Good afternoon, welcome to the Supermarket Income REIT plc Investor Presentation. Throughout this recorded presentation, investors will be in listen only mode. Questions are encouraged and can be submitted at any time by the Q&A tab situated in the right corner of your screen.
Just simply type in your questions and press Send. The company may not be in a position to answer every question it receives during the meeting itself. However, the company will review all questions submitted today and publish responses where it is appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand you over to Steven Noble, Chief Investment Officer. Good afternoon to you, sir.
Good afternoon, good afternoon, everyone. Thank you for joining. My name is Steven Noble. I'm one of the co-founders of Atrato Capital and currently CIO of Atrato. I'm joined by Robert Abraham, who is the Managing Director for the Supermarket Income REIT Fund. I just wanted to start by giving you an overview of the three core pillars behind the investment strategy of the Supermarket Income REIT Fund.
The first of those is long inflation-linked income. We target long leases. The average duration of a lease in our portfolio is 14 years. Within that, we also target progressive rental growth through contractual uplifts to our rents, of which 80% is index-linked. The second core pillar to our investment strategy is around omni-channel stores or what we like to view as future-proofed stores.
The stores that we target not only fulfill in-store sales, but they also play a key role in the fulfillment of online sales of our tenants. Rob's gonna take you through that strategy in a lot more detail shortly. The third pillar of our investment strategy is just the nature of the sites that we acquire. One of the benefits of acquiring supermarket properties is that we get a large land footprint with our assets.
Currently, on average, our site size is around 8 acres, and that gives us a lot of flexibility to respond to the changing needs of our tenants and how they want to use the property. Most recently, of course, investment in online fulfillment and additional distribution docks and fulfillment capacity. Just to give you an overview of the grocery sector before we get into more detail. I mean, grocery market is growing.
Annualized, it's 8.8%. That equals robust income for us. Now, Supermarket property is not immune from the macroeconomic environment, and we can take you through the impact of the movement in property yields on our overall portfolio. However, we have attractive leverage returns, and we have strong balance sheet flexibility.
Again, we'll take you through this shortly. Just starting with an overview of the grocery market. In an otherwise uncertain world, U.K. grocery market continues to go from strength to strength. Monthly annualized store volumes are up 0.8%, and this is, of course, having a positive impact on the financial performance of our tenants. The Q3 update cash flow guidance from both Tesco and Sainsbury's shows how these stronger volume trends, together with momentum behind cost reductions, is driving material financial growth.
Elevated cash flow generation is resulting in increased investment in their own real estate as seen through their activity in the property market, which I will take you through shortly. The wider economic headwinds, strong growth feature of the grocery market over the last 5 years. Over this period, U.K. grocery has recorded persistent growth, increasing by GBP 33 billion to a GBP 222 billion market as of December 2022.
Now, our specialist investment strategy is dedicated to this growing market, which is non-discretionary spend sector with growth from three powerful drivers, mainly including from home, inflation, and population growth. In addition, we are benefiting from the alignment of our investment strategy to the powerful structural changes in the way in which grocery is filled. Let me take you through that in detail now.
On this graph, we show how that GBP 33 billion of growth is distributed by fulfillment format. As you can see, omni-channel is the largest growth format in UK grocery. Over 80% of online grocery orders are fulfilled through an omni-channel supermarket, and that number is growing.
Our deliberate decision to build an investment portfolio of omni-channel stores provides a long-term structural driver to our ERV growth, thereby providing us with the opportunity to capitalize on the growth that we're seeing in our occupational market. Rob's gonna take you through an example of an omni-channel store in a bit more detail shortly to bring it to life.
As you can see in these tables of sellers and buyers, over the last five years, supermarket transactions has totaled over GBP 8 billion. This rotation of supermarket property into long-term specialist investors, combined with the acquisition activities of the operators on their own leasehold property is leading to a net contraction of supply, which we believe is favorable to our long-term investment yields.
It's no surprise investment volumes in our sector have materially reduced in 2022, consistent with other property asset classes. However, our market is unique given the tenants' activity in this investment market. Our investment market looks materially different when we add the operator's own activity. It's no surprise to us that our tenants are the biggest buyers of their own stores, given the long-term value in supermarket property.
2022 shows the extent of this activity as the operators recycle growing free cash flows back into investment in their own leasehold property. Let me take you through investment yields now in a bit more detail. Firstly, I'll just take you through the total size of the market. As you can see here, we break down UK grocery property in total is around GBP 85 billion.
