Azrieli Group Ltd. (AZRG) Earnings Call Transcript & Summary

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 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 respective 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 today are Mr. Eyal Henkin, CEO; and Ms. Irit Sekler-Pilosof, CFO. Mr. Henkin, would you like to begin?

Thank you, and good afternoon, everybody. Thank you for joining Azrieli Group's conference call to review the financial statements for Q2 2020. We will review the group's conditions, the markets and the activities of the group, considering the events in Israel and worldwide as a result of COVID-19. Some words about the COVID-19 era. We entered the era well, both in terms of mix and occupancy. The occupancy rate has never been as high as it is right now at close to 100% in all of the segments. The group has very low leverage, low interest rate, significant cash balances, around ILS 3 billion, and with the Bank Leumi stock close to ILS 4 billion after raising ILS 1.7 billion in April, with an average duration of 7.6 years and a weighted interest rate of 1.32%. We keep and perform strict and responsible cash management. Our asset base is combined of unencumbered assets of ILS 24 billion. Our financial strength and solvency helped us to focus most of our material time during the COVID-19 era mainly on issues related to optimal operations vis-à-vis the tenants, preparations for resumption of normal operations and exploration of relevant opportunities. Some words I would like to say about the Israeli local economy and commercial markets. The Israeli economy's macro figures appear reasonable despite the virus and the expected decline in the GDP and in the macro economy. Clearly, the virus and the closure are having negative impact. The decrease in the GDP in the second quarter in Israel was 8.1%, which I would say is reasonable compared with an average decrease of 11.7% in the EU countries and compared with 9.5% decline in the U.S. In July, the Bank of Israel reported that the GDP will drop by around 7% in the year 2020, but will grow up back by 7.5% in 2021. In other words, it is forecasted that we will witness a sharp correction next year. Also, the unemployment rate, which immediately before the crisis was around 3.5%, will rise according to the forecast to around 10% at the end of this year in a positive scenario. And at the end of 2021, it will return to around 5% to 5.5%, which is higher though close to the pre-corona figure. Well, regarding the Azrieli Group's segments, I will start with the retail. Today, we have around 99% of the stores back open and active. Footfall has increased and is growing. In August, around 85% to 90% of the previous footfall was achieved. We find that the large tenants and the strong firms are still strong and are enduring the period. It is harder for the small and weak tenants, and we're supporting them, including with the aid fund and waiver of rent. The situation is challenging for the restaurants and related food sectors due to the tough restrictions. For these tenants, we are helping and supporting as well, for example, by giving discounts for July in advance. It is important for us to retain tenants in which we believe whose business is good for the malls' mix in the long term, but which are currently suffering. Just as an example, luggage stores, travel equipment, et cetera. We are seeing an increase in conversion rates, namely customers spend more money in the same amount of time spent in the mall. Customers are more decisive, buy and shop more. We have some new deals with Zara. After 2.5 years of negotiations, we've renewed all of the contracts in all of the stores until mid-2025. Additionally, we are opening 2 new, very large stores, one in Azrieli Jerusalem, which is going to be one of the 3 largest stores of Zara in the world; and one in Azrieli Modi'in, 2,500, even 700 square meters store. And we are checking together with Zara for other opportunities to open other large Zara stores in another mall. We are opening -- we just signed a contract with Nike for a very unique store in the new Sarona mall. This store is going to occupy 2,400 square meters in 3 floors. The model -- the type of the store is what we call [ rights-elevated ], and Nike is planning to open between 5 to 10 stores in the world. Right now, they are planning on 5. The first one is going to be open in Barcelona by the end of this year. And this store is a unique type. It's going to have unique product, and it's going to be a unique store in the state of Israel. The store is going to be open in August next year, and we'll give additional details throughout the coming months. In May and June, we opened a total of 32 brand-new stores in all of the malls. And as been indicated, we're maintaining almost 100% occupancy in the malls, and we are working hard on the rents collection. In our estimation, a positive effect of the closing of the skies is that there are no overseas flights and there are no overseas shopping. And therefore, people will shop more extensively in Israel. Regarding our online arm, azrieli.com, the business has grown significantly to double the sales and improvement -- and there are lots of improvement in terms of tenants coming from the malls to the online and finalizing the omnichannel that we are aiming to. For example, in July 2020, one of our largest tenants, MGS, having Adidas, Converse, Skechers, et cetera, is opening with us one project which is a collaboration for a very strong fashion and sports brands in azrieli.com, which provides us both the online platform and the off-line working together. We are ensuring significant disinfection and discipline at our malls as well as COVID-19-appropriate maintenance, whether it's restrooms, public areas, elevators, escalators, et cetera. Regarding our offices, on the overall, our sense regarding the office market is very positive, despite news from around the world on such or other companies that are transitioning to working from home. The commercial conditions of the contracts that we signed in this segment since the beginning of the year were very impressive, a 9.1% growth in rent price. Even if we address the COVID-19 period and analyze the contracts from the beginning of March 2020, the growth relative to the previous rent was over 14% in price, including contracts with giant companies in relation to many thousands of meters. For example, we signed with Facebook, 5,000 meters. We signed with Intel, 6,000 meters. Both Facebook, Amazon and others want more space and are paying full rent despite partial work in the offices. When the economy opened after the first wave, about 65% of office workers came to the office. This has now dropped to around 15% to 45% mainly due to management decisions of the foreign companies overseas on a global basis. There neither is nor was a trend of contract renegotiation. According to negotiations being conducted for space ahead of opening, it seems that prices, as indicated, are at least being maintained. I find that the quality of their properties, the access and good management has led to the relative strength also in times of crisis. Just to go over some numbers. If we look at the offices, options exercised and new leases, we had, since the beginning of the year, 128 contracts on a GLA of 104,000 square meters with an increase of 9.1%, as indicated in rent prices. The rise in office contracts is good. And I would like to emphasize that from March 2020, the contracts we signed reflect a rise of more than 14% related to the previous rent. About senior housing. Palace sales, since the beginning of the year, 66 residential units have been sold. This is a pace of 280 residential units per year, which is an entire home. The deposit's at ILS 99 million, which is an average of ILS 1.5 million per residential units. More than 50 residential units have been occupied, most of which in Palace Lehavim, which is a new home. Very high demand in the last month, namely June, with dozens of contracts in all of the homes, mainly Lehavim and Modi'in. The Palace chain has had isolated cases of COVID-19 only, mainly in the medical. These cases were dealt with swiftly and efficiently. We feel that the product is good and is required. And we get very high resident satisfaction, I think, due to the managerial and family support, family, it means Azrieli family support, that the residents receive. We did not shut the residents in their apartments. We encouraged supervised activities and an active lifestyle. We feel and live the formula, which dictates loneliness versus corona, people, first and foremost, do not want to feel lonely. This is what we find. Going to data centers, it's a hot segment. It experienced significant growth. There's high momentum in our platform named Compass that we acquired a year ago. The sales funnel is excellent. You can see that the REIT prices in this segment in the U.S. are at all-time high. From the beginning of the year, the data center index is more than plus 40% compared to S&P 500, which is plus 4.1%. The large hyperscale customers present significant growth in the cloud operations, whether it's AWS from Amazon, whether it's Google, whether it's Microsoft. Just to give an example, AWS is performing or -- the contribution in terms of EBIT line is more than 75% of all Amazon sales, which is huge. We are looking into expansions of Compass into additional areas of activity around the globe while using the company's contacts and knowledge to enter other interesting territories with high developer yield on cost. About development. We are currently developing over 1.1 million square meters at various development phases. We have short-term projects, we have long-term projects. All the short-term projects which are due in this year 2020 are all fully pre-let. I talked about Lehavim. We opened it in May 2020. There are contracts of over 52% for this new senior housing. No cancellations. Manor, 80% leased to Bezeq. I remind you that Bezeq is the AT&T of Israel. Azrieli Town, the first office building, which is 54,000 square meters, is fully leased to 4 companies, out of which Samsung, PwC, et cetera. Long-term projects are under construction, as usual. We are controlling the pace of construction and the cash flow. At the initial stages, planning, shoring and excavation, the expenditure is relatively low. With respect to medium- and long-term projects, longer-term projects such as the Spiral Tower, Holon 3, Palace [ Rishon Lezion ], Petach Tikva, et cetera, are at initial stages of shoring and excavation. So if we want to slow down the pace of construction in these projects and to control completion and marketing, we could do so. But the decision at this stage is to continue building them as scheduled originally. As indicated, we have considerable flexibility in medium- and long-term -- in these medium- and long-term projects. The projects are expected to move ahead as originally scheduled, but we will manage their investment cash flow more conservatively as required by these times. Opportunities for purchases at attractive prices may be exploited as well, and the liquid balances will allow also new business opportunities to be explored and exploited. We are exploring a large number of such opportunities, and I hope that some of them will materialize. I will now hand over the floor to Irit to speak about finance.

