What it does
Set up two years ago and listed on London’s main market, Supermarket Income’s current portfolio comprises nine stores – five occupied by Tesco, three by Sainsbury’s and one by Morrisons.
The company was set up by an ex-Goldman Sachs pair, Ben Green and Steve Windsor, who used to work with supermarkets to sell and lease back stores, carrying out several billion pounds worth of deals over the years.
With the advent of IFRS accounting rules, meaning that assets that supermarkets had been able to class as off their balance sheet now were being classed on their balance sheet, Green and Windsor saw a consolidation role would be profitable.
They set up Atrato Capital, which is the trust’s adviser and since March has counted ex-Sainsbury’s chief executive Justin King as a senior investment advisor.
How does the trust work?
Purchases are made only of supermarket property with long unexpired lease terms, with a targeted average lease term of more than 15 years, leased only to the UK’s big four supermarkets on upward only rental contracts to provide investors with income security and considerable inflation protection.
Raising new money for investments is done each time an investment is identified, with £100mln raised on IPO in summer 2017 and £30mln later that year, then raisings of £75mln and £45mln, a £100mln revolving credit facility with HSBC, another £48mln loan in August and then a £100mln from a placing in October that was increased from £50mln due to strong institutional demand.
After the ninth acquisition was made in October, the market cap was around £350mln versus total assets £483mln, which could rise to around £600mln with full deployment of all agreed funds.
“Two years in and we're well on the way to the £1bn target we initially envisioned. Hopefully, progress accelerates from here as we get more access to equity capital,” said Windsor.
Estimating that supermarkets represent around a £100bn section of property sector, Windsor says, “we like about 10% of it and we think we could be 10% of that, so that's our £1bn”.
He also stresses the “ridiculously cheap” cost of debt that the REIT enjoys, making it “one of, if not the cheapest-funded property company in all of the UK,” as August's five-year, fixed-rate, interest-only loan was secured at 1.9% with Germany's Dekabank versus most generalists being “in the high two or low threes”.
Meanwhile, total rent from the portfolio was £17.2mln in the year to 30 June, but after further investments and annual rent reviews at two of its stores in December, this had risen to £26mln.
While the supermarket sector has not been having the easiest of times in recent years, with German discounters Aldi and Lidl storming the castle, the industry is not going anywhere and in fact is one of the brightest spots of UK property.
Furthermore, one of the many boxes that supermarket properties need to tick in order to make it into the trust’s portfolio is that they need to be “future-proof”, that is they must be larger stores operating both as a physical supermarket and as a fulfilment centre for the supermarket’s online grocery operations.
This is because Green and Windsor see the 'store pick' model of online grocery as the only truly viable option for the industry in the short, medium and long term.
“Online grocery is very different from general retail,” says Green. “Operationally it's very complicated to do as the customer needs one-hour slots, the trucks need to maintain three different temperature zones and most importantly is distance.
“Apart from in London, the model requires the companies to use existing physical stores in an omnichannel capacity, for their proximity to the customer, via click-and-collect or for store-picked deliveries.”
Indeed, this is why Amazon snaffled Wholefoods and why Chinese online giant Alibaba’s Hema stores are sweeping through China.
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What’s the investment case?
- Dividend target for year to June 2020 of 5.8p
- Based on the forecast dividend, the forward yield is 5.66% at 102.5p with bond-like properties
- The re-rating of Tesco's balance sheet back to investment grade is key, as Windsor explains:
- "The fund is really a long-dated credit risk play. We are a property fund but have 18 years on average of lease length - so the most important thing to us is that our tenant pays us the money they owe us on the lease and actually not the value of the property, because the value of the cash flows way exceed the value of the property. So the higher the credit risk of your tenant the more risky those cashflows are and the better credit risk of your tenant the less risky those cash flows are. So we are investing into a sector of improving tenant strength, so the riskiness of our proposition is getting less, not more."