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

Good day and thank you for standing by. Welcome to Azrieli Group's Annual 2022 Conference Call for foreign investors. [Operator Instructions] With us today are Mr. Eyal Henkin, CEO; and Ms. Irit Sekler-Pilosof, Deputy CEO and CFO. [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 and the Media Room 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. Please note that today's conference is being recorded. I'd now like to hand the conference over to your speaker, Mr. Eyal Henkin, CEO. Please go ahead.

Good afternoon and thank you for joining the Azrieli Group earnings call summarizing 2022. This was a very good quarter and a record year in the operating parameters, whether it's NOI or FFO. Based on the last quarter annualized, the NOI is over ILS 2 billion. I emphasize that this 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. I'll give more details on that later. FFO in 2022 we recorded ILS 1.3 billion, excluding senior housing, which contributes another ILS 100 million to ILS 200 million per year. Interest. The Bank of Israel interest continues to increase to 4.25% [indiscernible] at 0.1%. Obviously, the increase in interest increases the input for all companies. But I think that in situations like this, we can appreciate and understand that our low leverage will enable us to be less affected by this process because of 2 major things. One, all of our debt is at a fixed interest, and 90% of our interest is linked to the CPI, while almost all NOI of the Azrieli Group is also linked to the CPI, i.e., these to mitigate themselves. It's a closed box. Their leverage is low 33% net debt-to-asset ratio, which again give us our financial solvency. Signed data center contracts in Compass and Green Mountain are not yet expressed in our NOI, which gives us quite an horizon going forward in the coming 2 to 3 years. Some words about the macro in Israel. Israel economy grew by 6.5% in 2022, which was a good rate compared with the OECD economics -- economies, which, on average, grew by only 2.8% in 2022. Growth of 2.8% is expected in 2023, while in 2024, it's going to be 3 -- it's expected to be 3.5%. Private consumption was up by 7% in 2022 and is expected to increase by 4% per year in the coming 2 years. In Israel, there was high inflation. But when we say high, it's only 5.2%, which was higher than the target but still significantly lower compared to inflation in Europe and the U.S. The debt-to-GDP ratio was 62%, which is quite a good figure. The biannual budget was approved by the government around 1 month ago. And the unemployment is still low, which is a very important parameter for us. It's still around 4%. In this call, we will review all of our operating segments. I'll start with the segments in Israel. The office segment market is doing well, with a need for spaces in high-demand areas despite the changes taking place in the high-tech industry and their impact on the employment market in such field and the repricing of stock and risks in the field. Contract renewals continue to be a positive trend. Examples of contracts are transactions signed in Q4 2022, for example, in Azrieli Tel Aviv, we just signed with a high-tech company 1,400 square meters. The price per meter for months raised from ILS 123 to ILS 147 per meter, 19% increase. We had another high-tech company in [indiscernible], almost 800 meters, ILS 78 it was in the past, went up to ILS 82. One of the largest banks in Israel in Holon, 4,000 square meters. Rental was ILS 42, went up to ILS 70, very long-term contract. Our law firms in Tel Aviv, 6,000 square meters, ILS 110. [indiscernible]. We renewed an option of 24,000 square meters with an increase of 5%. Regarding the customers, there are existing tenants like law firms and accounting, for instance, contracts totaling tens of thousands of square meters, and these are being renewed or will be renewed. And again, we are very humble specifically at this period, but we think they will stay with us. We're still experiencing longer negotiations with tenants. We continue on aiming them strong and good customers, and we believe that one of our strengths is the customer mix. Some words about high-tech after COVID, 2 things. One, people are back to the offices. I would say that people work between 3 to 5 days or 3 minimum to 5 days a week in high-tech. On the other hand, with the turmoil that the high-tech industry went through, there are some -- we see some subleasing going on in the market. We don't see yet an impact as a consequence, but there are still some subleases, which are expanding very slowly, but expanding in the market. To summarize, demand is not as we used to. Decision-making takes time still. Renewals and new contracts with higher rates, and we get very strong customers within our portfolio. Regarding malls, the NOI from the segment is ILS 238 million, the highest in the group's history, an increase of 22% year-over-year. Even without the NOI of Mall Hayam, looking only at the same property NOI, you can see an increase of ILS 90 million in the quarter, up 9%, mainly thanks to the Azrieli, Jerusalem, Tel Aviv Mall, Modi'in, Holon, Givatayim, [indiscernible], Rishonim, et cetera. Very nice -- moderate, but very nice and strong lifting of the NOI in all these assets. March through December 2022 compared to March through December [ 2029 ], we compare March through December because in [ 2029 ], the first quarter up until February 21 was lockdown. So we only start from March. The increase in store revenues was almost 5%, which is very high. And this demonstrates the results of the rework that we carried out in the properties, specifically throughout the COVID stage. We're starting 2023 with a good and solid trajectory, good store revenues. And I would say that we are optimistic about this quarter. Senior housing on track, strong demand. Dozens of contracts have been signed in each of their homes, mainly Lehavim and Modi'in. And 2022 was a good continuation of 2021, which was a strong year as well. We raised prices in 2021 by some 5%, similar to the CPI. In 2022, we signed deposit contracts for 162 apartments in all of the homes, and 23 apartments were occupied. In Lehavim, we finish Stage B. Tenants have started moving in, and we have already reached 39% occupancy, with options and contracts close to 53%. Data centers. The data center segment is a significant growth engine for us and currently comprises some 17% of the group's operations and 7% of the NOI. The market continues to show strong parameters. There is high demand by tenants, mainly hyperscalers. In the European flat B market, the new market supply figures and take-up figures seem to be very strong at an annual level of around 400 megawatts per year. In flat B in Q4 2022, it was extremely strong, with half of all megawatts leased in 2022 having been leased in this quarter. According to CBRE study, the take-up was 202 megawatts, which is above the supply of only 1 84 megawatts, which represent the excess demand in flat B. Hyperscalers was growing strong at 30% last year, very high demand. It reflects increase in rents. And although construction costs are getting higher, the spread is positive. I would say the hyperscalers are doing these days less self-build. So this supports the business of leasing data centers. For us, the [indiscernible] Compass in North America, we had some impressive growth rates in contracted megawatts. In Europe, Green Mountain is in the midst of interesting negotiations for contracts with hyperscalers. We are working to bring it to another -- to other countries as we did with the acquisition in London and the breakthrough with a TikTok contract, which I'll now discuss. Just about these 2 companies, our share of NOI is expected to be $172 million, which is ILS 635 million, which is 4.5x the NOI that we are seeing today from our holdings in Compass and Green Mountain. And this is actually the contracted NOI. In Green Mountain, 2 weeks ago, we reported a significant transaction for the company, which will establish the hub of TikTok in Europe, which will start with 90 megawatts. It is already being built, and it is being built in 3 stages. The first stage is going to be ready by the end of 2023, and it's going to be leased for at least 11 years. The other 2 are going to be ready by mid-2024, with each having 30 megawatts deployment in place. We have an option for another 3 megawatts and another 30 megawatts -- an additional 30 megawatts, which may bring us to 150 megawatts in total. The transaction is expected to produce an annual average NOI for the 90 megawatts of $79 million, assuming its full operation of the 90 megawatts and the total investment in building the project is expected to be some EUR 750 million. Regarding Compass, we increased our holdings from where we've been up to 32.5%, thanks to capital injections, which is actually the maximum we can get. The contracted NOI rate is very high and assumes that these contracts will start to produce income in the coming year. And just about the customers, whether it's Amazon or Google or Microsoft, just to give you some indications. When you look at this company's EBIT line, one might find that for Amazon, for example, 190% of the EBIT line is AWS. It means 100% plus 90%, covering losses of other segments. In Microsoft, it already reached on the EBIT line the cloud activity to 43%. And in Google, which started very late, it's still negative, but it's about to be balanced and go for the positive shortly. Our development pipeline, we finished building and have started to occupy the following 2 projects this year. Multifamily -- first multifamily projects in Israel, we finished it in August, and it's moving very well. The other one is Lehavim Stage B, 110 residents, which, as I said, more than 50% already listed. In 2023, we'll have the Lot 21 in Modi'in, which is a full multiuse complex, and another fully leased for 25 years, commercial area in the north near Haifa. In the Spiral Tower, we have reached the ground floor, and we're starting to go up with the building. From here, I'm going to hand it over to Irit who will review the financial parameters.