Now, within that, a large majority of stores are owned freehold by the operators, so the addressable leasehold market is around GBP 30 billion. As I mentioned earlier, with the buyback activity of the operators, this market is shrinking. That will be favorable to our yields. Today, Supermarket Income REIT has GBP 1.6 billion of gross assets. Now, let me take you through those yields. On this graph, we show the MSCI yield series for supermarkets, all property, and logistics.
Whilst the supermarket index is a broad series of assets, not fully reflective of our long income omni-channel focus, it does highlight the relative correction in yields we've seen since September. On the right of this graph, you can see that supermarket yields have rebased faster than any other sector, with yields of 5.7% or 90 basis points wider than all property.
What's particularly noticeable here is that at a time when the prospects for our occupational market is at its strongest level, supermarket investment property is at its cheapest level. On the left, when we contrast this to the 2009 global financial crisis and the relative value difference to all property, you can see supermarkets were one of the most expensive asset classes. Again, in contrast today, supermarkets are one of the cheapest.
Our investment market has never looked more compelling, and we believe represents one of the most attractive asset classes in UK property. For those of you who know us well, you'll know we produce our own yield series for long lease supermarket property. Our rules in formulating this index have not changed.
As a reminder, we compile this yield series based on trailing transactions within each 12-month period and which are representative of our investment market. Being transactions which have over 10 years of unexpired lease terms benefiting from index linked or fixed uplifts.
Not surprisingly, given the economic backdrop, transaction yields have moved out to 5.6%. On average, our portfolio is valued at 5.5%. As we showed earlier, the correction to yields does, however, present a real opportunity for us to acquire investments at a more attractive entry point.
On this graph, we contrast the historical IRRs to the current implied IRR following the rebasing to supermarket investment yields, both on a levered and an unlevered basis. At current yields, supermarkets now provide over 200 basis point improvement, increasing from 7%-8% levered IRR to 9%-10% today, which we believe provides a highly attractive return over the risk-free rate and comparable to other asset classes.
In addition, we consider these returns to be even more attractive, especially when you consider the strength and quality of our underlying tenants. With the weakening economy, this quality factor has never been more important, providing a higher degree of income resilience.
In summary, despite the turbulence within the investment market, the attractive entry point, long-term high-quality income makes supermarket assets one of the most attractive asset classes in the U.K. property market. I'm now gonna hand over to Rob, who will take you through our investment strategy and our portfolio in a bit more detail. Rob?
Good afternoon, everyone. Just to take you through our portfolio, and our investment strategy in more detail. First up here, we've got an example of what it is we target, and we'd have mentioned that 93% of our portfolio is omni-channel. This example here is Tesco Thetford, which is the very first store that Supra acquired.
This is a really strong trading location for Tesco. You can see in the image on the left, we've highlighted the various areas within the store. You've got the in-store shopping highlighted as Item A, that's providing significant sales of GBP 49 million of that total GBP 70 million.
You can also see that the combination with the online generating significant sales, it's the combination of all four of these elements of the store that gives total revenue for Tesco of around GBP 70 million per annum. Significant source of revenue. The store trading here benefits from the nearby center and also the immediately adjacent Kingsfleet development of 5,000 new homes.
All of that provides a very strong trading supermarket. You can see there also the large roof is ideal for a PV solar array. This slide here, you may have seen us talk to in the past. It just gives a better explanation of why omni-channel is the winning method of fulfillment for the grocers.
On the left here, you've got Tesco's online distribution network, the blue dots being all of the stores that Tesco do home delivery from. There's around 350 of those in total. The red dots are clustered around London. These are online fulfillment centers. These are online only. You may hear them referred to as dark stores.
The point being, proximity to consumers is key. On the right-hand side, you can see how that translates into lower fulfillment costs. The stacked bar on the left, the CFC model. This is akin to Ocado's fulfillment method.
You can see that the picking and packing cost is broadly comparable to that of omni-channel on the right-hand side, but the delivery cost is significantly higher, and the reason for that is the further distance to travel on average to consumers. The average number of drops that Ocado can achieve in an hour is around 2. Omni-channel stores, by being closer to consumers, can achieve, on average, 4 drops per hour.
In some of the stores in our portfolio, that's as many as 6 drops per hour, and that just gets the average delivery cost down significantly. Therefore, the cost of fulfilling an order, an online order through an omni-channel network, is around GBP 9 per order, compared with the Ocado method at GBP 14 per order.
