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

Good morning, and welcome to our results presentation for the 6 months to 31st of December 2021. It's great to be able to present to you in person on such a strong set of results. And thank you to those of you who battled through to achieve, chaos to be here in person in the room. Welcome also to everyone else who's here on the webcast. If you have any questions, you can type those into the portal as we go along or at the end, we'll obviously if you pick your hand up, we'll get a mic to you, and we'll take questions from the room. I'm going to take you through some introductory highlights. Then we'll have a detailed financial update, followed by a review of the business and ESG, and then we'll look at the sector and how that affects in SUPR. I'm joined this morning by Haff Kala, who is the Finance Director for SUPR and Rob Abraham, the Fund Manager. So I'm sure you all know Rob, and I'm sure most of you in the room have also spoken to Haff over the last year or so on analyst calls. Our Chairman, Nick Hewson should be joining us very shortly as soon as he can battle his way through the chaos. And you've got most of the rest of the Atrato team in the room as well available to take questions at the end. So since we last presented our results to you, we've been extremely busy. We've made GBP 370 million of acquisitions. We've assigned an investment-grade rating for our debt, and we've also managed to migrate to the premium list of the London Stock Exchange. In terms of the period itself, we've continued our track record of accretive growth with assets now of GBP 1.6 billion, while at the same time, maintaining our WAULT at 15 years and growing NTA per share by 5% to 113p per share. I'm now going to hand you over to Haff, who'll take you through the financials.

Thank you, Ben. Good morning. I'm pleased to report the results for the 6 months to the 31st December 2021. Starting with the income statement overview. Net rental income is GBP 32.6 million, up 60% from GBP 20.4 million when comparing to the same 6-month period in the prior year. As you will see over the next few slides, the rental increase has been driven predominantly through new purchases, where, in addition to the acquisitions announced during the June full year results, we also successfully announced a further 8 new supermarkets to our portfolio. Let me now talk you through the annualized net rental income numbers in more detail. Annualized net rental income stands at GBP 72.8 million at the period end, a movement of over 50% when comparing to GBP 48 million in the prior year. As you will see on the right of this slide, a further 3 stores were added to the portfolio post 31st December. And as always, I provided a pro forma net rental income number to help you with your modeling. The total pro forma net rental income number now stands at GBP 79.7 million. I've also included further pro forma metrics within the appendices. Focusing now on rent reviews. Seven of our leases were reviewed in the period, we achieved an average rental increase of 6.3%. This included a number of 5 yearly rent reviews. In the appendix, I've provided you with the full breakdown of the rent reviews achieved during the period. The appendix also includes inflation setting for the reviews for the remainder of this financial year, where we have already almost perfect visibility. Moving back to the income statement overview. EPRA net income from joint ventures is GBP 6.2 million, an increase of 113% on compared to GBP 2.9 million in the prior year. You may recall that the joint venture increased its stake within the underlying structure in February of last year. And so the prior year comparative does not show any impact on earnings from the additional interest held. For information, I've included a breakout of this within the supplementary appendices. Administrative and other expenses have increased with the growing size of our business. However, as you will see at the bottom of this slide, the EPRA cost ratio has fallen and now stands at 15.8% compared to 19.9% in the prior period. We expect this ratio to be broadly consistent over the remainder of the next 3 to 4 reporting periods. Finance expenses have increased to GBP 5.7 million, up from GBP 3.7 million during the period, which has increased linearly, given the size of our business, and I'll talk you through our financing in more detail during the later slides. All in all, we are pleased to report that EPRA EPS is 3.1p per share compared to 2.8p per share for the same 6-month comparative period. We continue to grow shareholder returns as we scale the business. EPRA earnings have increased to GBP 26.9 million, which is up 74% compared to GBP 15.5 million in the prior period. A material element of this growth has been the undistributed net income from our joint venture portfolio. As always, we have provided a more conservative adjusted EPRA earnings figure, which backs up this number. As we have mentioned in previous presentations, all cash from the joint venture is used to pay down debt within the underlying structure. In doing so, this is highly accretive to EPRA NTA and accretive to overall shareholder value. Bob will take you through further detail on our JV returns to date later. By stripping out the EPRA net income of GBP 6.2 million, EPRA earnings on an adjusted basis is GBP 20.7 million. Adjusted EPRA dividend cover now stands at 0.87x for the period, which is marginally down from the prior year. This is as a result of us increasing our stake in the joint venture in February of 2021. However, on an EPRA reported basis, dividend cover has improved to 1.13x compared to 1.12x. We are confident that this ratio will improve once we have deployed our remaining debt capacity to fund acquisitions. Moving away from the income statement onto the statement of financial position. Again, the first thing that stands out on this page is the continued growth that the fund has gone through over the last 6 months. Gross assets stand at GBP 1.6 billion, up 24% when compared to GBP 1.3 billion as of the 30th of June from a combination of strong accretive acquisitions and valuation growth. This has resulted in EPRA NTA per share increasing by 5% to 113p per share, up from 108p per share. Here, we have separated out the key components in the 5p movement in EPRA NTA. The key point to highlight on the right-hand side is the positive valuation contribution from the joint venture, and as mentioned, Bob will take you through this in more detail. Moving on to the next slide, focusing now on our direct portfolio. We are pleased to report once again that our direct portfolio has shown significant growth of over GBP 25 million, of which GBP 14 million has come from rental growth and the remainder coming from yield shift, all-in-all, contributing strongly to the 5p increase in EPRA NTA. Moving on to financing. Our reported debt balance was GBP 481.8 million, representing a conservative LTV at the period end of 32%. During the period, the running cost was -- interest cost was 2%. For full transparency, I've also included our fully loaded weighted average cost of debt. During the period, we upsized our banking facilities with HSBC and DekaBank and after the year-end with Barclays and RBC, providing us with total credit facilities available today of GBP 793 million. As Ben has already mentioned, the fund has achieved a key milestone by obtaining an investment-grade credit rating. As of today, we have GBP 625 million drawn with a 4-year average maturity and have comfortable headroom on all of our banking covenants. To sum up, this slide shows our performance over the last few years as we've continued to grow and scale the business. And that's been particularly the important, for example, in being able to migrate super from the specialist fund segment to the premium list. This growth has been accretive to shareholders as we've increased our dividend and NTA per share every year and delivered returns in excess of 48% since our IPO. I will now hand over to Rob, who will talk us through the review of the portfolio.

