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Supermarket sweep

Supermarket Income REIT 13 December 2021 Update
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Supermarket Income REIT

Supermarket sweep

Capital deployment and
outlook

Real estate

13 December 2021

Price

121p

Market cap

£1,192m

Net debt (£m) at 30 June 2021

390.1

Net LTV as at 30 June 2021

34.0%

Shares in issue

984.9m

Free float

99.5%

Code

SUPR

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

1.9

2.5

14.2

Rel (local)

2.9

0.3

2.1

52-week high/low

125p

105p

Business description

Supermarket Income REIT, listed on the special funds segment of the London Stock Exchange, invests in supermarket property, primarily let to leading UK supermarket operators, on long, inflation-linked leases. The investment objective is to provide an attractive level of income, with the potential for capital growth, with a 7–10% pa total shareholder return target over the medium term.

Next events

H122 period-end

31 December 2021

Analyst

Martyn King

+44 (0)20 3077 5745

Supermarket Income REIT is a research client of Edison Investment Research Limited

Supermarket Income REIT’s (SUPR’s) development continues apace. Including the three recently announced acquisitions (c £150m before costs), we forecast up to £600m of acquisition investment by FY24 as the proceeds of the recent £200m (gross) equity raise are deployed and the cash proceeds from the JV maturity are recycled. Acquisition yield have compressed with a positive impact on net asset value. With a low average cost of capital, we expect SUPR to grow without diluting dividend growth, while benefiting from further scale economies.

Year end

Net rental income (£m)

EPRA earnings (£m)

EPRA EPS*
(p)

EPRA NTA**/ share (p)

DPS
(p)

P/NTA
(x)

Yield
(%)

06/20

26.4

16.8

5.0

101

5.80

1.20

4.8

06/21

47.9

36.8

5.6

108

5.86

1.13

4.8

06/22e

70.7

57.5

6.2

113

5.94

1.07

4.9

06/23e

81.8

64.8

6.6

118

6.10

1.03

5.0

Note: *EPRA EPS is normalised, excluding gains on revaluation. **EPRA net tangible assets.

Further accretive acquisition

FY21 results confirmed the benefits of increasing scale, with a further reduction in the EPRA cost ratio to 16.8% from 19.2%. Since closing the £200m September equity raise, c £150m has been deployed and we forecast a further £150m by end-FY22, including associated debt. Current market acquisition yields, averaging c 4.5%, are ahead of our estimate of the ‘break-even’ yield of 4.3%, above which SUPR can grow without diluting dividends. As the maturity/unwinding of the Sainsbury Reversion Portfolio approaches (calendar H123), in which SUPR has a 25.5% joint venture interest, we forecast material capital uplifts and a cash return of c £180m for recycling into an additional c £300m of investment on a geared basis. Our net asset value (NAV) forecasts do not assume further yield compression or increasing asset prices although many property agents and analysts expect this.

Visible income and growth potential

SUPR’s portfolio of UK supermarket assets, with long leases and predominantly upward-only, inflation-linked rents, is let to strong tenants. SUPR mainly targets omnichannel stores (combining in-store and online fulfilment) that can benefit from both the forecast long-term growth of grocery sales and the increasing popularity of online. The positive impact on supermarket operator sales, especially online, during the COVID-19 pandemic is forecast to have a sustained effect and has enhanced operator financial strength. This has been reflected in all of SUPR’s rental income due being collected in advance with no defaults, deferrals or rent reductions. Income visibility is strong with good prospects for capital growth, driven by rental uplifts as well as strong investment market demand for supermarket property.

Valuation: Secure income with capital potential

SUPR provides visible growth in DPS with good potential for further capital growth. The FY22e DPS of 5.94p represents an attractive yield of 4.9%, a slight premium to the average of a selected peer group of other long income REITs. The yield and inflation indexed rents support the 13% premium to end-FY21 NAV.

Investment summary

SUPR continues to grow strongly through accretive acquisitions funded by increased equity and debt capital resources. Meanwhile, the market in which it operates is benefiting from strong supermarket operator performance, particularly for the omnichannel stores that SUPR targets, further enhancing income security and supporting strong investor demand for supermarket properties. This strong demand is driving up asset prices and SUPR’s NAV but is compressing acquisition yields. We nevertheless expect the strong asset sourcing capabilities of the investment adviser (transactions are typically off-market and therefore somewhat less competitive) and SUPR’s low average cost of debt to support continuing accretive acquisition led growth, especially when combined with economies of scale. The impending maturity (in the first half of calendar 2023) and subsequent unwinding of the Sainsbury’s Reversion Portfolio securitisation vehicles in which SUPR has a 25.5% interest, and reported as a joint venture (JV), will also generate NAV growth and cash for redeployment. We assume deployment will be into further asset growth but should acquisition yields compress to a level where this no longer creates value we expect SUPR to consider alternative options, including a return of capital to shareholders.

In this note we focus on these developments. A detailed review of SUPR’s strategy, including its strict asset selection criteria, can be found in our last note. As detailed below, we forecast further strong, accretive asset growth as the proceeds of the recent £200m (gross) equity raise and the cash return from the JV unwind, with associated gearing, are deployed into a strong near-term and longer-term acquisition pipeline. The prospect of higher inflation for an extended period is beneficial for organic income growth. Our NAV forecasts assume unchanged yields (plus uplifts from the JV) although the prospects for further yield contraction are favourable (and expected by the investment adviser).

