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

Thank you, and good afternoon, and thank you for joining the Azrieli Group's second quarter conference call for international investors. I'll start with an update on COVID-19 and local GDP data. The economy now opened up and hopefully will stay open with a potential trend of decrease in illness. Thanks to the third vaccination campaign. As of mid-August 2021, 1 million people are fully vaccinated with the third dose, 5.4 million people have had the second dose and 900,000 people have recovered. This makes 85% of the eligible population vaccinated in Israel. The GDP increased in the quarter, 15.4% compared to Q1 and is up 15% from Q2 2020. This is an effect on private consumption, which is up 36% annually. Therefore, the local economy figures are looking quite good. Going to Azrieli Group, I'll start with the data centers, market strategy and the recent acquisition we -- we're finalizing these days. About the market, the data center space is now considered one of the fastest-growing industries worldwide. U.S. REIT prices in this market are at all time high. We perceive this market as a high-growth market with a good fit for the Azrieli Group. There are a number of reasons which I will go through in a minute. One, is pure income producing real estate, some look at it as infrastructure, some look at it as technology. We perceive it as pure income producing real estate, instead of people, you have service. It is an income-producing real estate market with 34% annual growth, not comparable to any real estate market in the world. The market is driven by the huge growth of the cloud, 5G, streaming, gaming, VR, whether it is the Facebook, metaverse or others. It is fueled by the AI growth, autonomous vehicles, crypto, HPC storage and others. It encompassed the most strongest and super large customers in the world, particularly Microsoft, Amazon, Google, Oracle, IBM, Salesforce, Netflix and others. It combines very long and very sticky contract. It is a market requiring significant development and engineering expertise with critical time-to-market capabilities perfectly fits with the Azrieli Group capabilities. It incorporates attractive high single-digit and double-digit yield on cost. It is a capital-intensive market where cost of capital is a material factor. And it is a market with several channels where the prominently growing channel is hyperscale with an exclusive members club of data center providers which are deemed hyperscaler fit, of which only few signed contracts with any or more than 1 hyperscaler. It is a global market with the same customer base and the same teams managed from Seattle, Ireland or others for all the major territories. About our strategy. We believe in data centers and that it will serve as significant growth engine for the group. How are we planning to grow in this market? As we mentioned before, our strategy is to acquire platforms with aggressive growth potential in the secondary -- mostly in the secondary markets and to expand from there into the main markets. We started with both in America -- both Canada and the U.S., and we chose this market, first of all, because it's the largest one. Second, it's highly mature. It's a sophisticated market with suppliers, regulations, advanced interest through with common practices, and the markets of [ Nova ], DFW, Phoenix are amongst the 5 largest markets in the U.S., together with Montreal and Toronto which are growing enormously within the recent years. It's a market with some of the largest or the world's largest hyperscalers, and we are there developing our assets. We are making strong process with development. I remind all of us, we started with acquiring a stake in Compass with $18 million NOI, 2 years ago. Today, we're reaching $85 million NII and beyond, which is 5x as much as what we bought. This is only through the some M&A, mostly development. At the same time, we're looking for platforms in Europe. And why Europe? Because it is high-growth market, development yields 250 to 500 basis points higher than the U.S. It is a market that the major U.S. cloud players are entering aggressively, where self-build is still very scarce. If in the U.S., it's some -- it's between 40% and 50%. In Europe, it's less than 15%, 1-5%. It is a market with barriers to entry and local expertise. We are planning to acquire a number of strong platforms, consolidate them under one roof, one umbrella, to do a reverse merger with Northern American business and proceed to expand from there maybe through an IPO or other ways of expanding the business. About Green Mountain transaction. We've been looking it for some time for several companies in Europe, whether