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Research: Real Estate
Supermarket Income REIT (SUPR) reported strong H119 earnings growth on the back of its growing portfolio, contracted RPI-linked rental uplifts, and well-controlled costs. The Q219 DPS was increased by 3.2%, in line with RPI. Rental growth also drove revaluation gains, sufficient to offset property acquisition costs in the period. EPRA NAV total return in the six-month period was 3.1% or an annualised 6.3%.
Supermarket Income REIT |
Visible income and growth potential |
Interim results |
Real estate |
13 February 2019 |
Share price performance
Business description
Next events
Analysts
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Supermarket Income REIT (SUPR) reported strong H119 earnings growth on the back of its growing portfolio, contracted RPI-linked rental uplifts, and well-controlled costs. The Q219 DPS was increased by 3.2%, in line with RPI. Rental growth also drove revaluation gains, sufficient to offset property acquisition costs in the period. EPRA NAV total return in the six-month period was 3.1% or an annualised 6.3%.
Contracted RPI uplifts drive rental and DPS growth
During H119 all key financial metrics increased strongly. The portfolio value reached £320.7m (end-FY18: £264.9m), including the acquisition of a sixth asset for £51.7m. The portfolio annualised passing rent reached £16.5m. All of the properties are on let on long leases (a weighted average unexpired lease term of 19 years) with upwards only RPI-linked rent reviews. The two rent reviews completed in the period (average annual RPI uplifts of 3.2%) generated like-for-like rental growth of 1.6%, driving 1.3% gross revaluation gains, more than sufficient to offset property acquisition costs. A third rent review has since been concluded (also at 3.2%) and others will follow in coming months. With the EPRA cost ratio falling further (to a relatively low 18%), EPRA earnings rose to £4.7m, covering dividends paid by 93%, with the company expecting full or close to full dividend cover for the year. EPRA NAV per share was unchanged at 96p compared with end-FY18.
Targeted investment
SUPR is building a diversified portfolio of UK supermarket assets, with long leases and upwards only RPI-linked rents, let to quality tenant covenants. It predominantly targets omnichannel stores (combining in-store and online fulfilment) that can benefit from both the expected growth of grocery sales and the increasing popularity of online, in strong locations, with asset management potential. The investment adviser brings a high level of experience and knowledge of the sector, and its principals have been involved in more than £4.0bn of supermarket transactions over the past decade. RPI-linked rent uplifts, strong tenant covenants and long lease lengths provide secure income growth prospects and good potential for capital growth.
Valuation: Attractive, growing yield potential
The Q219 DPS of 1.419p annualises at 5.58p, representing a prospective dividend yield of 5.5% with visible potential for growth. A comparison with a narrower group of long income-focused REITs shows that SUPR offers an above-average yield with a similar P/NAV.
Consensus estimates
Year |
Revenue |
EPRA EPS* |
EPRA NAV/ |
DPS |
P/NAV |
Yield |
06/18 |
8.9 |
3.8 |
96 |
5.50 |
1.06 |
5.4 |
06/19e |
16.3 |
5.4 |
99 |
5.63 |
1.04 |
5.5 |
06/20e |
17.3 |
5.9 |
104 |
5.75 |
0.99 |
5.6 |
|
Source: Supermarket Income REIT data, Consensus data calculated from Stifel and Goodbody estimates. Note: *EPRA EPS is normalised, excluding gains on revaluation. |
||||||
Visible income and growth potential
Supermarket Income REIT, which is listed on the special funds segment of the London Stock Exchange, invests in a diversified portfolio of supermarket property, let to leading UK supermarket operators on long, RPI-linked leases. The investment objective is to provide an attractive level of income, with the potential for capital growth and a 7–10% pa total shareholder return target over the medium term. The long, indexed-linked leases that SUPR targets provide a high degree of visibility to contractual income streams, and strong income returns for supermarket property have underpinned a long record of positive total returns, making this a relatively low-risk segment of the UK commercial property market. The company has an independent board of non-executive directors and has appointed Atrato Capital as investment adviser. The Atrato management team brings a very high level of experience and knowledge of the UK real estate sector, having advised on, structured and executed more than £4.0bn of supermarket transactions over the past decade.