Deploying the proceeds of the recent capital increase

SUPR’s most recent equity raise closed on 20 October 2021 with 173.9m new shares issued at 115p per share to raise £200m (gross). The issue was very well received by investors with a scaling back of subscriptions despite an increase in the target issue size from up to £100m to up to £200m, reflecting both the strength of demand for the shares and a strengthening of the acquisition pipeline during the issue roadshow. The investment adviser had identified four assets with an estimated aggregate purchase value of c £180m (the ‘target assets’), three of which were under exclusivity1, and a further seven assets that also meet the company’s strict acquisition criteria, with an expected aggregate value of c £480m (the ‘pipeline’). It has since completed the acquisition of three of the target assets comprising:

  Three of the target assets were under exclusivity at the start of the offer period, with a fourth in advanced due diligence.

Sainsbury’s Swansea and Tesco, Maidstone, announced jointly on 16 November, for a combined £73.0m (before costs). The combined passing rents of c £3.4m pa are reflected in a net initial yield of 4.6% based on standard purchasers’ costs2.The Sainsbury's store opened in 1989 and was refurbished in 2016. The seven-acre city centre site comprises a 65,000 sq ft net sales area supermarket, an 18-pump petrol filling station and more than 500 car parking spaces. The store has a purpose-built online fulfilment centre which operates 16 vans, supporting Sainsbury's online grocery network across the region. It was acquired with an unexpired lease term of 27 years, with five-yearly, upwards only, open market rent reviews.

EPRA acquisition yields assume standard purchasers’ costs of 6.8% although the actual costs incurred can vary considerably from this, particularly in the case of corporate acquisitions with considerably lower stamp duty land tax payable compared with an individual property acquisition. For SUPR, acquisition costs have averaged c 5%.

The Tesco site in Maidstone, Kent, was purpose built for Tesco in 1990 and extensively refurbished in 2007. This seven-acre site comprises a 39,000 sq ft net sales area supermarket, a 12-pump petrol filling station, 369 car parking spaces and a small parade of adjoining units. It was acquired with an unexpired lease term of 13 years, with five-yearly, upwards only, open market rent reviews.

Sainsbury’s in Cannock (announced 1 December) for £75.8m (before costs) with a rent roll of £3.2m pa reflected in a net initial yield of 4.0% based on standards purchasers’ costs. The store opened in 1997 and was extensively refurbished in 2011. It covers a large 9.1-acre site comprising a 73,000 sq ft net sales area supermarket, a 12-pump petrol filling station and 490 car parking spaces. The store has a purpose-built online fulfilment centre which operates 12 vans, forming a key part of Sainsbury's online grocery network across the region. The unexpired lease term is 15 years, with five-yearly, upwards only, RPI-linked rent reviews (subject to a 4.0% cap and 1.0% floor).

Strong record of swift capital deployment

Progress with deploying the recent equity raise proceeds builds on SUPR’s strong record of swift capital deployment, achieved by identifying a range of suitable assets ahead of capital raising, primarily off-market and at an advanced stage of due diligence or under exclusivity. By having a range of opportunities, its bargaining position is protected, and swift deployment has usually followed. It has generally been able to deploy equity proceeds within three months and achieve full deployment, including associated debt capital, within six months. Deployment of the £150m (gross) equity placing in March 2021 took slightly longer than normal but within six months c £185m (including costs) had been invested.

We forecast significant further capital deployment and capital recycling

From the existing strong pipeline of acquisition opportunities, we assume an additional £150m (before costs) of deployment by the end of June 2022 (end-FY22), fully deploying the equity raise proceeds on a geared basis. Available debt capacity is discussed in detail in the following section. We have assumed a net initial yield on investment of 4.5%. This implies a full use of SUPR’s existing £644m of debt facilities and an end-FY22 net loan to value ratio (LTV) of c 40%.

In the following section we discuss the maturity and unwind of the JV in the first half of calendar 2023 (H223). Until then we assume no further capital deployment from the existing capital base, although since its initial public offering (IPO) it has shown a consistent ability to identify attractive assets and access the equity and debt capital required to fund their acquisition.

Upon receipt of the JV proceeds we assume a further £300m (before costs) of re-deployment, also at a 4.5% net initial yield, in early FY24. This is consistent with a net LTV of c 40% and, we estimate, will require additional debt funding of at least c £125m.

Joint venture generating strong underlying returns with capital value potential to be unlocked

SUPR’s 50:50 joint venture with British Airways Pension Fund has a 51% beneficial interest in a portfolio of 26 high-quality supermarket stores (‘the Sainsbury’s Reversion Portfolio’), let to Sainsbury’s, and valued at £932.5m at 30 June 2021. The reversion portfolio was created through two sale and leaseback transactions (Highbury Finance and Dragon Finance) in 2000 by Sainsbury’s, which has a 49% beneficial interest in the portfolio, occupies the stores and pays all the rents under the current occupational leases, which expire in March 2023 and June 2023. SUPR’s indirect beneficial interest in the portfolio was acquired in two tranches, at a discount to book value, representing an investment of £108.5m (before costs) and was valued at £130.3m at 30 June (end-FY21). The investment generates a strong recurring return for SUPR (before valuation movements) of c £12.6m pa, a c 11% return on its investment. It also provided SUPR with potential access to a valuable pipeline of assets or the opportunity to benefit from lease renewal or, as now seems to be the case, the sale of the assets at a premium to book value.