it's in Switzerland, U.K. and Nordic. We looked for a company in a secondary market, having strong management with potential, solid high-quality engineering, proven time-to-market capabilities and an existing stable and growing installed base. We look for a company with hyperscale customers and capabilities, which complement Compass and in synergy with Compass to provide a global presence for hyperscale customers worldwide. Green Mountain will serve as a platform for development from the northern part of Europe, South part, to be hopefully joined with the central, maybe Southwestern and maybe U.K. based platforms that we will acquire. What's the advantages for Norway and the Nordic countries? One is [ TUC ], very low electricity costs, lowest in Europe; very good power availability; high government support, whether in tax or other policies; close to most of the European population with improving latency and high connectivity. As we speak, there are 2 subsea cables that are being laid between Norway, the U.K. and the EU continent. And it's 100% green energy which is very important to our large customers and in fact, to all customers, and it's one of the values of the Azrieli Group. In terms of the advantages of Green Mountain, we found an excellent, very good experienced management, which is a key factor for us. There's a very solid engineering capabilities. It has significant experience in marketing relationships with top customers. There's many years of experience in enterprise, design, location and development of land for data centers. It has facilities with close and available power sources. It is high connectivity sites, close to fiber infrastructure. Its assets rely on 100% alternative energy, green energy. Again, as I said, it is very important for the customers and for us. And we are going to make the closing scheduled for August 24, which is next week. About the customers in this segment, which I would like to point out. If we look at the segment, the most important customers are 3: Amazon, Google and Microsoft. If we look at Amazon in this quarter, just to understand, in 2020, Amazon grew in the cloud, 28%; Q1 2021, it grew 32% and in Q2; it grew 37%. Amazon is having a market share today of more than 50%, almost 54%, still growing 37% quarter-on-quarter. The cloud is generating 13% of Amazon revenues, but 54% of the EBIT line. Google, the revenues in cloud grew 53% quarter-on-quarter. On the first quarter, it grew 43% quarter-on-quarter. In other words, additional 10% growth. And Microsoft Azure, revenues as of today for the quarter -- for this quarter was $17.4 billion, 30% higher compared to Q2 2020. And this makes something like almost 40% -- 38% of Microsoft's revenues, growth is 30% to 50% quarter-on-quarter. And in terms of operating profit, it is today 41% of the profit of Microsoft and its 47% increase quarter-on-quarter. So this is -- these are the reasons why and how we see the data center space, what's our strategy and how we continue growing there. Going back to Azrieli Group's traditional flywheel. Malls. We have a strong rise in all parameters. We are back with an occupancy rate which is between 98% to 99%. More footfall and store revenues have been good and growing since reopening on February 21. About the local Israeli customers, Israelis cannot leave the country today, almost to any place in the world, and there is a lot of liquidity in the market. Thus, Mall customers have a very strong hunger to return to routine into their customer habits. We saw this at openings after previous lockdowns. February through June 2021 compared with the same period in 2019, store revenues increased 5.2%, excluding businesses that were closed down or partially operated. We are taking intensive measures to adjust the mix in Jerusalem Mall, Modi'in Mall, Azrieli Tel Aviv Mall and Givatayim. Most of the stores, 16 total, accounting for about 9% of the NOI will be reopened in new, very attractive mix throughout Q1 2022. Offices. As we speak, Azrieli is missing at least 60,000 square meters. We just don't have enough inventory and there's lots of demand. Generally and specifically speaking, at Azrieli, I believe we enjoy very strong product, service and customer service, which provides us very high customer loyalty. The demand in the market is far -- is by far the strongest ever. The offices segment continues to perform very well, and we are signing large lease transactions at high rental prices. In Israel, Israeli companies are now back at the office with close to 100% employee attendance. And international companies like Facebook, Amazon, Intel, also have many employees back at the office. Companies are recruiting large number of employees, specifically in