Exhibit 1: Summary of H119 results
£000's unless stated otherwise |
H119 |
H118 |
H119/H118 |
FY18 |
Rental income |
8,293 |
3,151 |
163% |
8,942 |
Administrative & other expenses |
(1,517) |
(965) |
57% |
(2,097) |
REIT expense ratio |
18% |
31% |
23% |
|
Operating profit before investment property change in fair value |
6,776 |
2,186 |
210% |
6,845 |
Net finance expense |
(2,057) |
(649) |
217% |
(1,917) |
EPRA PBT |
4,719 |
1,537 |
207% |
4,928 |
Tax |
0 |
(231) |
(227) |
|
EPRA earnings |
4,719 |
1,306 |
261% |
4,701 |
Change in fair value of investment property |
792 |
(4,859) |
(4,081) |
|
IFRS earnings |
5,510 |
(3,553) |
620 |
|
EPRA EPS |
2.6 |
1.2 |
107% |
3.8 |
DPS declared (p) |
2.7940 |
2.7500 |
2% |
5.5000 |
EPRA earnings/total dividends paid |
93% |
95% |
103% |
|
Investment properties (£m) |
320.7 |
207.9 |
54% |
264.9 |
Net debt (£m) |
(137.8) |
(92.6) |
(85.9) |
|
LTV |
43% |
45% |
32% |
|
EPRA NAV per share (p) |
96 |
94 |
3% |
96 |
EPRA NAV total return |
3.1% |
-4.9% |
0.0% |
Source: Supermarket Income REIT
The key financial highlights of the H119 results were:
■
Strong growth in all key financial metrics compared with H118, reflecting the growth in the portfolio since IPO in November 2017. Between IPO and end-H118 SUPR moved quickly to acquire its first four assets with an aggregate rent roll of £10.7m. A fifth asset was added in May 2018, taking the end-FY18 annualised rent roll to £13.6m. The sixth asset was acquired early in H119, in July, making a reasonably full contribution to the period, which saw rental income increase materially year-on-year to £8.3m (from £3.2m). This asset is the Morrison’s, Hillsborough, Sheffield acquired for £51.7m (before costs), adding £2.54m to the annualised rent roll.
Exhibit 2: Portfolio summary
H119 |
H118 |
FY18 |
|
Number of properties |
6 |
4 |
5 |
Valuation (£m) |
320.7 |
207.9 |
264.9 |
Annualised rent roll (£m) |
16.5 |
10.7 |
13.6 |
Weighted average unexpired lease term (years) |
19 |
18 |
19 |
Net initial yield (%) |
4.9% |
4.9% |
4.9% |
Source: Supermarket Income REIT
■
All of the properties are on let on long leases (a weighted average unexpired lease term of 19 years) with upwards only RPI-linked rent reviews. Annual reviews were completed during H119, covering £6.4m of contracted rents, and were settled with an average uplift of 3.2%, adding c £200k or 1.6% to annualised rent roll. A third review has since been concluded, adding an annual RPI increase of 3.2% to the c £1.5m of contracted rent from March 2019. Two further annual RPI-linked rent reviews will take place during H219 and the sixth asset, on a five-year RPI-linked rent review in October 2019, after the FY19 year-end (see Exhibit 4).
■
The REIT expense ratio declined to 18% (or 17% excluding certain non-recurring expenses) with the main driver of cost growth being the investment manager adviser fees levied at a competitive 0.95% of average net assets. The expense ratio is relatively low within the REIT sector and should decline further with future planned portfolio acquisitions.
■
Net finance expenses increased with borrowings, utilised to part fund portfolio additions. Gross drawn debt increased to £146.9m, with a current average cost of 2.5%. Net debt was £137.8m and the loan to value ratio (LTV) was 43.0%.
■
EPRA earnings increased to £4.7m, similar to that earned in the whole of FY18, and EPRA EPS, taking account of the increased number of shares in issue, increased to 2.6p.
