Azrieli Group Ltd. (AZRG) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by. Welcome to the Azrieli Group Conference Call. [Operator Instructions] This conference call will be accompanied by a slide presentation. It can be found on the Azrieli's site, www.azrieligroup.com, on the Investor Relations page under Presentations, and the financial reports can be found on the website as well. I would like to remind everyone that forward-looking statements for the respected company's business, financial condition and results of its operations are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated. With us on the line are Mr. Eyal Henkin, CEO; and Moran Goder, Head of Capital Markets. Mr. Henkin, would you like to begin, please?

Yes. Thank you. With us Irit Pilosof, which is Deputy CEO and CFO as well. And good afternoon to everyone. Thank you for joining the Azrieli Group earnings call summarizing the quarter. This was a very good quarter in the opening -- in the operating parameters, whether it's NOI, FFO, occupancy, traffic, tenants turnover and so forth, with a good business environment. Some major highlights of the quarter, one, annual NOI rate based on the last quarter times 4 plus transactions we closed, whether it's Mall Hayam and others, is close to ILS 2 billion annually. I emphasize that this is -- does not yet include the NOI from significant contracts signed in the data center segment which will be expressed in the coming year or 2. Regarding the acquisition of Mall Hayam, which is one of the strongest malls in Israel, it's not the strongest, this was closed on July 1 or in other words, in the third quarter. And the ownership of the property has been transferred to us. I truly believe in its fit and contribution to the Azrieli portfolio. In terms of the mix of contributions of the different segments of the group, it is well balanced and reflects the investments in the development of the new growth engines, whether it started a couple of years with additional offices and senior housing and, of course, to data centers. FFO annual rate higher than ILS 1.3 billion. If you look at it closely, it builds the future horizon on the short term, but bringing very high income, which will be in place in the mid and long term. Irit will go over the financial parameters in the coming minutes. Interest rates. The interest increased to 1.25% after several years at 0.1%. Obviously, this increase in interest increase of the input for all companies. But I think that in situations like this, we can appreciate and understand that our lower leverage will enable us to be less affected by this process because of some of these following parameters: one, both rentals and debt are all indexed to inflation rate. Another thing, the leverage is very low. It's 31% today, net LTV. The average duration of the debt is long. As you can see on Slide 49, in recent years, we extended the average duration to 6.3 years from 2.3 years as well as lowered the average interest to 1.7% from almost 5% a decade ago. So in view of all of this, we are ready for the current inflation trend and the interest rate hikes. The fifth subject matter I want to indicate is the acquisition of labs in Azrieli Sarona. These were actually the sixth highest flows of the stories of this building. They were leased up until 2042, and we bought them back. We bought the contract back, which in terms of annual NOI, the additional contribution of these floors is almost ILS 17 million a year. We signed additional data center contracts, both in Northern America and with Green Mountain in Europe. Some words about the macro Israeli economy. The Israeli economy is functioning well and is still solid. The recent inflation indicators were up to 5.2% annual rate related to other economies in the OECD, the major parameters are strong. In this quarter, Israel's GDP increased by 6.8% compared with the previous quarter of Q1 2022, strongly by the private consumption and export components but also investments in infrastructure. The private consumption expenditure increased by 10.4% in the quarter compared with Q1. The private consumption per person increased by approximately 8%. Fashion and footwear up almost 5%, 4.9%. The business sector related also to the office segment grew by 8.5% compared to Q1 2022 and up 8.8% compared with the equivalent quarter in 2021. The updated growth focus for the Israeli economy or growth of 5% for 2022 and 3.5% growth in 2023. In this call, we will review all of our operating segments, but I'll start with the Data Centers segment. In the past 3 years, data centers have been considered one of the fastest-growing industries in the world. Just to express this, the expectations up until 2027, specifically for cloud and hyperscalers, is 34% growth each year. Development and supply to the market, just to exemplify in the major markets we operate in Northern America, which are north of Virginia, Dallas Fort [indiscernible] in Phoenix, this supply was this year -- last year was more than 320 megawatts. On the demand side in this market, -- it was almost 550 megawatts just to exemplify the difference between supply and demand. Also, last year, there were a number of M&A transactions, such as the acquisition of CyrusOne and CoreSite and earlier that year, QTS, which were $10 billion to $15 billion companies, all priced with multipliers of between 25 to 30 on the EBITDA, reinforcing our view and our requirement of both Compass and specifically Green Mountain, which are smaller companies with very high rates of growth and reflecting very good prices that we bought these platforms. The Data Centers segment is a significant growth engine for the group and currently comprises some 14% of the group's operations. [Technical Difficulty]

Please, continue.

