UK Edition
Income will be a major source of anxiety for many investors at the moment thanks to the hundreds of dividend cuts already announced by listed companies in response to the Covid-19 epidemic.
We wrote two weeks ago that investment trusts with large reserves, which could be used to cushion a fall in the trusts’ own dividend income, offered one source of hope.
But even better, perhaps, is a trust that can expect to receive more income from its assets each year and hence be able to pay more to its shareholders too.
This is because its assets are supermarkets, which are among the few businesses not only able to remain open but in a position to thrive during the lockdown.
The trust in question, Supermarket Income Reit, owns stores operated by only three chains: Tesco, Sainsbury’s and Morrisons. The trust, which listed in July 2017, is also careful about its exact choice of assets.
“It owns supermarkets fit for tomorrow, such as those able to operate as distribution centres for online deliveries, those in good locations or those where a change of use to residential development would be possible,” said Richard Curling, who holds a stake in the Reit in his Jupiter Fund of Investment Trusts.
As is common in the commercial property market, rent reviews favourable to the property owner are part of the rental agreements. The reviews are “upward only” and increases are linked to inflation.
This statement from the trust on March 27 gives a flavour: “The company announces agreed rental increases from the two rent reviews due in the quarter. The review at the Tesco superstore in Lime Trees, Bristol, has resulted in a retail price index (RPI) increase of 2.2pc from March 2020. The rent has increased from £1.58m to £1.62m.
“The review at the Morrisons supermarket in Hillsborough, Sheffield, has resulted in an increase based on five years of RPI of 13pc from October 2019. The rent has increased from £2.54m to £2.87m per annum.”
Supermarket Reit said the total rent from its portfolio had increased from £28.03m to £28.4m following the reviews. Its assets were valued at £490.4m on Dec 31, according to its interim report, so the trust makes a gross return on its property portfolio of about 5.7pc. Naturally it has costs, not least the interest on its debts of about £166m. But it is still able to pay a generous dividend to its shareholders.
Last week it declared an interim dividend of 1.46p per share for the first three months of 2020, which is the third quarter of its financial year. Should it pay the same in the fourth quarter, the total dividend for the year will be 5.799p. At the current share price of 106.75p, that equates to a yield of 5.3pc.
Mr Curling contrasted that yield with those available in the bond market. “Tesco’s own 2029 bond yields 2.8pc but offers no inflation protection,” he said. “By owning its supermarkets instead you are exposed to the same ‘credit risk’ – and Tesco is now rated investment grade by the credit rating agencies – but getting about twice the yield.”
He pointed out that inflation-linked bonds issued by the British Government yielded minus 2.5pc.
“This is an anomaly,” Mr Curling said, “although perhaps bonds are too expensive rather than supermarket freeholds too cheap. But certainly this kind of trust is so much more attractive than the bond market.”
He said Supermarket Reit had benefited by buying Tesco freeholds cheaply. “The opportunity arose when everyone was worried that Tesco had too many big stores and before it was investment grade,” he said. The trust also has the opportunity to enhance returns from its assets by, for example, installing solar panels on supermarket roofs.
Morrisons and Sainsbury’s are also rated investment grade and on average the trust’s leases have 18 years to expiry, which offers long-term stability of income.
The shares do trade at a premium of about 10pc but this column believes the trust’s high, rising and secure income, at a time when all three of those attributes will be in short supply, makes it a compelling opportunity.
Questor says: buy
Ticker: SUPR
Share price at close: 106.75p
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