the technology sector. Companies like Facebook and Amazon are taking more space and paying for the best office space. Some examples of contracts or transactions in the offices which was signed in the second quarter and until the end of July. At the Azrieli Center in Tel Aviv, we had the leasings of more than 1,000 square meters, which were before ILS 109 per square meter per month, from ILS 109 to ILS 138, from ILS 78 to ILS 135, from ILS 115 to ILS 125, from ILS 105 to ILS 150. In other words, between 15% to 30% increase in the new rentals. In Sarona building, there's a phenomena where technology companies, which are growing, have no space to grow. And unfortunately for them and for us, they have to live and look for other office buildings. With the remaining ones, they are growing fast and occupying the vacant square meters. To give you some proportions of what's going on there, from ILS 139 per square meter, it's growing to ILS 150 with the new expansions. Another expansion from ILS 139 million grew to ILS 160. Another expansion from ILS 129 to ILS 175. In other words, we have very good contract renewal trend which is very positive and continuously growing. Senior housing. Senior housing is on track with strong demand. The very high resident satisfaction with our COVID-related management goes to the best marketing we have, which is word of mouth. Dozens of contracts were signed in all the senior homes, mainly in the new Lehavim and Modi'in Palace, our senior housing, while Tel Aviv and Ra'anana maintained close to full occupancy. We raised our prices by 8% at the beginning of the year and by 5% in the middle of the year. Lehavim, which we opened on the first lockdown in May 2020, we are finishing Stage A with a marketing rate of 82%. 160 out of the 241 apartments have been occupied, and additional 37 have been marketed and sold and are about to be occupied. Stage B, which is 109 apartments is being launched with occupancy scheduled for July 2022. Modi'in which was opened back in October 2018, is already 98% sold and 95% occupied. Development pipeline. Currently, the Azrieli Group is developing approximately 1.1 million square meters. Where the phenomenal deal signed with SolarEdge which is a $14 billion market cap company for a 38-square-meter -- 38,000 square meter campus. This is going to generate about ILS 63 million a year NOI. And adjacent to this we're going to build additional 50,000 square meters, which are going to generate the same. This is going to be finished and occupied on March 2025, and we're already starting working. We completed in 2020, the following projects on time, on budget. Lehavim Senior Housing, we discussed it before; Manor, which is a building of 28,000 square meters, occupied by Bezeq. Bezeq is the AT&T of Israel back in October 2020, 3 months ahead of schedule during COVID-19. And Azrieli Town the first building out of 3, which is the office building having 4 prominent companies, PwC, Fischer Behar, which is one of the 3 largest law firms in Israel. All of the R&D of Samsung in Israel. And WeWork, which is fully occupied already. There are 3,200 employees in this building and all the tenants moved there in January 2021. Just to give some measure and understanding of the numbers, this building, land plus building was -- the cost was ILS 670 million. Annual NOI is ILS 72 million a year, which is a yield on cost of a double-digit percentage. The residential and retail areas are scheduled for completion in 2022. All our long-term projects are -- we are building as usual. And going back to margins, the margins on the projects under development, the yields are over 80%, sometimes over 10%. And compared with the cost of capital, it's a very impressive spread. Debt and leverage. In July, we made an exceptional debt raising. We raised ILS 3.655 [ billion ] in 2 series with a long average duration 9.3 years and 13.2 years with a weighted interest rate of 1.278%, less than 1.3% interest rate. Last thing for me is the ESG. We're in the process of finalizing a new broad and significant CSR policy. We're starting with segments connected and related to real estate, such as green building. We have a huge program of recycling and waste reduction in our facilities. We're continuing and refreshing our corporate governance and ethics policy. We are refreshing our employee-related policy. We're working on social initiatives, both at the properties level and also at the headquarters level. And of course, we're working on a new donation policy. We are close to finishing our ESG corporate social responsibility report, which we expect to release sometime around October this year. Irit will take this from here to review this quarter's financial parameters.