Okay. We will continue from this point. I'm sorry, for the problems on the line. As we mentioned, our strategy is to acquire platforms in secondary markets with potential for aggressive expansion and to enter the main markets from there. With the U.S. activity or the Northern American activity, we started mainly from Canada and then expanded to Nova, the FW and Phoenix, incorporating some of the largest hyperscale customers in the world. As of today, the EBITDA of Compass is almost $190 million contracted EBITDA. We continued with the acquisition of Green Mountain last year. Green Mountain is a fully green energy platform, all green energy. It is a hyperscaler platform fully fitted for these customers and operating with these customers. In the current circumstances, in the EU continent, some of which are quite -- I would say, bad and not convenient where secured electricity and volumes, redundancy, green energy, low prices and cold -- where there are abundant, the Green Mountain value proposition is supported with hyperscalers requiring 3 to 10x larger capacity compared with the previous years. On top of that, with the outstanding management and very high quality of engineering and development capabilities of Green Mountain, this acquisition provides a very strong horizon for future growth in the space. This quarter, we signed a contract to acquire a DC platform in the London market to serve as a long arm of Green Mountain in this market. What we're aiming to do is having a very low latency product close to the customer, with the back office of storage and high-performance computing back in the Scandinavian area, specifically in Norway, thus having both low latency platform and very green and redundant and high-capacity platform at the back office. As we indicated in the past, we will develop and expand our platforms, consolidate them under one umbrella, if we assign -- if applicable, merge them with our operations in the various continents and continue expanding from there. As we speak, we explore additional M&A opportunities, which will make this area even more significant to the Azrieli Group in the future. Some words about the hyperscalers to customers. If you look at the 3 major players, which are Amazon through AWS, Microsoft through Azure and Google Cloud Services, what you can see is that Amazon with around 50% market share is having 16.3% of its revenues from cloud, while all of its EBIT line is from cloud services, all of it. Amazon additionally grew 35%, 39%, 40% and 36% and last quarter, 33% quarter-over-quarter in the recent year. Regarding Azure, Azure today is 37.8% of the revenues of Microsoft with more than 40% of the operating profits of this a great company. Azure was growing in the recent quarters 48% to 50% quarter-on-quarter, and is becoming maybe the major growth engine of Microsoft. With these great companies and these great this great expansion of cloud. We think this is a very relevant and good growth engine for a group like Azrieli, and we will continue to invest in this market. Regarding other segments, offices, the market is good and demand is strong despite the changes taking place in the high-tech industry and their impact on the employment market in such fields and the repricing of stock and risk in the field. Contract renewals continue to be on a positive trend with new contracts signed in the last quarter reflecting 15% to 20% increase in the rate per square meter. Some customer update and some things from the field. Just to exemplify in the Azrieli Center, which is full today, there are 16, 1-6 tenants, which are asking to expand and rent more space. And it is very difficult for us to find space for most of these customers because all of the space in the center has been occupied. Regarding new developments, SolarEdge, which is today on a market cap of around $17 billion, at the beginning of the year, we laid the cornerstone for the construction of the project, which is going to be launched on March 2025 and the listing is going to be for 25 years with this great customer. Regarding the mall segment, NOI was up ILS 70 million year-on-year quarter-on-quarter all same property. And just to reflect, occupancy a year ago was around 98%. Today, 99.1% occupancy and still the NOI is up almost 11%. On top of this, the acquisition of Mall Hayam will contribute more than ILS 90 million to the NOI from the most -- starting from Q3 2022. Store revenues increased by 10.4% year-over-year, April through June. If we look only at May to -- and June where we leave the Passover holidays aside, only May and June 2022 compared with May, June 2021, was an increase of 5.5%, which we presented just for the effect of the timing of the Passover holiday. Some interesting developments. We opened a DNA Food Truck venue in a few months ago at the ground floor of [indiscernible]. It's a great change of atmosphere and a very good refreshment of the -- this great area, and was very positive, and we got a very positive response from the tenants. We will open the anchor Nike store in Sarona mall on September 21. It is a Nike elevated [indiscernible] story [indiscernible] and one of a kind 3 stories too, of which 6 are planned to be built in the world and only one, this one, in Israel. In the Jerusalem and Modi'in stores, we opened the huge Zara flagship stores. They contribute a lot for the visitors, traffic and for the turnover, and I believe they are also impacting the store revenues of many other stores at those bonds. Regarding senior housing, we're on track on a very strong demand. Dozens of contracts have been signed in each of the homes, mainly Lehavim and Modi'in. And actually, we're out of inventory as we finish this quarter. Back in 2021, we raised our prices by 13%, 1-3, 13% in the aggregate. In Lehavim, we have completed Stage A with 250 out of 241 apartments, which is 90% occupancy. And we are opening in September Stage B with additional 109 apartments, of which already 45 contracts are already signed. Modi'in is already fully occupied. Regarding the development, we are currently finishing building and beginning to occupy the following 2 projects: As I said before, Stage B of Palace Lehavim, we finished on time, on budget, 109 apartments of which, as I said, [ 31% ] have been marketed already and having already contracts. In Azrieli Town, we finished on time and below budget the multifamily -- the first multifamily in Israel, 210 residential rental apartments where we easily begin to lease and are being occupied. We Finished it and launched it on August 1. And their [ span ] is very good. Next year 2023, we expect to complete Lot 21, which is mixed use of both hotel offices, commercial and residential in Modi'in, next to the mall, and we will complete the [ Czech ] project in Haifa. Other projects such as Lot 10, SolarEdge Compass, [indiscernible] housing, Jerusalem mall expansion, Spiral and other projects are on track and on budget. From here, I'm going to hand over to Irit, who will review the financial parameters in this quarter.