Thanks, Haff, and good morning, everyone. As you've already heard, it's been another busy period of transactions for the group, highlighting our ability to continue to grow the portfolio through our competitive and information advantage as grocery sector specialists. Haff has taken you through the financials as at period end. Well, I'll be talking you through our portfolio as at today. Since June, we have rapidly deployed a total of GBP 372 million into 11 high-quality assets with the deployment of our GBP 200 million equity raise in October being one of our fastest ever. These acquisitions were completed at 4.6% net initial yield and an accretive 17-year WAULT helped by the addition of our longest leased asset, the Sainsbury's in Washington with 34 years remaining. As a result, we have established a diversified portfolio of high-quality assets. Our direct portfolio value now exceeds GBP 1.5 billion and consists of 41 supermarket sites valued at a 4.7% net initial yield with a WAULT that has been maintained at 15 years through acquisitions. And as you can see from the map on the right, the portfolio is well diversified both by geography and tenant, which has been enhanced through the addition of our first M&S food hall in Liverpool. And in January, we were also delighted to welcome us to the portfolio. through the addition of a strong trading omnichannel store in Cwmbran, South Wales, which has recently expanded to support its home delivery fulfillment to the local neighborhood. Importantly, the group is also well placed in the current inflationary environment as 85% of our leases directly benefit from inflation uplifts. Of those leases linked to inflation, 64% benefit from annual reviews, providing regular rental growth with an average cap of 4%. As sector specialists, we're able to identify value-add opportunities and a great example of this is our Tesco store in Prescot Merseyside. We have been tracking this asset and engaging in off-market discussions with the vendor for around 2 years. This modern top trading omnichannel store operates 14 home delivery vans, providing fulfillment to a densely populated catchment. However, to the standard purchaser, this still was not without risk. With the remaining lease term of only 4 years and an oversized footprint, including 20,000 square feet of unutilized space, both of which provided uncertainty on the potential renewal outcome. But this is where we see the value. Through our strong relationship with Tesco, we were able to negotiate a lease regear whilst undertaking our due diligence on the asset in parallel. On the day of acquisition, we entered into a new 15-year term, replacing the open market reviews with annual CPI uplifts. And we rebased the rent to an affordable 4% rent to turnover which is in line with our wider portfolio. We also capitalized on an opportunity to acquire a vacant plot to the rear of the store, which is potential for Tesco to expand its home delivery operation. And through this regear, we have created material value for shareholders. SUPR's joint venture investment is driving value in the portfolio. And this is another transaction that demonstrates our ability to identify value-add opportunities through our information and relationship advantage. Our acquisition, we were confident in Sainsbury's long-term commitment to the stores. This is now being evidenced by Sainsburys' buying back 21 of the 26 stores driving a significant increase in the value of SUPR's investment of GBP 30 million. We also identified the potential for yield compression, which has driven a 13% gain on the value of our investment, totaling GBP 14 million to SUPR. The investment also produces a running yield of over 10% per annum on acquisition cost as rental income reduces outstanding debt, producing GBP 16 million for SUPR since purchase. On SUPR's investment of GBP 108 million, the total gain to 31st of December 2021 is GBP 60 million, resulting in an IRR of 19%, and we expect further upside to come. As a reminder, the proceeds will not be received until the second half of 2023, which will be deployed in whichever way is most accretive to shareholders at the time, whether that is through further acquisitions or returning cash to shareholders. SUPR and its tenants are committed to the sustainability agenda. The energy performance of each store is an important consideration in our investment process and 3/4 of our assets now have an EPC rating of C or above an improvement of 5%. The supermarket operators are continually investing to improve the environmental credentials of our stores. This includes initiatives such as installing energy-efficient lighting and refrigeration, which translates to improved energy performance scores across our estate at no cost to SUPR. We have also been introducing green provisions to all of our new leases, and we are fortunate that the supermarket operators all have a genuine commitment to the sustainability agenda with net 0 targets of 2040 or earlier whilst all of the grocers have signed up to the British Retail Consortium Climate Action road map. We are continuing to develop the sustainability agenda across the business. And the Board is currently conducting a search for additional board members seeking to deepen the sustainability skill set. And we are delighted to have recently welcomed Christoph Scaife to the Atrato team as Head of Sustainability. We have also engaged the services of a third party to start work on streamlined energy and carbon reporting for Atrato and its funds, and we are on track to become a signatory of the UN principles for responsible investment in the coming weeks. So we look forward to updating you on our progress and with our sustainability strategy when we report our full year results later in the year. I'll now hand you back to Ben to take you through the sector.