Thank you, Eyal. Good afternoon, everyone. In the second quarter, we can see the great impact of COVID-19 on the operating metrics of Azrieli Group. The concession that was given to the retail tenants, both in rent and in management fees from March 15 until the end of June 2020, is fully reflected in this quarter. I shall emphasize that the impact of the concession in respect of March was also included in the results of the second quarter. We can see a decrease of around ILS 168 million in the NOI compared with the second quarter of 2019, deriving [ aid from sale ] from the relief program for the retail tenants, which totaled approximately ILS 180 million. The same-property NOI decreased this quarter by around ILS 170 million. The company's FFO totaled around ILS 199 million this quarter compared with ILS 333 million in the corresponding quarter. This decrease is attributed to a more modest contribution to the FFO by the senior housing segment due to the occupation of a large number of units in the same quarter last year after the opening of the home in Modi'in and of course, due to the relief program for the retail tenants, net of the tax effect. At the end of the second quarter, the total value of the group's real properties was around ILS 29 billion. In the report period, we invested around ILS 458 million in the development of income-producing properties and construction, in addition to an investment of ILS 264 million for the closing of the purchase of the Mount Zion Hotel and the investment of around ILS 100 million in Compass, which specialized in server farms, an investment made according to the original share price of Compass and increased our stake in Compass. This additional investment in Compass was designed to build a server farm in Toronto after an agreement with one of the leading international hyperscalers was signed. The valuation for the company's properties as of the end of the quarter were updated by appraisers and impaired by approximately ILS 233 million. The impairment mainly includes a possible impairment due to the uncertainty in the short term in the retail segment until a vaccination is found for COVID-19, an impairment due to the decrease in the consumer price index in the report period and an impairment of the properties in Houston in the U.S. due to the effect of the oil price and the impact of COVID-19 on the economy in the region. The company's net debt is approximately ILS 9.2 billion, and it's around 26% of the total assets. The company's average effective interest rate is around 1.6% with an average duration of around 5.6 years. As of the end of the quarter, the company has a cash and deposits balance of some ILS 3 billion and with the Bank Leumi stock liquid means of approximately ILS 3.8 billion. As of today, the group's liquidity sources are more or less the same as of the end of June. In addition, the company has unencumbered assets totaling around ILS 24 billion, constituting around 70% of the company's assets. During the quarter, we performed a bond raising by way of expansion of Series E and F in the sum of around ILS 1.7 billion with an average duration of about 7 years and linked interest of 1.3%. We will now proceed to the Q&A session.