■
The two quarterly dividends declared in H119 amount to 2.794p per share, with the second quarterly DPS increasing by 3.2% as flagged with the FY18 results (an annualised 5.676p per share). The company expects to declare aggregate DPS of 5.632p for FY19 as a whole, barring unforeseen circumstances, with DPS paid during the year amounting to 5.588p. In cash terms, H119 EPRA earnings covered dividends paid by 93% during the period and on the same basis the company expects full or close to full dividend cover for the year.
■
The value of the portfolio increased by £55.8m to £320.7m compared with June 2018 (end-FY18), substantially reflecting the Morrison’s acquisition. Like-for-like revaluation gains of £4.1m, or 1.3%, reflected the underlying rental growth and were sufficient to more than offset acquisition costs. The blended portfolio net initial yield (NIY) was stable at 4.9%. IFRS earnings and NAV benefitted by a net £792k.
Exhibit 3: Gross and revaluation gains
£000's |
H119 |
H118 |
FY18 |
Gross revaluation |
4,050 |
6,360 |
10,360 |
Acquisition costs written off |
(3,071) |
(11,088) |
(14,113) |
Net revaluation |
979 |
(4,728) |
(3,753) |
Rent smoothing adjustment |
(187) |
(131) |
(328) |
Fair value movement recognised in P&L |
792 |
(4,859) |
(4,081) |
Like-for-like revaluation movement |
1.3% |
3.2% |
4.1% |
Source: Supermarket Income REIT
■
With EPRA earnings broadly matching dividends paid, and gross revaluation gains substantially offset by acquisition costs, EPRA NAV per share was unchanged compared with end-FY18 at 96p per share. Including DPS paid, the EPRA NAV total return during the half-year was 3.1% (an annualised 6.3%).
Focused investment policy
Exhibit 4 shows SUPR’s current portfolio in more detail. The key to income growth visibility is the selection of properties with RPI-linked rental uplifts and let on long unexpired lease terms to institutional grade tenants, although this is reinforced by a highly selective investment strategy that additionally focuses on:
■
Supermarkets fulfilling online delivery. With dedicated online only fulfilment centres only really making commercial sense around high population density London, the major operators have built a network of omnichannel stores combining supermarkets (the dominant channel) with online (the fastest growing channel). SUPR expects continued online growth and predominantly targets omnichannel stores.
■
Top trading stores. SUPR targets top performing stores with a strong trading record, identified using the knowledge and experience of the investment adviser.
■
Large flexible sites. A low site cover, with significant non-sales space provides opportunities to benefit from future asset management opportunities and which may offer good potential for alternative use over the longer term.
Exhibit 4: Overview of portfolio as at 31 December 2018
Tenant |
Tesco |
Tesco |
Sainsbury's |
Tesco |
Tesco |
Morrisons |
Location |
Thetford, |
Lime Trees, |
Ashford, Kent |
Cumbernauld, North Lanarkshire |
Gallagher Retail Park, Scunthorpe |
Hillsborough, Sheffield |
Acquisition date |
August 2017 |
August 2017 |
August 2017 |
December 2017 |
May 2018 |
July 2018 |
Purchase price |
£43.2m |
£28.5m |
£79.8m |
£50.0m |
£53.0m |
£51.7m |
Valuation at 31 December 2018 |
£44.2m |
£29.3m |
£84.3m |
£55.0m |
£55.6m |
£52.2m |
Passing rent |
£2.64m |
£1.53m |
£3.93m |
£2.94m |
£2.88m |
£2.53m |
Size (sq ft) |
78,000 |
55,000 |
125,000 |
117,000 |
98,000 |
113,000 |
Net sales area (sq ft) |
47,800 |
30,699 |
71,732 |
69,923 |
64,678 |
58,108 |
Rent review basis |
Annual RPI |
Annual RPI |
Annual RPI |
Annual RPI |
Annual RPI |
5 yearly RPI |
Rent review collar |
4% cap, 0% floor |
4% cap, 0% floor |
3% cap, 1% floor |
5% cap, 0% floor |
5% cap, 0% floor |
4% cap, 0% floor |
Next rent review |
December 2019 |
March 2019 |
September 2019 |
March 2019 |
March 2019 |
October 2019 |
Lease expiry |
December 2029 |
March 2031 |
September 2038 |
August 2040 |
August 2040 |
October 2039 |
Source: Supermarket Income REIT
The investment adviser estimates that from a pool of c £20bn of supermarket properties that are not owned directly by operators, c £10bn meet SUPR’s strict selection criteria aimed at assets that can deliver sustainable value in a shifting retail environment. SUPR believes that a portfolio value of c £1bn is a reasonable objective over the long term, or a c 10% share of its target asset pool, compared with c £320m currently.