Impending lease expiry will unlock value

In September, SUPR announced that Sainsbury’s has exercised a purchase option to acquire 13 of the 26 freehold stores., which will be completed in March 2023 on expiry of the current occupational leases. The price that Sainsbury’s will pay to acquire the stores will be based on the market value of an assumed new 20-year lease to Sainsbury's with the initial rent set at the higher of passing or open market, subject to upward-only, five-yearly market rent reviews. We expect this to be well above the 30 June valuation and to generate an uplift in the value of SUPR’s investment and its NAV. In addition, Sainsbury's has a remaining purchase option to acquire a further 10 stores in the reversion portfolio, which it can be exercise between December 2021 and January 2022, for completion in June 2023. We expect Sainsbury’s will exercise its purchase option over most of these stores with a further uplift in the value of SUPR’s investment.

Sainsbury’s will continue to pay rent until completion, and SUPR’s beneficial interest will continue to generate recurring returns, although we expect an uplift in valuation and SUPR’s NAV as Sainsbury’s exercises its options (with the exercise over 13 stores benefiting SUPR’s H122 NAV).

Where Sainsbury’s does not elect to repurchase the stores, we expect they will be sold, although some may continue to be leased by Sainsbury’s.

Exhibit 1: Schedule of option terms

Two securitisations

Highbury Finance

Dragon Finance

Current lease expiry date

Mar-23

Jun-23

Sainsbury's option to purchase or regear

Aug 21-Sept 21

Dec 21-Jan 22

Option price setting date

Mar-22

Jun-22

Option completion date

Mar-23

Jun-23

Source: Supermarket Income REIT

The valuation of the stores will reflect their quality and assumed long lease length

The price that Sainsbury’s will pay for the stores that it acquires will reflect their quality of the stores and the assumption of a long lease length (20 years) with upwards only reviews. At 30 June 2021 the valuation of the stores, with modest remaining lease length, reflected a net initial yield of 5.3% whereas current market transaction activity suggests a level of c 4.5%.

The quality and trading performance of the portfolio is indicated by the fact that it represents c 4% of the total Sainsbury’s estate (by floorspace) but generates c 7% of annual sales. Of the 26 stores, 23 are omnichannel, offering physical shopping, click and collect and online home delivery, and most also incorporate an Argos. The average store net sales area is c 61,000 sq ft with an average gross internal area of approximately 79,000 sq ft. Although geographically diverse, around 60% of the portfolio is in London and the South-East.

Exhibit 2, produced by SUPR, tracks whole of market transaction yields in respect of its target market (more than 10 years remaining lease length with fixed or index-linked rent uplifts). With strong investment demand for supermarket assets, most recently encouraged by the strong performance of the supermarket operators through the pandemic, yields have continued to compress to c 4.5% (and SUPR expects a further compression as discussed below, particularly for the omnichannel stores3 that it targets).

  Combining in store delivery with online transactions, both click and collect and home delivery.

Exhibit 2: Supermarket transaction yields

Source: Supermarket Income REIT

JV unwind offers significantly positive to SUPR NAV

At this stage we do not know to what extent Sainsbury’s may exercise options over the further 10 assets (Dragon Finance) during December 2021 and January 2022. Sainsbury’s exercised its purchase option in respect of 13 of the 16 Highbury Finance assets, or c 80% of the total. This may be a reasonable guide to the Dragon Finance outcome, and we have assumed this in our forecasts (eight of the 10 Dragon Finance stores). Although we believe that all of the assets are of good quality, we presume that Sainsbury’s will in fact ‘cherry pick’ the assets to acquire (although it will undoubtedly have other considerations) and we therefore attach a higher net initial yield to the assets not acquired. Our central assumption is that the assets acquired by Sainsbury’s are at a valuation that reflects a 4.5% net initial yield and, perhaps conservatively, attach a higher 6.0% yield to the other assets. This implies an increase in the overall reversion portfolio property assets from the 30 June value of £932.5m to £1,045.5m, or 12%, reflecting a blended net initial yield of 4.7%.

Exhibit 3: Our reversion portfolio revaluation assumptions

30 June 2021

Purchase option exercised

Purchase option not exercised

Total

Number of assets

26

21

5

26

Valuation net of buyers' costs

932.5

887.1

158.4

1,045.5

Buyers' costs

56.2

53.4

9.5

63.0

Buyers' costs (%)

6.0%

6.0%

6.0%

6.0%

Market valuation

988.7

940.5

167.9

1108.5

Annualised rents

52.4

42.3

10.1

52.4

Net initial yield

5.3%

4.5%

6.0%

5.0%

Source: Supermarket Income REIT data as at 30 June 2021, Edison Investment Research projections

In Exhibit 4 we illustrate the sensitivity of the reversion portfolio valuation and SUPR EPRA net tangible assets (NTA) to alternative assumptions for the net initial yield of the assets where we assume Sainsbury’s to exercise its purchase option as assumed in Exhibit 3. We show this in relation to end-FY21 EPRA NTA as our FY22 forecast already includes a valuation uplift based on a net initial yield of 4.5 % (for these assets only). Including recurring income up to mid-2023, which is not received in cash by SUPR but is recognised in the value of its investment, we forecast a closing value for the JV investment of £180.3m by June 2023 (end-FY23), received in cash as the JV is unwound, and reinvested early in FY24.

Exhibit 4: Sensitivity to the net initial yield assumption applied only to those assets where the purchase option is exercised.