Good afternoon, everyone. The second quarter reflects -- reflect a return to routine as demonstrated by all operating parameters for the quarter. The NOI in the second quarter was approximately ILS 407 million compared with approximately ILS 232 million year-over-year, and approximately ILS 400 million, if we compare it to the same quarter in 2019. The increase of ILS 175 million year-over-year is mainly derived from the retail segment with share of the increased amount to ILS 157 million due to the COVID-19 tenant relief and the rent waivers in the second quarter of 2020. Approximately ILS 50 million derived from the increase in the office segment, mainly from the completion of the construction of Azrieli Town in Tel Aviv and Azrieli Hamanor in Holon, a first by Bezeq's move from the Azrieli Tower Tel Aviv to the new building we built for them in Holon. Approximately ILS 4 million derived from an increase in the Senior Housing segment, mainly due to an increase in the occupancy of the homes in Lehavim and Modi'in. Even though Modi'in and definitely Lehavim have not yet reached the long-term run rate when they stabilize at full occupancy. There was a decrease of approximately ILS 2 million in the U.S. Real Estate segment, which was derived in its entirety from the decrease in the U.S. dollar exchange rate. The same-property NOI presents a trend similar to the NOI. In fact, the only properties which are not included in the same-property NOI are the Hamanor building in Holon, whose construction was completed in October 2020; the Senior Home in Lehavim was -- construction was completed in May 2020; Azrieli Town that we completed in 2020 in December; and the last assets that we bought this year in Tel Aviv in Mikveh Israel street. The company's FFO totaled approximately ILS 371 million in this quarter compared with ILS 199 million year-over-year and ILS 333 million if we compare it to the same quarter 2019. The increase of ILS 172 million in the FFO correlates with the increase in the NOI net of tax expenses. And in addition to a significant increase from the Senior Housing operations, which contributed another approximately ILS [ 38 ] million to the FFO from the differences from quarter to the corresponding quarter. At the end of this quarter, the total value of the group's real estate properties was around ILS 30 billion. In the statement period, we invested approximately ILS 490 million in development of income-producing properties and the development pipeline, including an investment of ILS 191 million for the purchase of the office property on Mikve Israel, in Tel Aviv which is currently known as Abraham Hostel. In the quarter, the company recorded an increase in approximately ILS 292 million due to the fair value adjustments of investment property, which is mainly derived from the cancellation of the provision for COVID-19 relief in the short term. And also from an increase in rent which derived from an increase in the CPI. The company's net debt is $9.5 billion -- sorry, ILS 9.5 billion. And it considered -- it constituted approximately 27% of the total assets. Similarly to the previous year, the said debt does not include the last debt raising of ILS 3.6 billion, which was carried out by the company approximately 1 month ago with an average duration of 11.5 years and an average interest of approximately 1.3%, and which will be expressed in the Q3 statements. The company's average effective interest rate after the said debt raising is 1.5%, which with an average duration of 6.8 years. The company has around ILS 25 billion in unencumbered assets, which constitute 70% of the company's assets. The net profit in the quarter totaled ILS 383 million compared with a loss of ILS 72 million year-over-year. The increase is mainly derived from an increase in the NOI plus an increase in fair value adjustments, net of the increase in financing expenses for linkage differences. The equity attributed to shareholders totaled ILS 18.3 billion at the end of the quarter, which was after the distribution of ILS 600 million dividend this year. We will now move to the Q&A session. Go ahead.

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

I have two questions. The first one on data centers. I think, Eyal, you mentioned the strategy of starting in the secondary market and then expanding into the main market. And I was just wondering, apologies, if it's a silly question, but what do you mean exactly by secondary market? Do you mean in terms of acquiring existing sites? And then going into more development or more in terms of location? So that is my first question.

We're -- when I say secondary markets, for example, in North America, the major markets are Northern Virginia, Dallas, Fort Worth, Phoenix, Chicago, et cetera, and Silicon Valley. The other ones are anything, whether it's Atlanta, whether it's Toronto, Montreal, et cetera. So -- and in Europe, the [ flat D ] market, which are Frankfurt, London, Amsterdam, Paris and Dublin. And there are other markets like whether it's the Nordics, whether it's Munich or Berlin, whether it's some areas in Lyon, France, Madrid, Milan, Switzerland, et cetera. So our policy or we're trying to start penetrating a territory from secondary markets, where it's not very, I would say, crowded in terms of demand or competition even though there was quite a competition on Green Mountain. And the margins are much higher compared to the high-volume markets. So we start -- we try to start there and then expand to the major markets. What happened to us in Northern America was our plan to start with a company named Root, which was in Montreal. And at the middle of the process we understood it, we are competing against Compass, which was our second stage in terms of entering the major markets. So we joined hand with -- we acquired a portion in Compass and then we bought Root. So we saved 3 or 2 to 3 years. And the whole plan was shortened tremendously. In Europe, we're trying to do the same.