Contractual RPI rent increases provide visibility
To better illustrate the potential impact of contractual RPI rent uplifts on rental income growth, SUPR has provided the data in Exhibit 5, which assumes an annual RPI change of 3.2%. Obviously RPI may differ from this level, but we believe this to be a reasonable assumption and consistent with current experience. In practice, there is a ceiling to the earnings benefit represented by the rent review caps on uplifts, of up to 5%.
With the illustrated growth in rents, the yield on property purchase values also increases. However, if we assume no change in property valuation yields, the external market valuations of the properties would be expected to increase further. We estimate that applying an unchanged 4.9% valuation yield to the illustrated FY23 rental income would add c £50m to the portfolio valuation, or c 27p per share.
|
Exhibit 5: Illustrated impact of contracted RPI uplifts on rental growth |
|
|
Source: Supermarket Income REIT. Note: *Assumed annual RPI uplift of 3.2%. Company illustration only and RPI may differ from this assumption. |
There is potential for yields to positively tighten
In addition to the potential for property valuations to increase with rental growth at unchanged yields, the investment adviser highlights the scope for supermarket property yields to reduce, relative to other classes of commercial property potentially in absolute terms, which would have a positive effect on supermarket property valuations.
Supermarket property has historically been priced at yields below the UK all-property sector; however, this has not been the case since c 2015 (see Exhibit 6). Supermarket property yields have increased in recent years, even as the broader UK commercial property market and the distribution warehouse subsector has seen yields decline. The period of yield widening for supermarket property obviously corresponds to a period of intense competition among the supermarket operators, against a background of continuing growth in online retail and its transformational impact on traditional retail distribution. However, unlike some of the pressures being felt elsewhere in the retail sector, UK consumer spending on grocery products has grown each year since 1999 and is forecast by IGD Retail Analysis to grow by a further 15% over the next five years, from £190bn in 2018 to £218bn in 2023. All of the major operators are currently seeing sales growth even if the discounters continue to grow fastest, helped by new store openings. The robustness of the food retail sector can be seen in a share price comparison with general retailers and the FTSE100 in Exhibit 7.
|
Exhibit 6: Supermarket property net initial yields |
Exhibit 7: Food retail outperforming |
|
|
|
Source: Supermarket Income REIT, MSCI |
Source: Bloomberg. Prices at 11 February 2019 |
|
Exhibit 6: Supermarket property net initial yields |
|
|
Source: Supermarket Income REIT, MSCI |
|
Exhibit 7: Food retail outperforming |
|
|
Source: Bloomberg. Prices at 11 February 2019 |
Reinforcing this more positive view on the covenant strength provided by the supermarket operators is the recent upgrade of the Fitch rating of Tesco to investment grade and the investment adviser expects that if the proposed acquisition of Asda by Sainsbury goes ahead, all of the main operator/tenants are likely to be rated as such. The investment manager views the acquisition, currently the subject of a Competition and Markets Authority enquiry, as a positive development, and believes that consolidation within the operator sector has the potential to further support tenant covenants. It does not anticipate any competition issues with its Sainsbury’s Ashford store, and given that Sainsbury’s and Asda will continue to target a different customer segment, the combined group is expected to retain stores from both brands wherever possible.
Financials 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. We would also expect SUPR to target further acquisitions, funded by a mix of new debt and equity funding. Edison does not produce forecasts for SUPR but its outlook, without acquisitions, is reflected in the current market consensus expectation for SUPR as shown in Exhibit 8.