Yeah. This is a key insight in our investment strategy. What we're essentially targeting is all the blue dots in that map because of the power of the omni-channel format to the operators. As Rob said, grocery is incredibly difficult from a logistic model, and hence, in that respect, you can see the grocers use a distribution model or last mile fulfillment model using supermarkets because the cost is materially lower.
This slide just really highlights that point. You on mute there. Am I coming through?
I've got no-
Yeah. Looks Rob's having a few problems with his microphone here. I'll carry on. In here, you can just see an illustration of the power of the omni-channel model and just around the additional drop densities that are achievable using last mile fulfillment as opposed to big logistics units.
Of course, to really understand this is the reason why Amazon acquired Whole Foods in the U.S., recognizing that to be successful in online grocery, you need a distributed model of last mile fulfillment centers done through supermarkets. I'll now hand back to Rob, who I think Mike's problems have been resolved.
Thank you, Steven, and hopefully I'm back. This is just to highlight our portfolio here on this page. We've grown the portfolio since IPO, to now 50 supermarkets, handpicked stores. These have been compiled in individual acquisitions, rather than portfolio deals. It is really is a unique portfolio that you couldn't replicate today.
Weighting towards Tesco and Sainsbury's, you can see on the left-hand side there, but a highly diversified portfolio, both by tenant and geography. As I've mentioned, 93% of our stores are omni-channel, and we've got a highly affordable average rent to turnover of 4%.
Just to take you through our in-income profile, and it's the combination of those highly affordable rents, but also the mission-critical nature of our assets for our tenants, and also the strength of our tenants. That means that Supra's achieved 100% rent collection since inception.
We also have highly contracted rental income with a 14-year WALT, and we're also continuing to see rental growth come through with that 80% inflation-linked uplifts for our rent reviews, with a total rent roll now at over GBP 95 million. This slide just summarizes the breakdown of our rent reviews.
Primarily, RPI-linked reviews at 73%. We do have some CPI, 18% open market. The reason we have acquired more open market recently is because these reviews are uncapped and we see an opportunity potentially to capture a greater share of inflation through those uncapped reviews over the long term. We just have a small proportion into fixed uplifts.
That's a key observation. You'll note at the start of the presentation, the growth we're currently seeing in the U.K. grocery market is exceeding the elevation in the rental levels because of our average cap. In that respect, we are seeing additional under-rentedness building in this portfolio, and we're trying to capture that through a small increase in our overall exposure to open market rents, which of course will review by reference to the market rather than a formulaic inflation uplift.
When we're targeting really strong trading supermarkets, we do sometimes also acquire adjacent non-grocery units that are complementary to the operation of the supermarket. You can see on the page there, over 75% of these units are essential retailers that trade really well alongside a supermarket, as I say.
The likes of Boots can be quick service restaurants, take drive-throughs like Starbucks there. We take a very conservative approach. These are held at an 8.2% net initial yield in our valuation and represent less than 7% of the portfolio. As you can see in the table on the right-hand side, it's a really diversified portfolio, there's no single point risk or exposures.
It's diversified by sectors, tenants. As I say, this is all about targeting really strong supermarkets, but sometimes in unlocking those, it comes with some non-grocery exposure as well. Just turning to sustainability. Well, on the left-hand side here, we've shown our EPC ratings in the portfolio at 84% A to C.
But we're not just stopping there. We're looking to continuously improve the sustainability of our assets. We've recently had Tesco enter into a 20-year PPA for a new rooftop solar array at one of our stores. We've also agreed terms for EV charging at 8 sites. Planning is underway for those. On the right-hand side, we're working towards net zero as well. SUPER recently became a signatory of the Net Zero Asset Managers initiative.
On the right-hand side, TCFDs, so the Task Force on Climate-related Financial Disclosures. This relates to our reporting, in our annual report in September, we went to TCFD, but we are targeting full compliance ahead of the deadline in 2025. We're also working with specialists, so Anthesis, and they're involved in producing a science-based carbon reduction target for SUPER.
Related to that, we've also now, for the first time, started to receive carbon emissions data or energy consumption data, but from some of our main tenants, and we're working on expanding that to our full tenant base. Also, SEN ESG have been appointed to develop SUPER's sustainability strategy further and perform a benchmarking exercise against peers. Turning now to our Sainsbury's Reversion Portfolio investment.