Good afternoon to you all. I will now review the main operating parameters in the 2022 financial statement and discuss the statement highlights on annual level. In 2022 reflect the company's continued excellent results. The NOI in 2022 was ILS 1,953 million compared with ILS 1,590 million in 2021. This was an increase of ILS 363 million, which is 23% increase in the results of this year compared with 2021. The malls segment contributed ILS 211 million to the NOI increase among others because 2021 included a waiver on rent and management fees during the COVID lockdown. The office segment contributed ILS 71 million to the increase, mainly from organic growth. And the data center segment contributed around ILS 80 million to the increase, mainly due to the acquisition of Green Mountain in the third quarter of 2021. The same property NOI in 2022 includes -- excludes from the NOI the result of both Mall Hayam and, among others, the results of Green Mountain, which was acquired in August 2021. The company's FFO totaled ILS 1,360 million in 2022 compared with ILS 1,318 million in 2021. The increase mainly derived from the increase in NOI, net of the rise in the management, marketing and interest expenses. The company is building a future growth engine by investing in data centers. The yield will be expressed in the NOI in the coming months, while the growth in financing expenses and G&A is already expressed and evolving the increase in NOI. Please note that in the presentation that was published, you can find current data on the volume of lease agreements, which were signed in data center segment, and that was still under construction, as well as data on the expected NOI generation by quarter over the next 2 years. In 2022, the cash flow from resident deposits in the senior housing, which was included in the FFO, was approximately ILS 81 million lower than in 2021. In view of the high occupancy rate of first-time occupancy of apartments last year, we are pleased that we currently have extremely high occupancy rates, and as a result, have a smaller number of apartments that are marketed for first occupancy. At the end of the quarter, the total value of the group's real estate properties is around ILS 39 billion. In the report period, we invested around ILS 3.5 billion in the acquisition and further development of income-producing properties and properties under development, including purchasing the Mall Hayam in Eilat and closing the purchase of land in Herzliya for the construction of the SolarEdge campus. Depreciation, in respect of fair value adjustments during 2022, totaled around ILS 1.5 billion and derived mainly from a revaluation of the properties in Israel due to the increase in rent prices. The company's net debt is around ILS 16 billion, which is around 33% of the total assets. The company is very financially robust and adds around ILS 33 billion in unencumbered assets in addition to cash balance and deposits totaling ILS 3.4 billion. During 2022, the company has performed an around ILS 3 billion expansion of 3 of its bond series with an average duration of 8.1 years and an average linked interest of 2%. Around 83% of the company's debt is CPI linked multiple bonds in Israel with an average duration of 6.5 years and an average interest rate of around 1.7%. According to the current trading data, the interest rate for debt raising and a similar average duration will be around 1% higher than the company's average interest rate in Israel. So our current ranges are still very comfortable for debt raising. This is why the average cap rate of the company's property is around 6.8% such that the spread between the average interest rate expenses and the cap rate is 5%, which is highly rated by all accounts and which enables company to absorb the marginal increase in the interest expenses to the extent that such interest rates will remain in the near future. The net income from 2022 totaled around ILS 1.8 billion compared with ILS 2.9 billion in 2021. The decrease mainly derived from the NOI increase net of decrease in profits from fair value adjustments and an increase in financing expenses, which mainly derived from the linkage differentials on the debt. The equity attributed to the shareholders totaled ILS 22.1 billion at the end of 2022. The company's Board of Directors approved the distribution of dividend of ILS 700 million, which continues the trend of increasing the dividend amount of previous years and is reflecting around ILS 5.77 per share. Now we will move to the Q&A session.