Exhibit 8: Consensus forecast summary
Year to 30 June (£m unless otherwise stated) |
2018 |
2019e |
2020e |
Revenue/rental income |
8.9 |
16.3 |
17.3 |
EPRA EPS (p) |
3.8 |
5.4 |
5.9 |
DPS declared (P) |
5.50 |
5.63 |
5.75 |
EPRA NAV per share (p) |
96 |
99 |
104 |
Source: Company data. Consensus data calculated from Stifel and Goodbody estimates.
SUPR is one of a group of companies within the broad property sector that focuses on income returns derived from long leases. As can be seen in Exhibit 9, this group
of companies has outperformed the broader property sector as well as the FTSE All-Share Index over the past 12 months which we attribute to the continuing search for yield by investors and a recognition that within the property sector, income returns have historically been a less volatile component of overall returns than capital returns. SUPR’s average unexpired lease term of 19 years is above the average for this group and its RPI-linked rent growth provides investors with considerably visibility of income with protection against inflation. The current quarterly DPS annualises at 5.676p per share which represents a yield of 5.6%, above the average 5.1% for the group, while at 1.07x the SUPR P/NAV is only slightly above the average 1.05x. We note the potential, discussed above, for yield tightening in the supermarket sector to lift NAV.
Exhibit 9: Summary of long lease REITS
Price |
Market |
P/NAV* |
Yield** |
Share price performance |
||||
(p) |
cap. (£m) |
(x) |
(%) |
1 |
3 |
12 |
From 12M |
|
Assura |
58 |
1400 |
1.11 |
4.5 |
4% |
2% |
-2% |
-7% |
Impact Healthcare |
103 |
198 |
1.00 |
5.8 |
0% |
-1% |
-2% |
-3% |
MedicX Fund |
90 |
399 |
1.10 |
6.7 |
14% |
12% |
7% |
0% |
PHP |
117 |
912 |
1.12 |
4.7 |
2% |
6% |
4% |
-1% |
Secure Income |
399 |
1283 |
1.04 |
3.6 |
2% |
6% |
12% |
-1% |
Target Healthcare |
114 |
439 |
1.07 |
5.7 |
6% |
4% |
6% |
-2% |
Tritax Big Box |
137 |
2012 |
0.93 |
4.9 |
0% |
-2% |
-2% |
-13% |
Average |
1.05 |
5.1 |
4% |
4% |
3% |
-4% |
||
Supermarket Income |
103 |
189 |
1.07 |
5.4 |
5% |
0% |
2% |
-3% |
UK property index |
1,702 |
5.1 |
6% |
-3% |
-1% |
-9% |
||
FTSE All-Share Index |
3,898 |
4.6 |
3% |
0% |
0% |
-10% |
||
Source: Historical company data. Prices as at 11 February 2019. *Last published EPRA NAV. **Trailing 12 month DPS declared.