£m unless stated otherwise

30 June 2021 (end-FY21)

4.0% NIY

4.5% NIY

5.00% NIY

Total portfolio valuation

932.5

1,156.4

1,045.5

956.8

Total portfolio blended net initial yield

5.3%

4.3%

4.7%

5.2%

Rent receivable

29.6

29.6

29.6

29.6

Bonds notional value

(372.6)

(372.6)

(372.6)

(372.6)

Interest accruals & other liabilities

(71.8)

(71.8)

(71.8)

(71.8)

Book value

517.7

741.6

630.7

542.0

SUPR share of net assets

130.3

189.1

160.8

138.2

Uplift in JV interest

58.8

30.5

7.9

SUPR EPRA NTA

871.8

930.6

902.3

879.7

Uplift in SUPR EPRA NTA

7%

4%

1%

Source: Edison Investment Research

Low cost of capital supports acquisitions despite asset yield compression

Although asset yields have compressed since SUPR’s IPO, SUPR has continued to identify attractive acquisition opportunities, supported by a low cost of capital. The FY22e DPS of 5.94p represents a 5.2% yield on the 115p issue price for the September equity raise, while the average running cost of its debt facilities is 1.8%. Although most of the debt is floating rate more than 60% is hedged. However, over time we would expect SUPR to seek longer-term and fixed-rate funding. The company has grown to a scale where, combined with stable, predominantly indexed-linked rental income and strong tenant covenants, access to the unsecured sterling bond market is a real possibility. In current market conditions we would expect the bond market to provide longer maturity debt at a similar overall cost. Moreover, an unsecured bond funding platform should provide increased funding flexibility than is the case with secured debt.

Since IPO, SUPR has targeted a medium-term LTV of 30–40% but we expect it to operate towards the top of this range reflecting the increased scale and diversification of the portfolio as well as the improving financial position of tenants. Based on an LTV of 40%, the equity raising dividend yield and current cost of debt imply a blended capital cost of c 3.8%. Including investment adviser fees at a marginal rate of 0.65% of NAV we estimate a ‘break-even’ acquisition yield of 4.3%, which continues to provide a margin for SUPR to grow without diluting dividend cover. We would not expect SUPR to strictly benchmark every transaction against the ‘break-even’ level as its investment strategy seeks to balance risks and returns across the portfolio, seeking a spread of counterparties, assets and lease terms. While long leases provide income visibility, shorter leases may provide enhanced returns, blending a higher immediate yield with asset management opportunities to regear (extend) the lease. On a limited number scale, we would expect SUPR to acquire additional assets subject to open market rent reviews where the investment case is strong. We assume a net initial yield of 4.5% on future acquisitions.

Active debt management in tandem with equity raising

Active debt financing during FY21 and continuing into FY22 includes new facilities with Barclays/Royal Bank of Canada and Wells Fargo and extensions to facilities with HSBC and DekaBank. The increase in debt capacity has been achieved at a slight reduction in SUPR’s already low cost of debt. At the end of June 2021 (end-FY21), SUPR had total secured debt facilities of £514m plus a further £100m accordion option to extend its £60m revolving credit facility (RCF) with Wells Fargo, of which £413m had been drawn. In September it announced an increase of £20m in its term loan facility with DekaBank, a £10m increase in its HSBC RCF, and the exercise of £61.3m of the £100m accordion option attaching to the Wells Fargo RCF (£39m remains undrawn and exercisable at any time).

Including undrawn accordion options, total facilities now amount to £644m, of which £515m had been drawn as at 23 September 2021 with £129m remaining undrawn. Our capital deployment forecasts assume the facilities are drawn in total by end-FY22.

Exhibit 5: Summary of debt facilities

Lender

Facility size

Interest cost

Maturity

Term to expiry

Bayern LB

£52m

2.56%

Jul-23

2 years

HSBC

£150m

1.74%

Aug-23

2 years

Bayern LB

£35m

2.02%

Aug-25

4 years

Barclays/RBC

£150m*

1.55%

Jan-26

4 years

Wells Fargo

£100m**

1.45%

Jul-26

5 years***

DekaBank

£97m

1.95%

Sep-26

5 years****

Wells Fargo

£60m

2.19%

Jul-27

6 years*****

Total facilities

£644m

1.80%

4 years

Source: Supermarket Income REIT as at 23 September 2021. Note: *Includes £36.2m undrawn accordion facility. **Includes £38.7m undrawn accordion facility. ***2 years plus 3 one-year extension options. ****3 years plus 2 one-year extension options. *****4 years plus 2 one-year extension options.

The interest rates on Bayern LB and Dekabank facilities are fixed at attractively low levels and SUPR operates a hedging strategy designed to mitigate the impact of any significant rise in interest rates that would impact the floating rate debt4, including tighter monetary policy to combat inflationary pressures. Approximately 55% of end-FY21 drawn borrowings were fixed or hedged, in line with the 55%-60% that SUPR is managing to. Of the expanded total debt facilities c 40% are currently fixed or hedged. The average running cost of the group’s total debt facilities of c 1.8% includes the cost of this hedging.

  £63.5m of the HSBC facility is capped at 3.35% until expiry. The BayernLB and DekaBank facilities are fixed, at the rates shown in Exhibit 5, until expiry.

Good potential for further yield compression

As Exhibit 2 shows, market acquisition yields for the assets that SUPR targets have compressed from c 5–6% at IPO to c 4.5% currently, and this has been reflected in the valuation of SUPR’s portfolio5 and NAV. In FY21, like-for-like portfolio valuation growth was 8.5% with 4.1% growth in the valuation of assets acquired during the year.

SUPR’s directly owned portfolio net initial yield at end-FY21 was 4.6%.