[Operator Instructions] Your first question comes from the line of Charles Boissier from UBS.

Two questions on my side. The first one is on offices, I think, Eyal, you mentioned that the turmoil in the tech market is affecting the office conditions and overall comments on it, slightly less positive than historically. You mentioned also some subleasing taking place in the office market. What is your expectation in terms of rental conditions and occupancy for the rest of 2023?

Thank you for the question. I would say that -- I put it this way, in the recent 18 months, the rates went up significantly, I would say, 20% to 30% up. I'll say that I don't expect this to continue within the coming year. What I would expect is that all the contracts, which are being opened, which will be aligned with the new rentals or the new numbers that are in place today, but I don't expect the -- I would say, the market to go up again in these figures or, in other words, I would say that it's either will be stable or maybe a little bit positive trajectory in terms of prices. That's how we see it.

Okay. And my second question is for Irit on the financing side. So last quarter, you mentioned that LTV is still very low. And after the development pipeline, probably LTV would go from 33% to 35%, 40%. As interest rates have been going up, as you mentioned also, the debt is 90% linked to CPI. Would you consider an alternative scenario where maybe you would do a bit more on the disposal side to keep leverage at this comfortable level?

Yes. Charles, I can tell you that you are right, our net debt to balance today is 33%. We assume it will be increased because of all the projects in the construction, including the data centers. I don't assume it will be more than 30%. Regarding disposal, this is -- of course, everything is always open, but I can tell you that we are far from this option since we are in a very low leverage already.

[Operator Instructions] There seems to be no further questions at this time. So we'll hand back for closing remarks.

Thank you. I would summarize as following. The group is making strong progress in all the operating parameters in all segments, offices, malls, and continuing in senior housing, of course, data centers. We perform full occupancy rates, NOI for footfall, which is growing double digit, and store revenues in our malls. We focus on the development of our core businesses. In parallel, we are working on the growth engines, and we had a breakthrough this year with the data segment -- center segment in terms of contracts with the digital contract. We believe -- in the data center segment, we believe data is growing exponentially. We think it's the right time in the market of development with high margins, massive growth and the strongest customers in the world. Despite the increase in yields, the contracts are very long and sticky. In a world driven by technology -- [ still ] technology, it only accelerates the need to increase towards space, all leading to data centers. I would summarize that we are proud of our business and financial results, but we work forward both cautiously and conservatively with the uncertainty in the markets. Thank you very much for listening, and we'll see you in the first quarter of 2023. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect. .