Thank you, Rob. So let me take you through how our strategy benefits from structural support and what's going on in the property market. So in terms of the U.K. grocery sector, we're benefiting from 3 big themes; greater working from home, the inflationary backdrop and the digital transition. So in terms of working from home, that's resulted in a step change in grocery sales. As for inflation, we benefit doubly. So firstly, the grocery sector just tends to benefit in an inflationary environment. But secondly, as we've mentioned already, our rental uplifts are 85% inflation linked. And so we get 2 benefits from that inflationary backdrop. And with the digital transition, we're seeing greater online penetration, which benefits omnichannel stores like ours. So let me take you through how our strategy benefits from those changes in consumer habits in numbers. So that's this greater working from home and the digital transition. So grocery sales remain up 10% versus pre-COVID levels, and that's largely as a result of greater working from home even as the economy fully reopens. Obviously, the [indiscernible] strike has been pretty helpful today as well. That's coupled with enormous growth in online grocery, which is up 88%. But meanwhile, physical store sales are only up 4%. So what does that mean for omnichannel stores like ours? What that means for omnichannel stores is that sales in omnichannel stores are up about 16%. And you can see that, that provides a huge structural support for the segment of the market that we are focusing on. Our rents become ever more affordable for our tenants in these omnichannel stores. We're really keen to arrange an analyst visit. So you can see this happening on the ground. We'll get that in place later on in the year. So then turning to the grocery property market. This is our yield series that we produce because we don't think that the MSCI and IPD indices really reflect the sector that we're focused on. So our series is comprised of all market transactions for supermarkets with leases over 10 years. And you can see that we're still seeing yield compression occurring in our space. We think the market is now at 4.4%. Our portfolio is still conservatively valued at 4.7%. So we firmly believe that there's this further upside in the yields on our portfolio. And that's because it just takes time for values to reflect what's going on in the market in our valuations. Over the last 3 years, approximately GBP 5 billion of supermarket properties have transacted. We've seen increased interest in the sector, and that's largely what's causing that yield compression that I just showed you. However, this is a specialist sector, and we have an information and a relationship advantage. What does that mean? It means that we can understand store trading, and we can understand which stores are critical to the strategy of the operators. That means that we can select the best stores from this very large volume of transactions that are available in the market. And we do continue to see accretive acquisition opportunities out there. And as Haff mentioned, we've got plenty of balance sheet capacity to go after those. As I said, we still see room for further yield compression, not only from the market transactions, but also the relative value to bonds. So Tesco's and Sainsbury's bonds are still trading significantly tighter than property yields. And of course, we also get the benefit of inflationary uplift. So in actual fact, we're underwriting returns of 6% to 8% on an unlevered basis. Now as you can see, as the bonds are trading wider than property yields, that might actually provide us with an opportunity to do selective direct sale and leasebacks with Asda but only on the stores that we like. So we have a very strong view on which stores within that portfolio we'd be interested in. Constant theme for Supermarket Income REIT is that supermarket leases still provide a cheap source of inflation for investors. The spread between supermarket property yields and U.K. index-linked yields is at almost all-time highs. Now of course, we do have caps on our inflation uplifts in our leases. The average cap is around 4%. But actually, interestingly, when you look at the long-term level of inflation that the U.K. index in gilt market is pricing in, it's actually 4.1%, which isn't far of our cap. And we've given you the time series at the bottom there of the implied level of inflation in linker pricing. So to conclude, we're really pleased with the strong set of financial results. We've once again scaled up the business while delivering NTA and earnings per share growth. We achieved key strategic milestones with our investment-grade rating and migration to premium list, and both of those have been long-term targets for SUPR. We have an investment strategy, which is structurally supported by inflation, working from home and the growth of online grocery. And we're really well positioned for the future. We expect rental growth to be driven by inflation. We think there's scope for further yield compression and there's more value to come from the Sainsbury's JV. So as the macro backdrop becomes ever more uncertain, we feel very fortunate to be focused on the sector that we are in. So that concludes the presentation. I'll be very happy to take questions. Feel free to type them into the online portal or if you're in the room, just put your hand up, and we'll get a microphone to you.

