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

Good day, and thank you for standing by. Welcome to Azrieli Group First Quarter 2023 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 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 would 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 Q1 2023. This was a good quarter with continued growth in the operating parameters, whether it's NOI or FFO. The annualized NOI rate based on the last quarter [Technical Difficulty]

Ladies and gentlemen, please continue to standby . The conference will resume shortly.

[Audio Gap] FFO in Q1 2023, we recorded NIS 335 million [indiscernible] quarter-over-quarter, excluding senior housing, which contributes another NIS 50 million, but in total NIS 350 million in the quarter. Last year, we had more residents, more rental apartments in Lehavim, which this year is already almost full. The FFO was still partially offset by the effects we spoke about in the previous quarter regarding the fast growth of the group's operations. Interest. The Bank of Israel interest rate continued to rise to 4.75% after several years at 0.1%. Obviously, the increase in interest increases the inputs for all companies. But I think that in situation 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 reasons. One, all of our debt is at a fixed interest rate; second, the leverage is low, it's 35% net debt to assets ratio. As you can see on Slide 39, the average duration of the debt is long. In recent years, we extended the average duration to 5.7 years after 2.3 years back in 2014, and we lowered the average interest rate from almost 5% a decade ago to around 2% at present. The last point on the general comments I would like to add is that we signed substantial data center contracts, both in Compass and Green Mountain. I will go over it later. Some additional indicators about the macro Israel economy. The Israel economy grew by 2.5% in the quarter. Growth of 2.5% is expected in the entire 2023 year and the growth of 3.5% is expected for 2024. Private consumption was down 1.7% in the first quarter of 2023, and it is expected to rise to 3.5% in the entire year and 4.5% in the next year 2024. There was 5% inflation rate in April 2023, which was higher than the target but still lower compared to other areas like Europe. Nevertheless, the interest rate rose this year for this quarter from 3.75% to 4.75%. The debt-to-GDP ratio was 60.9%, which is very good figure in any dimension. With the various discussions regarding the legal reforms in Israel, the rating agency Moody's confirmed Israel's Aa1 rating, changing the outlook from positive to stable. In this call, we will review all of our operating segments, but I'll start with the data center segment. The data center segment is a significant growth engine for the Azrieli Group and currently constitutes some 20% of the group's asset base. We can see that its contribution is growing. This quarter, it contributed NIS 39 million, approximately $11 million to our share of the NOI, which is $45 million on an annual basis even before the signed contracts in the data center companies. The market continues to demonstrate strong parameters. There is high demand from tenants, mainly hyperscalers. We can see significant demand as a result of both cloud development and the immense surge of AI. In the European FLAP-D markets, namely Frankfurt, London, and also Amsterdam, Paris and Dublin, the market take-up in 2022 was 384 megawatts but expected to grow in 25% this year to 480 megawatts. In FLAP-D, on the fourth quarter, it was extremely strong with most of the 2022 leases made in this quarter alone. According to CBRE study, it is a take-up of 202 megawatts, which is above the supply of only 184 megawatts, which represents the excess demand in FLAP-D, which we aim for. In Azrieli, as we mentioned, our strategy is to develop the data center platform. As we presented on our investors presentation on Slide 16, you can see the outline and timeline for our subsidiaries to reach an outpoint of 201 megawatt, our share, at which point our share of the NOI is expected to be $172 million, which is around NIS 640 million. One of this is based on signed contracts, completion of construction and entry into income production within the next 2 years, assuming that we maintain the current holding rates in the 2 companies. In Compass in Northern America, the company presents significant and impressive growth rates in contracted megawatts as well as in the expected NOI from signed contracts. In Europe, through Green Mountain, which is in interest in negotiations for contracts with market leaders, we are working to bring it to other countries like we did with our acquisition in London, the partnership in Germany, Frankfurt and the large contract we had with TikTok back in Norway. Some elements in Green Mountain. In January, we completed the acquisition of the Romford site in London. It's a 40-megawatt secured Green IT load, with 2 loads that we are developing. In March, we reported a significant transaction for Green Mountain to build a data center campus for the entire European continent for TikTok, which will comprise several buildings with an initial capacity of 90 megawatts. In April, we reported a transaction for Green Mountain to build a data center campus in Frankfurt together with KMW, the local -- 2 local municipalities with secured Green power of 54 megawatts. In Compass, the contracted NOI rate is very high, and we will see these contracts start to produce income in the coming year. Please take into account that our holding structure in Compass is under review and that the lockup on the shares was removed to our partners early 2023. And to the best of our knowledge, the partners in Compass are exploring the possibility of disposing their holdings. Our agreement with our partners provides separation mechanisms. Last point regarding data centers is about their customers. The major customers, both for cloud and AI, are Microsoft, Google and Amazon, all of which having a substantial part of their EBIT line comprised of cloud profits and projected in the future with AI profits. In Microsoft, 42% of the EBIT line is coming from the cloud. In Amazon, all of the EBIT line is actually coming from the cloud. And I would say that in Google, which started very late in this market, this is the first quarter where they have positive operating income, and it's growing more than 30% quarter-on-quarter. Regarding our backbone and traditional and very, say good real estate offices, the NOI from the segment grew 10% year-over-year, all in the same property. Generally, as you are aware, and here, there is a certain slowdown in the demand for rentals with a rising sublease market. Nevertheless, there is still demand in central areas from large and strong companies. The conference renewals continue to be in a positive trend, and there are transactions for very high rents. Some examples regarding office contracts. In the Azrieli Center, one of the largest accounting firms list almost 10,000 square meters with a rise of rental of 24% rent per square meter. In our business park in Holon, we had both one of the largest banks with 4,000 square meters, rising from NIS 41 to NIS 71, which is 72% growth in the rent per square meter. And we had another technology company with more than 7,000 square meters, which prolonged its contract for another 7 years in more than NIS 60 per meter. In the Sarona building, where the new tenants are taking the place of a previous tenant, which is going to end its contract by the end of 2023, the previous one was NIS 160 per square meter. The new one is NIS 190 per square meter. The overall meters are 4,300 meters and the contract is for 10 years. In Herzliya, we had another lease of almost 1,000 square meters of existing technology company with NIS 100 per square meters rental, which is one of the highest in the recent years. Other contracts were renewed with, I would say traditional law firms and accounting firms for tens of thousands of square meters. Still, we are experiencing longer negotiations with tenants, but we have always listed strong good companies, and we believe that the effects will be demonstrated in the customer mix and the average term of the leases. Regarding malls, the NOI from the segment was NIS 238 million. In this quarter, the highest in the group's history and 20% higher than the quarter-over-quarter. Even without the NOI of Ayalon, which is the [ Southern ] mall we bought, when we look at same properties, the increase is 9%. In January to March, it was an increase of 14.2% in the store revenues in the malls. In terms of occupancy, we see today an occupancy of 99.4% in our malls' deployment, and we have opened stores and brands that are in new in the Israeli market from Sunglass Hut to [indiscernible] that we're going to open by the end of the year and other brands. Senior housing NOI is up 19%. The occupancy rates today are 97%. The price environment in Q1 is unchanged, and we are succeeding in maintaining price levels also during this challenging period. We raised prices according to the rise in the CPI. Development pipeline in Q1, we are continuing the development of projects. In 2023, we will complete and launch Modi'in, Lot 21, which is a mixed use of offices, retail, rental apartments and the [ hotel ]. From here, I hand over to Irit who will review the financial parameters.