As a reminder, this is the culmination of 3 years of hard work. The JV was formed in 2020, with SUPER taking a 12.75% interest in that portfolio, increasing to 51% in January in a series of transactions, before finally being disposed of in full to Sainsbury's, which was announced earlier this month.
That's been a really strong performing investment for SUPER with a 1.9x money multiple and an IRR of 30%. It's a real value add there, let me just take you through how we got there. The initial investment by the JV was GBP 217 million into 26 Sainsbury's stores on short leases.
The value opportunity we saw here was in the strength of the stores, and we underwrote Sainsbury's long-term occupation of these locations beyond lease expiry. That was proven by Sainsbury's exercising its purchase options on 21 of those stores, for over GBP 1 billion, and that deal was struck at the peak of the market, with a net initial yield of 4.3% on those stores acquired.
There were also four stores that Sainsbury's took new 15-year leases on, and there's one that is to be sold subject to vacant possession. The result of that is GBP 431 million of sale proceeds to SUPER. We've received the first tranche of that, and the second tranche is due in July. Just again, that's been really attractive return to SUPER with a 1.9x money multiple and an IRR of 30%.
In terms of how we replace the income that we've been generating at GBP 12 million per annum from the Sainsbury's Reversion Portfolio, then there are options around how best to deploy the GBP 228 million of net equity received. Firstly, there are store acquisitions that could generate around GBP 13 million of income. Secondly, just the repayment of debt, which at current rates could save around GBP 11 million. Finally, share buybacks. The board is considering all of these options, and their respective merits, in deciding how best to use those proceeds.
I think that's back to me. To summarize, before we move into Q&As, the outlook for our sector, I mean, as we've taken you through the grocery market and how that's changed, we do believe this is a structurally supported sector. We are 100% dedicated to the U.K. grocery market.
The growth of that market has been persistent over the last five years, and that's been driven by core drivers that predominantly relate to increased working from home, growth in inflation, as well as increase in population growth. For us, as a fund, we have highly contracted inflation-linked rental growth. As a reminder, our WALT is 14 years. 80% of our income is index-linked.
On top of that, as Rob took you through, with the disposal of the Sainsbury's Reversion Portfolio, we do have a lot of liquidity that we can use to pay down debt, and of course, that gives us a really flexible balance sheet. We also have a sustainable dividend. As a result of the hedging activity we undertook on our debt, 100% of our funding cost is now hedged until mid-2026. In that respect, our dividend is sustainable. On top of that, we do have attractive levered returns from future market transactions that we could pursue.
As Rob also took you through with our optionality on the Sainsbury's Reversion Portfolio, that liquidity gives us options that we can consider to deploy, both into new assets, two, to repay debt to maintain our balance sheet strength, or alternatively, we could look at share buybacks as an option. At that point, I will pause, and we can go into a Q&A session.
Yes. Robert, Stephen, thank you very much for your presentation. Ladies and gentlemen, please do continue to submit your questions just by using the Q&A tab, which is situated on the top right-hand corner of your screen. Just while the company take a few moments to review those questions submitted today, I'd like to remind you that recording of this presentation, along with a copy of the slides and the published Q&A, can be accessed via your investor dashboard.
Robert, Stephen, as you can see, received a number of questions throughout today's presentation. If I could just ask you to read out those questions and give responses where it's appropriate to do so, I'll pick up from you both at the end.
Thank you. We can get straight into it. A really good question, first of all, that's come through, I think pre-submitted, just asking about banks, their appetite for Super and where we've hedged. I'm gonna flick through a few slides, unfortunately, it is worth taking you through this in detail. I'll probably take you quickly through this one.
Yes, there is strong appetite for Super's credit, and naturally so. I mean, we've got very strong covenants. We're secured by property. In that respect, there is a lot of banking appetite for us. We've always maintained a fairly large, well-diversified banking group. You can see here that in the last 6 months, we have refinanced as well as extending existing facilities. Right now, our total committed debt facilities stands at over GBP 850 million in total.
It's also fairly well staggered in terms of maturity. We do outline here the maturity of our various debts. For those of you who know us well, you'll know that we began the process of transitioning to an unsecured debt facility that was designed to take us into the bond market. We're still reviewing the bond market and the pricing that's available in the capital markets.