Miranda Cockburn from Panmure. Just on the joint venture. So GBP 37 million you announced uplift. Can you just explain a little bit more detail how that was calculated? Just looking back at your -- I think it's Page 21, and you've sort of split down the JV value, the GBP 30 million and then the yield compression GBP 14 million. So where is that GBP 37 million? How does that break down, I suppose? And what kind of yields is that assuming?

So the GBP 37 million is the value from the exercise of the options and the value has reflected -- most of the value of both sets of options. They kind of -- even though the second was post balance sheet, they sort of guided by what happened on the first one. And so that resulted in them sort of effectively raising the probability of the second one quite substantially. So most of that value has come through. And then you've also seen a bit of underlying yield compression as well in the space, and that's the combination of the 2 numbers.

So we shouldn't expect much more to come through in the second half from that?

That's right. So I mean we think there in terms of what's to come, there's the remaining sort of earnings from the rent received. And we do think there's more value to come. But that's going to be subject to actually agreeing a purchase price with Sainsbury's. So that's the commercial negotiation now. We hope there's more, but we need to go another negotiation with Sainsbury's.

Julian Livingston of RBC. On your yield series, just so Slide 28, I think, does that include stores that are unlikely to become successful omnichannel stores potentially?

It actually would, yes, so it's all long-leased stores. It's kind of hard just to weed out the omnichannel ones. And we've seen examples of competitors pay quite keen prices for stores that we wouldn't have bought because we think they're very long-term futures compromised by the inability to be on the channel.

Okay. I mean if you try to read them out how would it look a little bit different that line?