SUPR’s investment adviser sees a strong potential for further yield tightening. As we discuss elsewhere, this would be positive for NAV growth but reduces the income benefit of continued growth. We do not expect SUPR to chase non-accretive growth and, if acquisition yields compress beyond a certain level, we would expect SUPR to curtail investment. We do not forecast yield changes but estimate that a 10 basis point compression of the net initial yield of SUPR’s wholly owned supermarket portfolio (as at end-FY21) would add c 2.7p or c 2.5% to NAV per share.

Yield compression has been driven by strong investment demand for the secure income that supermarket assets provide, with those that have inflation linked or fixed uplift rents (as opposed to those with rents reviewed on an open market basis) providing good visibility of income growth. In addition to SUPR, significant investors such as Realty Income, a large US REIT, have been active in the market, while Tesco has also been active in repurchasing assets as an alternative to leasing. There is no sign of a let up in investment activity and SUPR’s investment adviser notes that while asset yields have compressed the spread versus operator/tenant unsecured debt yields have actually widened. Even before the pandemic boost to sales, the big four operators, led by Tesco, had been progressively improving cash flow generation through cost reduction programmes and enhancing balance sheet strength through sustained debt reductions. The continuing improvement in financial strength and prospects has contributed to a greater tightening in unsecured bond yields6 than has been the case for supermarket property yields. As an indicator of tenant covenant strength, the investment adviser anticipates that property yields will follow.

  The yield of the Tesco 5.5% January 2033 bond was c 2.3% in June 2021 compared with c 2.7% in June 2020.

Forecast update

Full-year results to 30 June 2021 (FY21) were published on 23 September. Between the FY21 year end and publication of the results, significant acquisition activity had already taken place and SUPR has subsequently raised £200m (gross) of equity. We provide an overview of the FY21 results at the back of this report but focus in this section on our forecasts. It is worth mentioning that the ‘core’ FY21 results were very much in line with our forecasts, but our EPRA earnings forecast incorrectly included £3.3m of negative goodwill (a positive income statement item). Adjusting for this, rental income, EPRA earnings and EPS, and DPS were all as we expected, while property valuation gains and EPRA NTA per share were well ahead of our expectations (Exhibit 6).

We have updated our FY22 and FY23 forecasts, primarily to reflect the equity raise and our expectations for its geared deployment. We have extended our forecasts to FY25 to capture the impact of the FY23 JV unwinding and reinvestment of the proceeds on a geared basis (we assume in early FY24) on a full-year basis (the first full-year contribution being in FY25).

Key forecasting assumptions

As detailed above, we have included the three transactions announced since the equity raise, amounting to c £149m (before costs) and assume the following further acquisition investment, all at a 4.5% net initial yield:

£150m (before costs) by end-H122, deploying the equity raise proceeds on a geared basis.

£300m (before costs) during early FY24, reinvesting the c £182m proceeds from the unwinding of the JV on a geared basis.

Our other key assumptions include:

Inflation indexed rent uplifts of c 3% pa in FY22 and c 2.5% pa thereafter. It appears this may be a conservative assumption, but it allows for a smaller uplift from the c 11% of rents that are reviewed on an open-market basis.

JV recurring (non-cash) earnings until H223 and valuation uplifts as detailed in Exhibit 3. At that time the JV will be unwound and the value of SUPR’s interest in it will be returned in cash.

Investment adviser feed in line with the agreed schedule, at marginal rate of 0.65% pa on net assets of more than £1,000m. We expect a further step-up in other administrative expenses to reflect the increased size of the business but then to increase broadly in line with inflation.

Finance expense follows the increases in borrowing detailed above, with a very slight pick-up in the average cost of borrowing from FY24 allowing for a slightly higher cost of debt on the assumed additional £125m of borrowing facilities, which we expect may be longer duration and fixed rate.

For the wholly owned portfolio, we assume valuation growth in line with rental growth. For clarity, we have not assumed gains from further yield compression.

A summary of our forecasts is shown in Exhibit 6. While we forecast further strong growth in rental income and EPRA earnings, our EPRA EPS forecasts for FY22 and FY23 are reduced. This reflects:

The increased number of shares outstanding.

Tighter yields on acquisition, reflecting market valuation movements.

Slower capital deployment than we expected in H221, although this has caught up in FY22.

We nonetheless continue to expect DPS growth in line with our inflation assumptions and for this to be well covered (c 1.1x) by EPRA earnings.

Exhibit 6: Performance versus expectations and forecast revisions

Net rental income (£m)

EPRA earnings (£m)

EPRA EPS (p)

EPRA NTA/share (p)

DPS (p)

Actual

F'cast

Diff.

Actual

F'cast

Diff.

Actual

F'cast

Diff.

Actual

F'cast

Diff.

Actual

F'cast

Diff.

06/21

47.9

47.6

1%

36.8

40.5

-9%

5.6

6.2

-9%

108

103

5%

5.86

5.86

0%

New

Old

Chg.

New

Old

Chg.

New

Old

Chg.

New

Old

Chg.

New

Old

Chg.