Right now, it's not as attractive as the banking market on a secured or unsecured basis, but we keep it under review. In terms of treasury management, I mean, we outline here our kind of approach to treasury management, which was really designed to maintain our dividend. As of September, this orange dotted line is the yield curve against SONIA, and you can see our approach to hedging was to really hedge out beyond the volatility period.
If we look at how that graph has moved, you can see it has moved around a lot. That was the benefit of one of us taking out a hedging policy to hedge 100% of our debt until around mid-2026. In that respect, we're fully fixed. We're fixed at a finance cost of 2.9%, and of course, that makes our dividend sustainable. Another question just outlining our tenant exposure. Rob, do you wanna take that one quickly, and our exposure to Asda and Morrisons?
Sure. Yeah, our weighting is towards Tesco and Sainsbury's, so around 80% weighted towards those names. I think that will always be the case for us. There is a greater supply of Tesco's and Sainsbury's because they undertook the largest scale, certainly spec programs historically, but they're also two of the strongest covenants in this space, two of the most dominant operators.
For us, that is no bad thing. We have relatively low exposures to the likes of Morrisons and Asda. For us, though, it really is about underwriting sites as grocery locations. There is a role to play for other operators in our portfolio, provided that these are strong trading omni-channel supermarket locations.
History tells you that many of these sites have been grocery for 30, 40, 50 plus years, they may have seen a change in operator, but they continue to be grocery locations. That is just simply because the scarcity of these types of sites in strong locations with good catchments that are perfectly positioned for both in-store shopping and home delivery. That means that if you were to lose a tenant, you would have another willing to step in. For us, yeah, as I say, I think you can always expect us to have that weighting towards Tesco and Sainsbury's.
Okay. We've got a lot of questions coming in on the replacement of the JV income, the use of proceeds, and whether we're considering share buybacks relative to where the share price is. I know we covered this in the presentation, it might be worth, Rob, just reiterating again how we're thinking about that.
Yeah. For us, it's just comparing at the time where the relative benefits are of whether that's acquisitions. The example we've given here is potentially deploying a 6% net initial yield. There are some value opportunities out there at the moment. That would generate around GBP 13 million of income.
Repaying debt, our long-term cost of debt is around 5%, so all-in cost, that is. That would save around GBP 11 million per annum. Then there is share buybacks, and that will be dependent on share price at the time, relative to, as I say, the occupancies or where long-term debt costs look to be. All of these options are on the table. It's kind of finely balanced at the moment, is how I'd describe it.
No decisions have been made. We do near-term debt rent options because we have revolving credit facilities which we're able to freely repay. In the short term, there is no cash drag. It's a question of, well, what is the right level of leverage for the fund to run at going forwards.
Just take one of the pre-submitted questions coming in around dividends, whether it's cut and the outlook for the dividend going forward. I'll just quickly jump to our P&L, which does outline the dividend cover. For the six months to thirty-first of December, it was at 98%.
There's a small drag as we deployed the proceeds of the equity that we completed in the first half of the calendar year. If we looked at that on a look-forward basis or a pro forma basis, then that would be fully covered. As I took you through earlier regarding our treasury management strategy, we have locked down 100% of our funding costs.
In that respect, when we look forward, without giving anyone guidance, which I'm not allowed to do, we do have a high conviction that we can maintain our dividend cover. Of course, some questions around dividend growth going forward. Again, I can't provide you with a prediction, but the board has maintained and is committed to maintaining a progressive dividend growth level.
Of course, Rob has taken you through our income profile and how that's linked to indexation subject to the cap. Another question coming in, Rob, which I'll hand over to you. Just a question around the 5.5% net initial yield, but we have 5.3% on the supermarkets portfolio. If we can explain that difference?
Yeah, absolutely. The 5.5 is our average across the total portfolio, including non-grocery. 5.3% is our average supermarket yield. There is a spread around that. Clearly shorter leased, over-rented stores will be at a wider yield, and we have some that are longer dated, and depending on review basis, that will be marked tighter. That's simply the explanation of the difference between the two.
We do have a slide which I was trying to find, but we'll probably move on to the next question. Apologies. Some of these are slightly repetitive, so I'll try and pull out some different ones. Question on ERVs, and how we're thinking about rental growth in their market. Is there a difference between entry and exit multiples? I could probably take the second one, Rob, but if you wanna give an overview of what we're seeing in the occupational market on rents.
Yeah. The benchmark for operators in terms of rents is 4%.