by Pritu Makan
| Name |
Supermarket Income REIT |
| Share Code |
LSE: SUPR ; JSE: SRI |
| Listing Date |
Friday, 13 December, 2024 |
| Issued Share Capital |
1,246,239,185 ordinary shares with a nominal value of one penny each |
| Market Cap |
£889 million |
Supermarket Income REIT (LSE:SUPR) is the largest landlord of omnichannel (online and offline fulfilment) supermarkets in the United Kingdom (UK). It is dedicated to investing in supermarket properties which are let to leading operators in the UK and Europe. The company has built a portfolio of strong trading, "mission critical" omnichannel supermarkets backed by blue-chip tenants.
The central pillar of the fund's investment policy is to acquire "omnichannel" supermarkets that form a key part of the tenants' last mile on-line fulfilment networks. These stores offer both an online provision (delivery and click-and-collect typically) as well as in-store shopping thus providing tenants with economies of scale and operational efficiencies and helping them capture overall grocery market share. Currently 93% of the group's supermarket assets are omnichannel, by value.
The portfolio's weighting towards investment grade tenants provides secure long-term income with a weighted average unexpired lease term of 12 years. In addition, the portfolio is heavily weighted (80%) towards upwards only inflation-linked rent reviews. The average cap on inflation-linked leases' rental uplifts is 4%. The rent profile of SUPR's supermarkets is broadly in line with the market at 4% rent to turnover (RTO).
As part of the company's investment strategy to acquire high-quality, strong trading supermarkets, it is sometimes necessary to acquire complementary non-grocery units (like fuel stations) that are co-located with the store. These units often create a retail destination, helping to drive further footfall into the supermarket. Non-grocery assets represent 6% of the portfolio by value.
Recent acquisitions
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July 2023: A Sainsbury's in Gloucester for £17.4 million. The store has a 15-year unexpired lease term and is subject to five-yearly upwards only, open market rent reviews.
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July 2023: A Sainsbury's in Derby for £19 million. The store has a 15-year unexpired lease term and is subject to five-yearly upwards only, open market rent reviews.
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March 2024: A Tesco in Stoke-on-Trent for £34.7 million. The store has a 11-year unexpired lease term and is subject to annual upwards only RPI-linked rent reviews.
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April 2024: A portfolio of 17 Carrefour supermarkets located in north and north-west France for £64.7 million. The portfolio was a direct sale and leaseback with Carrefour with 12-year unexpired lease terms and subject to annual, uncapped inflation-linked rent review.
The acquisitions were made at an average net initial yield of 6.7%, providing an attractive spread to the group's incremental cost of debt, and were immediately accretive to earnings. The increased exposure to index-linked income also generates further contractual earnings growth underpinned by strong tenants.
A brief look at the financial year ended 30 June 2024
The fund's operational performance remained strong over the period, boasting another year in which SUPR has achieved 100% rent collection and 100% occupancy
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The portfolio achieved 4% like-for-like rental growth on leases that had been subject to review, driven by inflation-linked contractual uplifts.
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The company's key tenants continued to perform strongly with impressive revenue growth. Sainsbury's and Tesco, representing 77% of the portfolio by value, reported like-for-like sales growth of 10.3% and 7.7% respectively in their full-year results and both reported even higher sales growth figures from their large format stores, like those owned by SUPR, up by 11% and 8.2%, respectively.
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Importantly, revenue growth remained ahead of rental increases, which ensures that rents remain affordable.
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The group's newest tenant, Carrefour, also performed strongly in its home market in France, with ROI margins up 6.2%, underpinned by accelerated price investments which have been more than offset by cost discipline.
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The group maintained a conservative leverage policy, with a medium-term loan-to-value (LTV) target of 30% to 40% (current: 37%).
Attractive qualities of the fund
The UK non-discretionary grocery market continues to experience strong growth
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The UK grocery market has highlighted its defensive, non-discretionary characteristics over the year with sales growth of 5.8% against a very strong inflation-led base of 9.2% in 2023.
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While sector growth will continue to ease as inflation moderates in 2025, the Institute of Grocery Distribution (IGD) projects continued healthy absolute sales growth in the coming years. With forecast annual growth of around 3% through 2029.