Good afternoon to you all. The second quarter reflects excellent results, as expressed in all of the operating parameters for the quarter and they can be viewed as an indication of stability further to the company's growth. The NOI in the second quarter was ILS 473 million compared with ILS 407 million year-over-year. The increase of ILS 66 million constitutes a 16% increase in the NOI. The Retail segment contribution to the increase was ILS 17 million. The entire increase derived from organic growth of same property ILS 23 million derived to an increase in the office segment, which was also due to the organic growth in higher rent as same property. ILS 4 million derived from an increase in the senior housing segment mainly due to increased occupancy in the Lehavim Stage A and Modi'in [indiscernible] and they're reaching full occupancy. ILS 24 million derived from an increase in the Data Centers segment mainly in view of the acquisition of the Norwegian company, Green Mountain. The same property NOI in the quarter presents a similar trend to the NOI and the gap between them -- between the same property NOI and the NOI is actually mainly stemmed from discounting the operating results of Green Mountain, which was acquired in August 2021. The company's FFO totaled ILS 331 million in the quarter compared with ILS 371 million year-over-year. The decrease mainly derived from volatility in the volume of deposits received from residents after we completed the occupancy of the income-producing senior homes. Therefore, in fact, we will see another boost from the flow of deposits after the opening of Lehavim Stage B in the coming months. The FFO net of contribution of senior rousing presents similar results year-over-year. And the company builds its future growth engine and invest in data centers. The yield will be expressed in the NOI in the coming months, while the growth in financing expenses and G&A are already expressed at this time. At the end of the quarter, the total value of the group's real estate property was around ILS 35 billion. In the report period, we invested ILS 868 million in the acquisition and further development of income-producing properties and properties under development, including closing the purchase of land in [indiscernible] for the construction of SolarEdge Compass, which is expected to be delivered to the tenant in 2025. In the report period, the company recorded appreciation in respect of fair value adjustments of investment property of around ILS 853 million. About 70% of the revaluation derives to an increase in the CPI and the rest of the increase was mainly thanks to an increase in rent prices. In addition to the revaluation that appear in the statement in the fair value adjustment section, revaluation were also conducted for the real estate properties owned by Compass, which is a U.S. company held by us engaged in data center industry. With our share of the revaluation totaling approximately ILS 376 million, and which is included in a different part of the P&L, which is called sharing results of companies accounted for on the equity method. The company's net debt is ILS 13.6 billion, which is 31% of the total assets. After the acquisition of Mall Hayam in Eilat, which closed last month, the leverage was increased to 34%. The company had around ILS 31 billion in unencumbered assets, which are 75% of the company's total assets, in addition to the cash balance and deposits, which totaled to ILS 2 billion at the end of the quarter. After the end of the quarter, the company's reformed and approximately ILS 3 billion expansion of 3 of its bond series with an average duration of 8.1 years and an average interest rate of 2%. The net income for the growth totaled to ILS 803 million compared with ILS 383 million year-over-year. The increase mainly derived from the increase in NOI and increase in profit from fair value adjustments, net of an increase in financing expenses which mainly derived from the rise in the CPI. Now we will move on to the Q&A portion.

[Operator Instructions] The first question is from Christopher [ Tang ] of UBS.

Chris from UBS. Maybe just one question on offices. I was just wondering what the office utilization is for your portfolio, meaning how much have employees actually returned into office on average? And if that has been stabilizing or is it still evolving?