06/22e

70.7

68.9

3%

57.5

58.3

-1%

6.2

7.2

-14%

113

106

7%

5.94

5.98

-1%

06/23e

81.8

71.7

14%

64.8

59.9

8%

6.6

7.4

-11%

118

110

7%

6.10

6.10

0%

06/24e

95.7

N/A

N/A

66.0

N/A

N/A

6.7

N/A

N/A

121

N/A

N/A

6.25

N/A

N/A

06/25e

100.3

N/A

N/A

69.4

N/A

N/A

7.0

N/A

N/A

126

N/A

N/A

6.41

N/A

N/A

Source: Supermarket Income REIT historical data, Edison Investment Research forecasts

Returns and valuation

The 7–10% NAV total return targeted by SUPR is the product of rental income increasing with RPI, supporting dividend growth and, to the extent that property valuation yields do not change, NAV growth. Targeted returns also assume a benefit from gearing, which the company expects to be 30–40% over the medium term and once the portfolio growth phase moderates.

SUPR has performed strongly since IPO, consistently deploying capital resources swiftly to reduce cash drag, acquiring well-performing assets and benefiting from increased scale and diversification. Total accounting return (the change in EPRA NAV plus dividends paid) has steadily increased, reaching 12.1% in FY21, taking the cumulative total since IPO to 33.0% (dividends paid added back but not reinvested) or a compound 7.5% pa. Returns would be higher if adjusted for the c 7.1p per share of acquisition costs incurred in building the portfolio since IPO. Dividends have been increased in line with inflation each year and represent two-thirds of the total return since IPO.

Our forecasts indicate a continuation of returns in line with recent experience and the company’s target range, reaching the top of that range by FY25 as scale builds further and assuming no acquisition costs in the year nor any further compression of valuation yields. Yield compression, for which there are positive indicators, would have a positive impact on our forecast returns.

Exhibit 7: EPRA NYA total return (accounting total return)

FY18*

FY19

FY20

FY21

IPO to end-FY21

FY22e

FY23e

FY24e

FY25e

Opening NAV per share (p)

97

96

97

101

97

108

113

118

121

Closing NAV per share (p)

96

97

101

108

108

113

118

121

126

DPS paid (p)

4.1

5.6

5.8

5.9

21.3

5.9

6.1

6.2

6.4

NAV total return

3.4%

6.6%

10.7%

12.1%

33.0%

10.8%

9.2%

7.8%

9.8%

Average annual compound return

3.4%

6.6%

10.7%

12.1%

7.5%

Source: Supermarket Income REIT data, Edison Investment Research. Note: *Adjusted for IPO issuance costs.

Based on the company’s FY22 target aggregate DPS of 5.94p the prospective yield is 4.9%. The share price premium to end-FY21 EPRA NTA per share is 1.13x.

In Exhibit 8 we show a comparison of SUPR with a group of other property companies that focus on income returns derived from long leases. Within the group, valuations and performance over the past year partly reflect investor perceptions of the strength of the tenant covenant. For example, the primary healthcare investors (Assura, PHP), where rents are paid directly to the companies by government or indirectly via GP reimbursement, have below-average yields and above-average P/NAV ratios. Compared with the group average, SUPR has a slightly higher yield and slightly higher P/NAV ratio. Its predominantly RPI-linked rent growth provides investors with considerable visibility of income with protection against inflation, while the strength of its tenant covenant has been successfully tested and even enhanced during the pandemic, suggesting the potential for further supermarket property yield tightening and NAV growth above our forecasts.

Exhibit 8: Valuation and performance summary of long-lease REITS

Price (p)

Market cap. (£m)

P/NAV* (x)

Trailing yield** (%)

Target yield ***

Share price performance

1 month

3 months

12 months

From 12M high

Assura

69

2032

1.21

4.2

4.2

-2%

-9%

-5%

-15%

Impact Healthcare

119

417

1.06

5.4

5.4

0%

0%

9%

-3%

Civitas Social Housing

97

600

0.90

5.6

5.7

6%

4%

-6%

-20%

Lxi REIT

146

1022

1.08

4.0

0.0

0%

1%

25%

-6%

Primary Health Properties

152

2027

1.32

4.1

4.1

1%

-7%

7%

-11%

Secure Income

397

1285

1.01

3.8

N/A

-2%

-2%

35%

-7%

Target Healthcare

116

744

1.05

5.8

5.8

-2%

-3%

3%

-8%

Triple Point Social Housing

98

394

0.92

5.3

5.3

2%

-4%

-8%

-14%

Tritax Big Box

239

4457

1.23

2.7

N/A

3%

2%

53%

-3%

Average

1.09

4.5

4.4

1%

-2%

13%

-9%

Supermarket Income

121

1192

1.12

4.9

4.9

2%

2%

15%

-3%

UK property sector index

1,961

2%

3%

26%

-2%

UK equity market index

4,147

-1%

2%

13%

-2%

Source: Company data, Refinitiv. Note: Priced at 10 December 2021. *Based on last reported EPRA NAV/NTA. **Based on last 12 months DPS declared. ***Based on current financial year company DPS target.

Brief review of FY21 financial performance

Exhibit 9 summarises the reported FY21 financial performance although, as noted above, SUPR had already completed a significant number of acquisitions before the results were announced. To illustrate the impact the FY21 acquisitions would have had on a full-year basis along with the post-FY21 acquisition contribution, SUPR provided pro-forma 12-month results. We first review the reported FY21 results, which demonstrate strong ongoing growth and scale efficiencies and then the pro-forma position.

