SUPR

H1 dividend per share 3.0p, unchanged 

CHAIR’S STATEMENT

Dear Shareholder,

The UK grocery sector continued to show strong growth in 2023 against a persistently uncertain economic backdrop. During the Period, Kantar reported an 8%¹⁰ increase in UK grocery sales building on the strong growth seen in the previous period. Tesco and Sainsbury’s, the UK’s largest grocery operators by revenue, and our two largest tenants, have performed particularly strongly, with both operators growing market share and sales, which is fuelling cash flow growth and profit margins.

In a tight market for new sites due to a lack of prime locations, planning restrictions and elevated construction costs, our large format stores provide the operators with the space to grow sales volumes and thus sales densities, which will further increase rental affordability and should feed through to higher rental income at lease expiry.

The importance of mission-critical supermarkets, the revenue hubs in this growing sector, together with long inflation-linked full repairing and insuring (“FRI”) leases, has attracted a growing range of investors to this market. In 2023 we saw a record £2.1 billion of investment volumes. In addition, we continue to see our two biggest tenants, Tesco and Sainsbury’s buying in their stores with over £2.0 billion of supermarkets purchased in the last five years, testament to the value that they see in owning their top trading, omnichannel stores.

Despite the strong grocery market backdrop, supermarket property yields continued to widen in line with the broader property market driven by the negative macro-economic environment. As a result, the Portfolio valuation declined 3.2% on a like-for-like basis, reflecting a Net Initial Yield of 5.8% as at 31 December 2023 (30 June 2023: 5.6%).

Given the uncertain economic and interest rate outlook for much of 2023, the Company took the prudent decision to use some of the proceeds from the sale of the Sainsbury’s Reversion Portfolio to pay down debt, reducing LTV to 33%. Despite this lower leverage position, we have maintained the EPS level we achieved before the sale of the SRP. The undrawn debt capacity means we are ideally positioned to take advantage of some highly attractive pricing, and earnings accretive acquisition opportunities in the market.

The reduction in the 5 year interest swap rate from 5.0% in June 2023 to 3.4% in December 2023 has reduced borrowing costs, generating an attractive spread to current supermarket investment yields. Combined with the strong, growing operational market and improving lease reversion values, we remain highly optimistic on the longer-term valuation outlook and remain open to future earnings accretive investments.

The Company has continued to build on the progress that it has already made on sustainability. Following the publication of our first standalone sustainability report in September, along with our TCFD compliant Annual Report, we have now submitted our science-based emissions reduction targets to the Science Based Target initiative (“SBTi”) for validation. We have also actively managed assets to deliver sustainability improvements and have now deployed EV charging at five sites and are continuing to support the roll out of solar PV with rooftop solar now installed at 20% of our stores. This is improving the environmental efficiency of our sites including our Tesco store in Thetford, which energised in the Period. The PV system provides clean energy directly to the store, helped to deliver an EPC upgrade from C to B and was completed with zero capex cost to the Company.

OUTLOOK

Once again, the grocery market has delivered a strong performance in a challenging, unpredictable economic environment. Whilst we have seen a decline in valuations based on transactions which completed late last year, constrained supply and falling debt cost conditions combined with evidence of increased competition for assets since the start of the year, suggest that we may see a more positive environment for valuations going forward.

With our current reduced leverage, we are now ideally placed to add earnings accretive assets. Meanwhile, our high-quality portfolio of mission-critical supermarkets continue to deliver stable, long-term inflation-linked income. Combined with our robust balance sheet, fixed borrowing costs and highly visible cashflows, the Board is confident of the Company’s ability to provide secure income to our investors.

Nick Hewson

Chair

INVESTMENT ADVISER’S REPORT

Atrato Capital Limited, the Investment Adviser to the Group (the “Investment Adviser”), is pleased to report on the operations of the Group for the Period.

Overview

Continued strong growth of the grocery sector

We observed UK grocery sales growth of 8% in the Period. Annual sales in the UK grocery market are currently forecast to reach £250 billion in 2024; an increase of £65 billion since the Company’s IPO in 2017. The sector’s non-discretionary nature ensures that it is highly resilient relative to the volatility of the economic cycle and is strongly correlated to inflation. The recent peak of UK price inflation has now seemingly passed and operators are reporting volume growth both in-store and online.

In October 2023, Tesco reported 9.3% growth in grocery sales from its supermarket estate and Sainsbury’s reported similar growth of 10.8%, outpacing the wider UK grocery market. Core to the operator’s growth are the omnichannel supermarkets that provide in-store shopping, but also operate as last mile, online grocery fulfilment centres for both home delivery and click and collect. Omnichannel stores provides the space, proximity to customers and flexibility to service customer demand in the growing physical and online markets. It is worth noting that approximately 80% of Tesco’s 1.1 million weekly online orders are now fulfilled from omnichannel supermarkets and, similarly, the increased focus on omnichannel stores has propelled Sainsbury’s to become the number one click and collect retailer in the UK.