Like a little bit. There's a couple of long-dated ones that are traded a bit wider. It wouldn't look a lot different, I don't think, actually, at the moment. I think that's where that value differential is going to come through over time is that the ERVs on our stores should be better because the store trading is up much more than on the physical only stores, and that is we are beginning to see that reflected in the sort of terminal value of the -- the reversion revalue of the stores at the end of the existing leases.

Okay. This is my second question. If I look at the direct portfolio overall, can you sort of say anything about where you think market -- current market rents are for that portfolio versus the passing rents?

Yes, we think we're, on average, pretty much rented -- so think that our view of rent to turnover is -- we're about 3.8% across the portfolio, and we think 4% is kind of the right place to be. So clearly, there are some that are under and some are over, but on average, it's -- we're at rented.

Colm Lauder from Goodbody. Just another question following on the Sainsbury's JV reversion portfolio. I'm particularly trying to understand the assumptions that the valuers might have made for that GBP 37 million gain. So when we look at the structure, obviously, it expires in 2023, and the assets would then be regeared. That's just my understanding a 20-year lease or whatever the equivalent is going forward. But when we look at the assets that have been bought out of the portfolio, do you have an indication of the sort of assumptions that might have been made by the value where payout is a gain? So are those values assuming a hypothetical 20-year leases?

So they have to assume -- so the purchase price the foragers to pay based on a new 20-year lease, and it's at the higher of passing or market rent. So there are some where we have a view that, that should be higher. So at the moment, the valuers have taken their independent view of what that 20 years is worth and what the ERV is on those stores to say some of them should be higher rents starting. And that's a 5-year open market rent review cycle on those. So that's the valuation assumption. Obviously, where there's -- and what they did effectively at year-end was sort of make an assumption about how many stores Sainsbury's exercise on for the second option, which is why most of the value has come through at 31st of December, even though the second option was post balance sheet.

Okay. So their base cases, they assume that hypothetical lease throughout a 20-year deal? Okay. Makes sense.

Exactly.

So could you explain if you have 4% caps in your rent reviews, how you had 6% average rent review for the period?

Yes, happy to take that. So although our average capital inflation is 4%, we have quite a few leases that review on a 5-year cycle. And so in the first half, we had several leases where we captured the full benefit of 5 years' worth of accrued inflation. So it's quite interesting that even though there's a perception that rent can only go up by 4%, actually, quite often it will go up by more than that in this kind of environment because of that dynamic. And then, of course, if you feed that through to earnings, the -- our cap is 4%, but actually, obviously, the balance sheet is levered 40%. So we've got the potential to grow earnings even at the 4% cap at more like 5.5%, 6%.

So webcast question from Jonathan Kownator, GS. What will happen to the 5 remaining Sainsbury's stores in the reversion portfolio?

So those are under negotiation with Sainsbury's, that's obviously quite commercially sensitive. We think that there is likely to be a level of rent at which Sainsbury's would like to commit to those stores. I mean it's worth just taking a step back and saying that the purchase price for Sainsbury's to buy the stores out is quite onerous on them, right? This 20-year basis for new leases. There aren't very many people signing new 20-year leases in any part of the commercial property market. So that's quite an onerous base. It's obviously great for us that they've exercised on so many stores. It's possible that they're not exercising on the 5 years just a negotiation position to get a better deal on those 5, that's possible. We obviously have a backup plan for what to do with those stores if they don't want to occupy them. We think we've got lots of good potential occupiers for those stores and a good fallback plan. And that's effectively the sort of conservative number that's in our valuation at the moment.

Webcast question from Andrew Rees at Numis. Are you able to comment on the value of the 5 JV stores where the repurchase option has not been exercised and has moved over the 6-month period?

I don't think we can break that out for commercial reasons. But the -- you can imagine that it's based on the valuers' view of the ERV for that store. And then it will be a yield based on a shorter lease than the 20-year lease given that Sainsbury's hasn't committed to a 20-year lease on that store.

Andrew Rees of Numis has another question. Are omnichannel stores seeing more notable yield compression than comparative stores that aren't set up for online fulfillment?

I think the answer to that is still no. But as I said, the -- where we expect to see that coming through is in the valuers views of rents on expiry, which will start to come through in a higher residual value on the stores. And that is underpinned by that 16% growth in sales in omnichannel stores, which isn't being mirrored in physical stores, physical-only stores. We've only had a year effectively of that effect of that so far, but it's certainly something that the valuers are noticing now. And so we do expect that to come through soon.