Exhibit 9: Summary of FY21 financial performance

£m unless stated otherwise

FY21

FY20

FY21/FY20

H121

Total net rental income

47.9

26.4

83%

20.4

Administrative & other expenses

(9.3)

(5.2)

79%

(4.1)

Operating profit before investment property change in fair value

38.7

21.2

84%

16.3

Net finance expense

(8.5)

(4.9)

74%

(3.7)

Share of income from joint venture (exc. revaluation gains)

6.6

0.5

2.9

EPRA earnings

36.8

16.8

121%

15.5

Negative goodwill

3.3

3.0

0.0

Change in fair value of investment properties

36.3

13.1

15.5

Change in fair value of investment properties within JV

5.6

0.0

2.0

IFRS earnings

82.0

32.8

151%

33.0

Period end number of shares

810.7

473.6

71%

665.9

Average number of shares

652.8

334.2

95%

561.4

Basic & diluted IFRS EPS (p)

12.6

9.8

5.9

EPRA & diluted EPS (p)

5.7

5.0

13%

2.8

DPS (p)

5.86

5.80

1%

2.93

EPRA basis dividend cover (x)

1.04

0.84

1.12

EPRA cost ratio

16.8%

19.2%

 

N/A

Gross assets

1,302.6

617.5

1,011.6

Investment properties

1,148.4

539.4

885.3

Net assets

871.3

477.2

691.8

EPRA NTA per share (p)

108

101

104

EPRA NTA total return

12.1%

10.7%

5.9%

Net balance sheet debt

(390.1)

(106.4)

(239.2)

Loan to value ratio (LTV)

34.0%

19.7%

27.0%

Source: Supermarket Income REIT

In brief we highlight:

Strong growth (+83%) in rental income, primarily reflecting acquisitions but also predominantly (89%) inflation indexed and fixed uplifts. The annualised level of rents at the end of the year was £60m.

A more than doubling of EPRA earnings (+121%) with economies of scale reflected in a decline in the EPRA cost ratio from 19.2% to 16.8%.

The number of shares increased by 71% and the average number (increased by FY20 issuance) by 95%.

EPRA EPS increased by 13% to 5.7p and covered DPS 1.04x (FY20 (0.84x).

DPS growth from 5.80p to 5.86p reflected modest levels of inflation and inflation indexing of rents earlier in the year. Both have since accelerated.

Significant uplift on pro-forma basis

Acquisitions completed since FY21 and rent reviews subsequently completed have increased annualised rents from £60m to £64.9m. These are included the pro-forma results shown in Exhibit 10 on a full-year basis. Interest expense also assumes a full-year impact of debt drawn during FY21 and subsequently to fund post-FY21 acquisitions. The cost of dividends reflects the end-FY21 number of shares and FY21 DPS on a full-year basis. EPRA EPS increases by 25% and EPRA dividend cover to 1.20x. This does not represent the actual FY22 result that may be expected as it does not include the effects of the September equity raise and future equity and debt deployment.

Exhibit 10: Pro-forma income statement

£m unless stated otherwise

FY21 reported

FY20 reported

12 months pro-forma

Net rental income

48.0

26.4

64.9

Net rental income

6.6

0.5

12.3

Share of income from joint venture (exc. revaluation gains)

(9.3)

(5.2)

(10.3)

Administrative expenses

(8.5)

(4.9)

(9.9)

EPRA earnings

36.8

16.8

57.0

EPRA EPS (p)

5.6

5.0

7.0

Dividends paid

35.5

20.0

47.5

EPRA dividend cover (x)

1.04

0.84

1.20

Source: Supermarket Income REIT

Exhibit 11: Financial summary

Year ended 30 June

2018

2019

2020

2021

2022e

2023e

2024e

2025e

£000s

 

 

 

 

INCOME STATEMENT

 

 

 

 

Rent receivable

8.5

16.9

25.5

46.2

68.6

79.8

93.7

98.3

Rent smoothing adjustment

0.5

0.4

0.9

2.0

2.1

2.0

2.0

2.0

Net service charge expense

0.0

0.0

0.0

(0.2)

0.0

0.0

0.0

0.0

Total rental income

8.9

17.2

26.4

47.9

70.7

81.8

95.7

100.3

Administrative & other expenses

(2.1)

(3.1)

(5.2)

(9.3)

(13.7)

(14.5)

(14.8)

(15.3)

Operating profit before investment property change in fair value

6.8

14.1

21.2

38.7

57.0

67.3

80.8

84.9

Change in fair value of investment properties

(4.1)

0.6

13.1

36.3

16.4

37.8

24.5

47.4

Share of profit of jv

0.0

0.0

0.5

15.5

39.4

10.6

0.0

0.0

Negative goodwill

0.0

0.0

3.0

0.0

0.0

0.0

0.0

0.0

Operating profit/(loss)

2.8

14.8

37.7

90.5

112.8

115.6

105.3

132.4

Net finance expense

(1.9)

(4.2)

(4.9)

(8.5)

(12.0)

(13.1)

(14.8)

(15.6)

Profit/(loss) before tax

0.8

10.6

32.8

82.0

100.8

102.5

90.5

116.8

Tax

(0.2)

(0.0)

0.0

0.0

0.0

0.0

0.0

0.0

Profit/(loss) for the period

0.6

10.6

32.8

82.0

100.8

102.5

90.5

116.8

Adjust for:

Changes in fair value of investment property

4.1

(0.6)

(13.1)

(36.3)

(16.4)

(37.8)

(24.5)

(47.4)

Share of changes in fair value of JV investment property

(5.6)

(26.9)

0.0

0.0

0.0

Negative goodwill

0.0

0.0

(3.0)

(3.3)

0.0

0.0

0.0

0.0

EPRA earnings

4.7

9.9

16.8

36.8

57.5

64.8

66.0

69.4

Share of profit of JV

0

0

(0)