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The future projected growth is in line with long run RPI/CPI projections and underlines the grocers' ability to efficiently pass through inflation to consumers. The increased sales revenue at the store level will support higher rents over the medium term
Online grocery channels in the UK has returned to growth following a post-pandemic rebase
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Online grocery now accounts for 12% of the total market. Online market share has fallen back from the pandemic peak of 15% but, having rebased to 12%, is still one of the fastest growing channels according to Kantar.
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The online channel was permanently enlarged throughout the pandemic - over 50% of online grocery shoppers in 2020 were new to the channel and the change in consumer behaviour has been sticky.
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Omnichannel stores are optimally placed to benefit from the combined growth of both in store sales and online. Operators can increase online capacity at low cost and benefit from shorter drive times due to their existing omnichannel stores' proximity to customers. This results in a greater number of deliveries per hour and drives greater profitability than the centralised fulfilment (or "dark store") model.
UK omnichannel stores capture the largest share of growth
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Large format omnichannel stores, such as those the fund targets, have captured the largest share of sales growth in the sector since 2019.
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Importantly, this growth is being generated from existing store estates resulting in improved sales densities and enhanced profitability at the store level. From a landlord perspective, this ensures that rents remain affordable for tenants, particularly as sales growth has been running ahead of capped rental uplifts. It also provides a strong backdrop for higher rents in the future.
Tesco and Sainsbury's maintained market share while discounter growth begins to slow
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The UK grocery market is highly consolidated with the six leading operators accounting for 83% of the market. These operators can be divided into two groups: the four multichannel (in-store and online) operators, Tesco, Sainsbury's, Asda and Morrisons, and two limited range in-store only discounters, Aldi and Lidl.
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Tesco and Sainsbury's, the company's key tenants, hold 27.7% and 15.2% market share, respectively. Both operators have increased market share in the last 12 months and are seeing the benefit of investments in their stores, product ranges, and loyalty schemes.
The grocery market in France has experienced robust growth
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The French grocery market is one of the largest in the world by value and has shown consistent growth over a prolonged period. The defensive and non-discretionary sector has experienced year-on-year sales growth of 2.1% against a strong average inflation-led base of 5.6% in 2023. The French grocery sector is expected to grow by 3% annually through 2028.
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Carrefour is one of the largest grocery operators in the world with forecast annual global sales of €100.4 billion in 2024. In France, Carrefour holds a similar position to Sainsbury's in the UK as the second largest operator with 19.6% of grocery sales.
The online market in France benefitted from the pandemic and investment is fuelling growth
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France has Europe's largest online grocery market, which is primarily serviced by an omnichannel store network and is growing rapidly.
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Online market share in France has been permanently enlarged due to an increase in take up throughout the pandemic. The channel grew 93% between 2018 and 2024 and has been further strengthened by investment programmes by operators such as Carrefour.
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Carrefour has set ambitious online growth targets to increase online sales to 30% of total sales by 2026.
Risks
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Adverse economic conditions (ultimately leading to pressure on consumer spending) or other macro-factors like high interest rates could result in slower growth rates and delays in expansion activities. The potential adverse impact of these factors on SUPR includes reduced demand for assets impacting property values in the investment market, the ability for management to continue to execute on the acquisition and development strategy, and increased financing costs, which could impact rental income and earnings.
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For South African investors, SUPR is regarded as a rand hedge investment and, while this is a good thing longer term because of the expected structural weakening of the rand over time, there is a risk of near-term volatility and downward pressure in the event of the rand strengthening meaningfully.
Outlook and valuation
The company remains focused on delivering sustainable earnings growth, driven by its high-quality portfolio of omnichannel supermarkets and secure income streams, which also provides an attractive dividend. Despite the ongoing impact of volatile macro factors, the solid momentum seen over the current year is expected to continue into the new financial period. Management will continue to consider all options to achieve earnings growth and will also explore disposal and joint venture opportunities which present capital recycling opportunities (the benefit of which comes both through proving the portfolio net asset value (NAV) in the open market and through opportunities to redeploy sales proceeds in the most earnings accretive manner).
The REIT is trading on a forward distribution yield of ~8.8% and a 22% discount to NAV, which appears attractive. Based on consensus, the average fair value comes in at 81.17 pence, which is reflective of 16.1% upside potential. We like the quality of the portfolio (bolstered by high-quality, strong trading supermarkets with blue-chip tenants), the experienced and rigorous management team, as well as its long-term omni-channel focus combined with prudent risk management.