Focused investment strategy targeting top trading, mission critical real estate

Our strategy is aligned with the future model of UK grocery, capitalising on the long-term structural trend toward growing omnichannel operations. We have handpicked the UK’s leading portfolio of supermarket investment assets. We are the largest landlord of omnichannel grocery stores in the UK, offering a combination of attractive, secure and growing income with potential for long-term capital growth. Our stores facilitate in-store shopping, home delivery, click and collect, and increasingly, rapid ready to eat food delivery. 93% of the Group’s portfolio by value are omnichannel stores, future proofing the portfolio and providing exposure to the fastest growing grocery market channel since the Company’s IPO in 2017^.

Omnichannel stores act as significant online fulfilment hubs. A typical omnichannel store will operate as many as 25 home delivery vans, with c.200 employees dedicated to online fulfilment, accounting for up to 30% of store turnover. These large sites, often exceeding 10 acres, have good road transport links in densely populated areas and thus would be very difficult to recreate today. The stores typically have long trading histories, many having been supermarkets for more than 30 or 40 years, underlining the strength of the site as a grocery location. The Company’s strategy of targeting such stores ensures that its tenants are committed to the location beyond the contractual lease term and provides assurance of strong alternative occupier demand in the highly competitive grocery market. The scarcity of alternative locations combined with increased build costs, up c.30% since 2022, are driving up supermarket replacement values, making existing omnichannel supermarkets even more valuable.

Income generated from strong tenant covenants

The Company has continued to achieve 100% rent collection during the period, of which 77% is received from its key tenants, Tesco and Sainsbury’s, the UK’s largest retailers by revenue. The Company also benefits from its tenants’ capital investment programmes, which are focused on enhancing existing stores, including those which are occupied leasehold, over new store openings. The limited new store openings and capital investment programmes mean that high sales growth is being achieved like-for-like, enhancing existing store trading performance and ensuring progressive ERV growth.

While the growth of the Discounters has gained attention, it is worth noting that much of their sales growth is achieved through new store openings and therefore at a lower margin. Tesco and Sainsbury’s have competed particularly well with the Discounters, with Clubcard and Nectar customer loyalty programmes proving highly effective in customer retention.

2023 was a record year for supermarket real estate investment volumes

The investment market for supermarkets saw volumes of £2.1 billion in 2023, highlighting the attractiveness of the asset class at current yields. The volume of transactions demonstrated the significant value of supermarket real estate to both the traditional institutional investors and also to Tesco and Sainsbury’s, as they continue to buy back leasehold stores. This operator buyback activity, given the knowledge of their own store estates, clearly demonstrates the value of their store networks.

The liquidity of the supermarket investment market means that valuers are able to base valuations on real world transactional evidence. This stands in contrast to other sectors of the real estate market where volumes were significantly reduced in 2023, reflecting the wide gap that still remains between buyer and seller price expectations in those sectors. The defensive characteristics of supermarkets, combined with the capex certainty provided by the Fully Repairing and Insuring lease structures are proving attractive for investors.

Challenging economic environment impacting property valuations

The high level of transactions in the grocery investment market provided clear market pricing guidance for the sector. For the majority of the year, supermarket valuations remained broadly flat following the valuation decline seen in Q4 of 2022. However, in December 2023, following an improvement in 5 year swap rates and forward financing expectations, some buyers opportunistically closed deals to purchase assets from some vendors who were under pressure. These transactions would have been priced earlier in the year when the interest rate outlook was less favourable. This short burst of transactions closing late in the year at wider yields resulted in a 3.2% like-for-like valuation decline of the Company’s portfolio as at 31 December 2023.

Since the start of 2024 we have seen strong investor interest, including for those stores for which demand was weaker in Q4 2023. This includes assets on short leases or let to non-institutional grade tenants such as Asda, Morrisons and Waitrose, providing confidence that we have seen a bottoming out of valuations in the sector. 

Whilst volatility remains, interest rate expectations have moderated somewhat and the 5 year swap rate has reduced from 5.0% in June to 3.4% in December, providing accretive opportunities to deploy capital. We expect that more constrained supply following very high transaction volumes in 2023 combined with falling interest rates will provide support for capital growth going forwards.

As sector specialists, we are able to identify value in often overlooked sub-sectors in a challenging real estate market. The prospective all-in fixed cost of debt for the Company is around 5.5% and we see accretive opportunities to deploy, whilst maintaining focus on high quality assets.

Strong balance sheet, well positioned to take advantage of opportunities in the market

The Company’s balance sheet is in a robust position. During 2023, the Board and Investment Adviser took the prudent decision to maintain lower leverage given the challenging macro environment, resulting in an LTV of 33% as at 31 December 2023 (30 June 2023: 37%). This conservative approach, which saw the Company reduce debt and step back from the investment market to conserve cash during a period of continued volatility, now provides the Company with capacity for accretive deployment in an increasingly attractive investment environment.

The Company’s cost of debt remains 100% fixed until FY26, through the peak of the interest rate cycle and we continue to see good access to refinancing liquidity from both new and existing lenders. We added Sumitomo Mitsui Banking Corporation to our group of relationship banks in the Period and we continue to maintain strong relationships with all lenders. Fitch ratings recently reaffirmed the Company’s Investment Grade, long-term Issuer Default Rating (“IDR”) of ‘BBB+’ with a stable outlook.

The Company has significant headroom on its bank facility covenants and given the attractiveness of current investment yields is currently assessing a number of earnings accretive acquisition opportunities.