ NXI ], for instance, trades at a 4% yield, you are close to 5%. What can you do to move from a full listing? Do you make or break the play of your non-food store tenants [indiscernible], et cetera? So 2 questions there from Simon. Do you want to take the specialist funds, Rob?

Yes. So it's something that we've been looking at in the past. And actually, we've kind of been putting together some arguments as to why we think it's not an appropriate place for us to be. Clearly, in the past, we had quite a small portfolio, a limited number of stores. It's now well diversified. And so actually, we think we're far better suited to a premium listing. So it's a good question. It's something that's in our kind of longer-term pipeline as a goal. But yes, absolutely. We feel like we're probably in a place now where we can put together a compelling argument.

And the last one around making a greater play of non-food to boost the share price. I mean, look, it's a small part of our portfolio. We are totally focused on supermarket acquisitions. So the non-food or non-grocery element will only be incidental to acquiring a really good supermarket. We can buy well and the net initial yield on our non-food portfolio was around 9%. It was quite a yield, we buy well, but it will never be a major feature of our investment story. Just conscious of time, I do want to pick up a question from Charles, which is a great question, and then also from Miguel. Charles asked, can you provide any comment on the recent IPO of the Atrato Onsite Energy and any potential beneficial links between Atrato Onsite Energy and Supermarket Income REIT? I mean it's a good question, Charles. Just for those who don't know, we did launch -- Atrato is the Investment Adviser to another fund, which recently launched -- which is Atrato Onsite Energy. That's a fund which is exclusively investing in rooftop solar programs. And hence, its stock market ticker is ROOF. There is crossover opportunities within Super. We have programs with most of our tenants now to explore and start installing rooftop solar energy on our supermarket assets. That will improve the environmental sustainability at the site. It also provides low-cost electricity to the operators, so it's a win-win for both the landlord and the tenant. Relatively small capital investment on each of our sites. It's generally between GBP 200,000 to GBP 300,000. I mean the Board of Super would rather us focus on the GBP 50 million acquisitions on supermarkets and installing our solar panels on the rooftops. There's a level of specialism there that goes beyond just property. So ROOF has a specialist team, which we've recruited. They'll be exploring rooftop solar installations across many assets across the U.K., but there is obvious synergies between Super and ROOF. And we hope and we expect that this will enable us to accelerate the rooftop solar installation across Supermarket's portfolio going forward. And then a question from Miguel, which is a good question. What's the rationale for grocers to do sale and leasebacks when omnichannel stores are so valuable, and the gap between transaction and yields and debt is widening? I mean it's a good question, Miguel. I mean the short and sweet is they're not doing any more sale and leasebacks. The original stock that's in the market and that we're targeting, well, that was done about 10, 15 years ago on 25- and 30-year lease terms. With the rationale for doing sale and leasebacks in the past was the cost of funding. There was a point where property transactions were cheaper than debt transactions. There was also an accounting play to a lot of sale and leasebacks because for those accountants on the Board, sale and leasebacks used to be off-balance sheet source of financing. Of course, the accounting rules have changed since then, and now all our leases are effectively capitalized on balance sheet as debt obligations effectively. So in short, we don't expect to see any additional sale and leasebacks to come into the market. In fact, there's an actual net reduction because as shown to you on the supply and demand tables, Tesco's are now buying back their scores. As you would have seen with our JV, Sainsbury's are in the process of buying back their stores. So we're actually seeing a net reduction of supply in this investment market rather than an increase in supply. And of course, that just further adds to the capital value of the real estate portfolio that we're building. We think that our total investment market, i.e., leasehold supermarkets, is around GBP 30 billion. If we can grow to be 10%, 15% of that market, where you can see how our gross assets could grow to about between GBP 3 billion and GBP 4 billion, that's probably getting to a maximum level of growth for us. We've got 4 more minutes. We'll try and squeeze in another question. Apologies, I'm just going to run through them, we're getting quite a few questions coming in. Is there development upside on our portfolio, for instance, smaller car parks? I think this is redeveloping car park space, Rob, would you share that with the supermarket operators?

Yes. And I think Steven touched on it earlier. So typically, our stores have been fully demised to the tenant and there's full control. So it means that any redevelopment we would do, so that's kind of drive-through restaurants and those kinds, then actually, we would need to work with the operators and therefore, share the upside. Something that's been one of the developments of COVID, this is something we were looking at back in 2019. But one of the developments there has been, obviously, the increase in grocery demand. And therefore, car park capacity has meant that store managers and operators are far less willing to give up the space for the sake of a drive-through restaurant. So actually, yes, their main focus now is ensuring the operational success of the supermarket rather than any kind of incidental smaller revenue from those kind of asset management initiatives. That said, we do have a couple of larger sites where we've got more control, and therefore, we're still exploring those opportunities.

Yes, we can get close to 100% on questions if I get these 2 down in the last 2 minutes. A question from Charles B., which is actually a good question. Your presentation points a very positive picture, can you provide an overview of the potential risks? I mean, in short, for us, on the fund side, obviously, we are a leverage fund. So there is a risk associated with the interest costs on our debt. Obviously, there is a view that interest rates will rise in the future. That would increase our finance costs beyond our existing debt, which is predominantly fixed, it has a term of 4 years. I think the answer to us is that, traditionally, there's been a correlation between inflation and interest rates. So therefore, if there is an increase in interest rates, it's corresponding to the increase in inflation. So there's a level of natural correlation there. We manage that through our treasury policy and fixing debt as much as possible. As I said, we're looking at the bond market as well as another source of fixed income borrowing. But primarily, the difference between our inflation growth and our borrowing cost is one potential risk, but we think we can manage that. Another question from Andrew S., will you look to acquire supermarkets outside of the U.K.? No is the answer. We're incredibly simple. We want to keep it that way, so we're predominantly focused -- or only focused on U.K. assets. And last question, which I'll let Rob handle, high inflation concern. Is that a concern at the 3% to 4% capital level?

Yes. And I think the short answer to that is no. Obviously, we're best placed to benefit from a 90% weight in our portfolio to -- which is linked to inflation rent reviews. So therefore, we're kind of better insulated from that. Clearly, if inflation runs for a sustained period above that, then it has the potential to erode over the long term, but we're expecting it to be more transitory in its nature. And certainly more in the near term, but our portfolio, yes, should benefit from a substantial increase in -- through the rent reviews this year.

Steve, I might jump in at this point to keep your 100% success rate on answering all the questions because I'm sure others will pop in. If they do, obviously, we'll make them available to you. But thank you to everybody for taking the time to submit questions. Rob, Steve. I know investor feedback is important to you guys, and I'll shortly redirect investors to give you their thoughts and expectations. But before doing so, I wonder if I could just hand back to you, Steve, just for a few closing comments just to wrap up with.

Yes. Thanks, Mark. I mean, look, thank you all for attending. It's been a fantastic year of growth for us in the fund. Both the increase in the size of our investment assets has helped us further diversify the portfolio, and we've got some exciting developments coming forward next year, both on our debt funding, both on our Sainsbury's joint venture. I mean the sector has a number of favorable tailwinds to it, and that builds into our primary view that we will continue to see further value and rental growth in this sector going forward. So we're really excited about what the future holds.

That's great. Robert, Steve, thank you very much once again for updating investors this afternoon. Could I please ask investors not to close this session as we'll now automatically redirect you for the opportunity to provide your feedback in order that the management team can really better understand your views and expectations. This will only take a few moments to complete, but I'm sure will be greatly valued by the company. On behalf of the managers of Supermarket Income REIT plc, we'd like to thank you for attending today's presentation. That now concludes today's session. So good afternoon to you all.