Good afternoon, everyone. The first quarter reflects excellent results with continued growth in the NOI, same-property NOI, store revenues, mall traffic and high occupancy rates. The NOI in the quarter was approximately NIS 525 million compared with NIS 456 million year-over-year. The 15% rise in the NOI of NIS 69 million year-over-year is mainly derived from the retail segment with share of the increase total of NIS 40 million and around one half of the amount is from the acquisition of Mall Hayam in Eilat and the other half from organic growth in the rent. Approximately NIS 18 million derived from an increase in the office segment, mainly from organic growth in the rent. NIS 2 million derived from an increase in the Senior Housing segment, mainly due to the growth in the occupancy rate of the homes in Lehavim and Modi'in. NIS 2 million derived from an increase in the residential rentals segment in view of progress in the marketing of the Azrieli TOWN project in Tel Aviv, which is in occupancy stages. The offices in the U.S. segment negatively contributed to the NOI by approximately NIS 2 million. And the data center segment contributed NIS 9 million to the rise mainly from completion of properties and hand over to the tenants. The same property NOI in the quarter present a trend similar to the NOI. In fact, the gap between them derives mainly from discounting the acquisition of Mall Hayam in Eilat and a data center whose construction were completed in the report period in North America. The company's FFO, excluding senior housing, totaled NIS 335 million in this quarter compared with NIS 310 million year-over-year. The 8% increase in the FFO correlates with the increase in the NOI net of increased interest expenses. The cash flow from senior housing residents deposits, which was included in the FFO was around NIS 12 million lower year-over-year, in view of the high number of the apartment occupied last year for the first time. We are now pleased to be seeing very high occupancy rates. And as a result, there is a smaller number of apartments available for first time occupancy. As of the end of the quarter, the total value of the group's real estate properties was approximately NIS 41 billion. This value does not include our share in the real estate properties of Compass, which is presented according to the equity method. In the quarter, real estate properties increased by around NIS 1.5 billion, both due to the acquisition of companies in the data center segment in England and due to development of income-producing properties and properties under development. In the report period, the company recorded value appreciation due to fair value adjustments of investment property of NIS 362 million deriving from an update to the rent in contract linked to the rise in the CPI and from an update to valuation to real estate properties in Norway in data center segment in which significant lease agreements were signed during this quarter. The company's net debt totaled NIS 16.9 billion, and it reflects 35% net debt to balance. The company's average effective interest rate is 2%, with an average duration of 5.7 years. The company is very strong, and has approximately NIS 34 billion in unencumbered assets in addition to cash balance, deposits and securities totaling NIS 3.2 billion. The net profit in the quarter is NIS 377 million compared with a profit of NIS 336 million year-over-year. The increase is mainly derived from growth in the NOI and an increase in profit from fair value adjustments. We will now proceed to the Q&A session.

[Operator Instructions] And the question come from the line of Charles Boissier from UBS.