(7)

(13)

(11)

0

0

Adjusted earnings

5

10

16

30

45

54

66

69

EPRA cost ratio inc. direct vacancy costs

23.5%

17.9%

19.2%

16.9%

17.3%

16.1%

15.5%

15.3%

Closing number of shares (m)

184.4

239.8

473.6

810.7

984.9

984.9

984.9

984.9

Average number of shares in issue (m)

124.2

198.1

334.2

652.8

931.0

984.9

984.9

984.9

IFRS EPS (p)

0.5

5.3

9.8

12.6

10.8

10.4

9.2

11.9

EPRA EPS (p)

3.8

5.0

5.0

5.6

6.2

6.6

6.7

7.0

Adj EPS (p)

3.8

5.0

4.9

4.6

4.8

5.5

6.7

7.0

DPS declared (p)

5.50

5.63

5.80

5.86

5.94

6.10

6.25

6.41

EPRA earnings/dividends paid

103%

92%

84%

104%

109%

109%

108%

111%

Adj. earnings/dividends paid

103%

92%

81%

85.0%

85%

91%

108%

111%

EPRA NTA total return

6.6%

10.7%

12.1%

10.8%

9.2%

7.8%

9.8%

BALANCE SHEET

Investment property

264.9

368.2

539.4

1,148.4

1,580.2

1,620.0

1,964.5

2,013.9

Associate

0.0

0.0

56.1

130.3

169.7

0.0

0.0

0.0

Other non-current assets

0.0

0.0

56.1

131.3

169.9

0.2

0.2

0.2

Total non-current assets

264.9

368.2

595.5

1,279.7

1,750.2

1,620.2

1,964.7

2,014.1

Trade & other receivables

1.0

3.5

1.7

3.1

3.8

4.1

4.9

5.0

Cash & equivalents

2.2

9.9

20.4

19.6

22.4

196.7

8.6

14.5

Other current assets

0.0

0.0

(0.0)

0.2

0.2

0.2

0.2

0.2

Total current assets

3.3

13.4

22.1

23.0

26.4

201.0

13.8

19.7

Deferred rental income

(1.7)

(3.5)

(5.2)

(12.1)

(12.1)

(12.1)

(12.1)

(12.1)

Current tax liabilities

(0.2)

(0.2)

0.0

0.0

0.0

0.0

0.0

0.0

Trade &other payables

(1.5)

(2.6)

(6.4)

(8.4)

(9.1)

(9.9)

(11.8)

(12.1)

Total current liabilities

(3.4)

(6.4)

(11.6)

(20.4)

(21.1)

(21.9)

(23.9)

(24.2)

Bank borrowings

(88.1)

(143.7)

(126.8)

(409.7)

(640.7)

(641.7)

(767.7)

(768.7)

Interest rate derivatives

0.0

(1.1)

(2.0)

(1.2)

(0.5)

(0.5)

(0.5)

(0.6)

Total non-current liabilities

(88.1)

(144.8)

(128.8)

(410.9)

(641.2)

(642.2)

(768.2)

(769.2)

Net assets

176.7

230.5

477.2

871.3

1,114.3

1,157.1

1,186.4

1,240.5

IFRS NAV per share (p)

96

96

101

107

113

117

120

126

EPRA NTA per share (p)

96

97

101

108

113

118

121

126

CASH FLOW

Net cash from operations

8.1

13.9

26.9

42.8

55.0

65.7

80.0

83.1

Acquisition & investment in investment property

(268.7)

(91.1)

(157.3)

(570.0)

(413.4)

0.0

(318.0)

0.0

Investment in associate

0.0

0.0

(52.6)

(58.7)

0.0

180.3

0.0

0.0

Other investing activity

0.0

0.0

0.0

(0.9)

0.0

0.0

0.0

0.0

Net cash from investing activity

(268.7)

(91.1)

(209.9)

(629.5)

(413.4)

180.3

(318.0)

0.0

Share issuance (net of costs)

180.9

43.9

234.8

345.6

195.0

0.0

0.0

0.0

Debt drawn/(repaid)

88.8

56.1

(16.2)

284.7

230.0

0.0

125.0

0.0

Interest paid and other financing costs

(2.3)

(4.3)

(5.6)

(9.3)

(11.0)

(12.0)

(13.8)

(14.5)

Dividends paid

(4.6)

(10.9)

(19.6)

(34.9)

(52.8)

(59.7)

(61.2)

(62.7)

Net cash from financing activity

262.8

84.8

193.4

586.0

361.2

(71.7)

50.0

(77.3)

Change in cash

2.2

7.7

10.5

(0.8)

2.8

174.3

(188.0)

5.8

Opening cash

0.0

2.2

9.9

20.4

19.6

22.4

196.7

8.6

Closing cash

2.2

9.9

20.4

19.6

22.4

196.7

8.6

14.5

Debt as per balance sheet

(88.1)

(143.7)

(126.8)

(409.7)

(640.7)

(641.7)

(767.7)

(768.7)

Net debt

(85.9)

(133.8)

(106.4)

(390.1)

(618.3)

(445.0)

(759.1)

(754.2)

LTV

32.4%

36.3%

19.7%

34.0%

39.1%

27.5%

38.6%

37.5%

Source: Supermarket Income REIT historical data, Edison Investment Research forecasts


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Australia

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New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are ‘wholesale clients’ for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a ‘personalised service’ and, to the extent that it contains any financial advice, is intended only as a ‘class service’ provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

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United States

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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