Next question from Tom Musson at Liberum. So firstly, how quickly to current levels of inflation get reflected in rental uplift? Is there a look-back period and so a lagged effect? And the second question is, what did the 2 lease regears due to the valuations of those assets? It looks like they were done at lower rents, but presumably longer leases, which means they were accretive to value.

Okay. I might hand over to Rob on a bit of the detail on that. But just the lag question is a really good one. I think our average lag is about 6 months. Some of them -- it really depends on how the lease was put together in the first place. Some of them have a very short lag. Most of them are more like 3 or 6 months. So it is a valid observation that the inflation that we observed in our leases in the first half was sometimes looking back to a period before we have this current inflation surge. So I think we would expect to be observing high levels of inflation towards our cap -- at the caps in the second half. And then --

Just to point to people to Page 41 in the deck, which is in the rent reviews, so we show the inflation reviews that we received in the period. But more importantly, because there is a lag. We already know what inflation reviews we will get for most of the second half. So where it's a known quantity. We have told you what those inflation reviews will be in the second half.

On the second point around the regears. So the first point is that where we have regeared assets, which is really less as only 1 we've done kind of actually while we've owned it, whereas Prescot, we did it at the point of acquisition. Those have involved rent reduction, but it's absolutely something that we had in our underwriting case. So it's not a surprise that the rent is going down on those stores. It's -- what we've always said is that the right level of rent is about 4% of turnover. And what's really pleasing about those 2 transactions is that up until now, I think we've been guilty of not having any actual case that is of real life regears that have happened at those levels. And actually, we have now achieved 2 of those with Tesco's. And in both cases, they've committed to a new 15-year inflation-linked lease. So I think that really validates our view that that's the right level of rent. And we always think about rent in rent to turnover. We never really think about it in rent per square foot in our market. And you're also right that it did deliver a value uplift on Prescot, it was much smaller because it was done at acquisition. And so really, it was about acquiring a store with the right-sized rent on an inflation lease, and it was really about creating value is about sourcing an asset that other people couldn't access. On Lester, we have created quite a significant amount of value. So maybe, Rob, you could just talk through the sort of overall value created there.

And as Ben mentioned, it was always part of our underwriting acquisition. So we were -- our acquisition yield was around 4% on that store. So fairly wide for net year remaining lease. The -- and our gain on valuation on the entire site is around 25% versus purchase price. So that offsets the rent reduction of around 20%.

Okay. Next question from online comes from Simon Smith, PVL. Now you have a credit rating. What are your plans reissuing debt securities?

Yes. So I think what we've done is create the flexibility to access the unsecured bond market. So it's something that we're evaluating at the moment. We don't want to make any promises because obviously, it's a highly kind of uncertain world at the moment, but we have the option if accessing the bond market will deliver shareholder value. That's what we'll do, and we'll update you further as we advance those plans.

Question from [indiscernible] has Tesco approach SUPR to buy back any stores?

It's a discussion we had kind of right at the beginning, actually, with the CFO at the time at Tesco's. So the discussion with Alan was that as it was quite a hassle for them to buy back stores 1 at a time. They don't have great market visibility on the investment market in supermarkets. And actually, we could be quite an interesting aggregation vehicle for them. They've -- we and they have sort of found enough things to do independently of each other. And we've actually quite often been helpful to them in finding them things to buy. So actually, that store in lesser that we were talking about, that was actually a third acquisition that we did where it was a pair of stores from British land, which we sourced and actually Tesco has bought one of them and we bought the other one, which sort of just, I think, illustrates the depth of our relationship with them, but it's very much a potential outcome. We haven't been approached by them to date, but you can envisage a time where they're no longer finding investments in the market, they might come on off for us for some or all of the stores. And that's very much something that we consider at the time, it would have to be at an appropriate premium that may worthwhile for shareholders. But yes, it's always been one of our sort of end game cases is that the supermarkets come and buy all of our stores back from us.

I think that completes the question from the webcast.

Thank you very much, everyone. We really do appreciate you battling through the traffic and achieves to be here and looking forward to catching up.