[Operator Instructions] The first question is from Charles Boissier of UBS.

I have 2 questions. The first one is, you mentioned the support to retailers. I just was wondering if you have some sort of assessment, what percentage of your retailers currently require support and will not be able to, let's say, to continue operations without the support. And then I was also wondering, what is your view on how fast we could move to turnover base rent in retail?

Okay. Regarding the first question, I'll put it this way. First of all, more than 99.3% of the tenants which are not restricted to be back in the malls are back in the malls. I would say that the restrictions today is for cinemas, mainly cinemas. So 99% of the tenants are back. I would say that we call them the red ones, which are the more risky ones, are something like between 2% and 3%, are mainly the ones who are related to restaurants, coffee shops, food courts, whatever. Why is this? It's because there are quite tough restrictions on these tenants. So I believe that our main -- the main focus within the coming weeks should be on these tenants. The other ones, I think, looking at their turnover, it seems okay. It seems okay. And specifically, in August, both the footfall and the turnover is quite strong. It's almost the same as previous corona. So to summarize, I think that between 2% and 3% of the tenants are what we call red and we focus on them, specifically on the ones that we think we can bridge this era, most of which are coming from the food sector. Ask again about the base rent, please.

Yes. And the second question was, I just was wondering, what is your view on how fast the industry could move to turnover base rent? It seems that some retailers are pushing for this, but I'm assuming that for the long run, it's something that is that -- will not be very welcoming. So just was wondering your view on this.

Okay. We -- I think, if I may say, Azrieli is the leading mall company group in Israel. We put the boundaries in terms of how we come back from corona, from COVID-19. One of the fundamentals is that there is a base rent. There is a base rent, and we go back to the current contracts. In other words, this is something with no flexibility. This is something that is strict. And I would say, I feel quite strongly that the market understands this. They had these demands at the beginning. They got negative, very strong negative answer. And going to the future, we are going back to the old formulas. Just to give you an indication, the 95% and more of the NOI in July and NOI which we expect in August is from a fixed base. So we are going there without any flexibility.

[Operator Instructions] There are no further questions at this time. Before I ask Mr. Henkin to go ahead with his concluding statement, I would like to remind participants that a replay of this call will be available later today on the company's website at www.azrieligroup.com in the Investor Relations section. Mr. Henkin, would you like to make your concluding statement?

Yes. Thank you. I would like to say that I believe that the Azrieli Group is well equipped with excellent portfolio, healthy customer base, together with the right customer mix, providing us the tools to handle the era and move forward with outstanding financial strength. We hope and believe in a good future, and we are well equipped for this. Thank you very much, and we hope to see you again at the investor call next quarter.

Thank you. This concludes the Azrieli Group conference call. Thank you for your participation. You may go ahead and disconnect.