Exhibit 10: Financial summary
Year ended 30 June |
2018 |
H118 |
H218 |
H119 |
|
£000's |
|||||
INCOME STATEMENT |
|||||
Rent receivable |
8,483 |
3,020 |
5,463 |
8,106 |
|
Rent smoothing adjustment |
459 |
131 |
328 |
187 |
|
Total rental income |
8,942 |
3,151 |
5,791 |
8,293 |
|
Administrative & other expenses |
(2,097) |
(965) |
(1,132) |
(1,517) |
|
Operating profit before investment property change in fair value |
6,845 |
2,186 |
4,659 |
6,776 |
|
Change in fair value of investment properties |
(4,081) |
(4,859) |
778 |
792 |
|
Operating profit/(loss) |
2,764 |
(2,673) |
5,437 |
7,568 |
|
Net finance expense |
(1,917) |
(649) |
(1,268) |
(2,057) |
|
Profit/(loss) before tax |
847 |
(3,322) |
4,169 |
5,511 |
|
Tax |
(227) |
(231) |
4 |
0 |
|
Profit/(loss) for the period |
620 |
(3,553) |
4,173 |
5,511 |
|
Adjust for: |
|||||
Changes in fair value of investment property |
4,081 |
4,859 |
(778) |
(792) |
|
EPRA earnings |
4,701 |
1,306 |
3,395 |
4,719 |
|
Closing number of shares (m) |
184.4 |
120.0 |
184.4 |
184.4 |
|
Average number of shares in issue (m) |
124.2 |
105.5 |
142.9 |
184.4 |
|
IFRS EPS (p) |
.5 |
(3.4) |
2.9 |
3.0 |
|
EPRA EPS (p) |
3.8 |
1.2 |
2.4 |
2.6 |
|
DPS declared (p) |
5.500 |
2.750 |
2.750 |
2.794 |
|
EPRA earnings/dividends paid |
103% |
95% |
107% |
93% |
|
BALANCE SHEET |
|||||
Investment property |
264,900 |
207,900 |
264,900 |
320,650 |
|
Interest rate derivatives |
37 |
55 |
37 |
60 |
|
Total non-current assets |
264,937 |
207,955 |
264,937 |
320,710 |
|
Trade & other receivables |
1,035 |
104 |
1,035 |
98 |
|
Cash & equivalents |
2,239 |
1,251 |
2,239 |
5,895 |
|
Total current assets |
3,274 |
1,355 |
3,274 |
5,993 |
|
Deferred rental income |
(1,666) |
(1,188) |
(1,666) |
(3,221) |
|
Current tax liabilities |
(227) |
(231) |
(227) |
(227) |
|
Trade &other payables |
(1,473) |
(1,525) |
(1,473) |
(2,307) |
|
Total current liabilities |
(3,366) |
(2,944) |
(3,366) |
(5,755) |
|
Bank borrowings |
(88,099) |
(93,822) |
(88,099) |
(143,710) |
|
Interest rate derivatives |
0 |
0 |
0 |
(289) |
|
Total non-current liabilities |
(88,099) |
(93,822) |
(88,099) |
(143,999) |
|
Net assets |
176,746 |
112,544 |
176,746 |
176,949 |
|
IFRS NAV per share (p) |
96 |
94 |
96 |
96 |
|
EPRA NAV per share (p) |
96 |
94 |
96 |
96 |
|
CASH FLOW |
|||||
Net cash from operations |
8,061 |
3,877 |
4,184 |
9,634 |
|
Purchase of investment property |
(254,540) |
(201,540) |
(53,000) |
(51,700) |
|
Capitalised acquisition costs |
(14,113) |
(10,660) |
(3,453) |
(3,071) |
|
Net cash from investing activity |
(268,653) |
(212,200) |
(56,453) |
(54,771) |
|
Share issuance (net of costs) |
180,883 |
117,562 |
63,321 |
0 |
|
Debt drawn/(repaid) |
88,844 |
94,743 |
(5,899) |
56,050 |
|
Interest paid and other financing costs |
(2,334) |
(1,356) |
(978) |
(2,187) |
|
Dividends paid |
(4,562) |
(1,375) |
(3,187) |
(5,070) |
|
Net cash from financing activity |
262,831 |
209,574 |
53,257 |
48,793 |
|
Change in cash |
2,239 |
1,251 |
988 |
3,656 |
|
Opening cash |
0 |
0 |
1,251 |
2,239 |
|
Closing cash |
2,239 |
1,251 |
2,239 |
5,895 |
|
Debt drawn/(repaid) |
(88,099) |
(93,822) |
(88,099) |
(143,710) |
|
Net debt |
(85,860) |
(92,571) |
(85,860) |
(137,815) |
|
LTV |
32% |
45% |
32% |
43% |
Source: Company data
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Research: TMT
GB Group (GBG) has acquired IDology, a US identity verification business, for an enterprise value of $300m/£231m. It has placed 39m shares at 410p per share to fund £160m of the purchase price, with the remainder coming from a new credit facility. We estimate that the deal offers significant cross-selling potential and will boost GBG’s international revenues to close to 50%.