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

Good day and thank you for standing by. Welcome to Azrieli Group's Second Quarter 2023 Conference Call for Foreign Investors. [Operator Instructions] With us today are Mr. Eyal Henkin, CEO; and Mr. Ariel Goldstein, CFO. [Operator Instructions] This conference call will be accompanied by the 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 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. 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.

Okay. Thank you very much and good afternoon. Thank you for joining the Azrieli Group Earnings Call summarizing the second quarter of 2023. We've just ended a good quarter and half year in the operating parameters with strong figures which exceeds the targets in all of the operating parameters, which I believe will continue until the end of the year despite the market conditions and uncertainty. The group has a good NOI rate of NIS 2.1 billion a year annualized with -- we have reported the sale of our holdings in Compass with impressive figures in for cash, which will help us to further improve the group's equity base. Concurrently, in Green Mountain, we signed significant contracts in the quarter with a very strong pipeline of significant transactions, which will be expressed in the coming year or 2 that I'll refer to later. We're at high occupancy rates in our malls, offices and senior homes, and we benefit from a good mix from contracts with long average duration. The interest rate environment obviously impacts the industry, although I know that the debt ratio in Azrieli is low, and approximately 90% of the debt is linked similar to most of the NOI, which is linked to the CPI. In addition, once the Compass transaction closes, it is expected to reduce the leverage ratio and to contribute to the group's already strong cash flow. Beyond this, it seems that the market is pricing a halt and even a drop in interest rates in the medium to long term. So with both the expectation for substantial cash from the cash -- from the Compass transaction and the expectation for interest or CPI drop, in the mid- to long term, we are currently trying to finance in -- our debt in a short-term method. In terms of development and construction, I can say that on one hand, we're continuing to develop the projects with an emphasis on projects like SolarEdge or the largest medical institute in Israel, Clalit, for which we signed long-term contracts. While at the same time, we are managing the development pipeline in a careful, informed and I'd say, balanced matter -- manner. Offices, first of all, we are pleased with the results. On the other hand, we are taking moderate actions. NOI increased by 7% in the quarter year-over-year and 9% compared to the same half year, all same properties. The market is not what it was. The uncertainty generates long negotiations and difficulties in making decisions. Still, we're signing high-volume contracts and mostly with existing tenants in-house, which I would say that we're really proud of this fact in terms of how they look at the product, how they get the service and what's the product mix that we have in our buildings. Tenant mix includes technology companies and liberal professions. We have an exposure to high tech, which is around 40%. When I say high tech, these are the strongest technology companies in the world from Intel to Proofpoint, IBM, Samsung, Amazon, [Facebook], Appian [indiscernible], et cetera. We just signed a very large deal, as I said, with Claritin Modi'in in Lot 10. It took us a few years to sign this deal and negotiate. This is a real anchor transaction. We're moving ahead with shoring an excavation. And by contract, we should -- they should occupy within 39 months. I think we can have it earlier by 1 to 2 quarters. It is going to be a medical center, the medical center, between Tel Aviv and Jerusalem with emergency medical rooms, operation rooms, advanced imaging systems, innovative treatment rooms, MRI, advanced medical institutes and more. We're establishing an ecosystem with a mixed-use concept in the Azrieli Modi'in Center, which will include hotel, retail, rental housing, clinics for doctors, main medical professions and the medical center. To summarize the office, tenant mix and long lease periods allow for the bridging of the current environment of uncertainty. A decline in demand is noticeable, but nevertheless, we are managing to maintain high occupancy, renewals -- renewed agreements with increased rent. Regarding malls, we have ended strong quarter for the entire portfolio. NOI is NIS 244 million. We're on the track of getting to NIS 1 billion NOI a year in the malls. It's the highest in the group's history, and it's up 19% year-over-year. Same-property NOI is up NIS 14 million in the quarter and NIS 34 million in the first half of the year, up 9%. We have full occupancy throughout the portfolio, 99.3% occupancy. H1, first half of '23 store revenues up 8.1% in same-property. And in terms of footfall and traffic, we have 12.5% increase this year in same-property compared with the first quarter of 2022 with a total increase of 22% in footfall in the entire portfolio of the malls in H1 2023 year-over-year. At the moment, the third quarter is also looking very good for the malls. Regarding senior housing, NOI in Q2 is up 19% year-over-year. The uncertainty in the second-hand apartment market created delays in decision-making, especially among the elderly population. In terms of occupancy rate, we are 92% with Lehavim Stage 2, which we opened in June 2022. In Lehavim, we are already 86% of the project which has been sold or under options. We are approaching exhaustion of inventory in existing homes. We are making progress with a senior home in Rishon LeZion in Rakafot. We're continuing to look for development opportunities in other locations. Regarding the Data Center segment. The Data Center segment is a significant growth engine for us. We believe in the prospects and growth of the industry in both the short and long term. The market is driven by 2 engines: one is the cloud, second is the AI. In both fields, we see massive market growth and demand -- and significant demand. We see the same customers we have today, which is extremely important, mainly hyperscalers like Microsoft, Google, Oracle, Amazon, HP and others. The emphasis is a double-digit yield on cost, which is our main objective, specifically in this high interest rate environment. And we get, I would say, between 11% to 13% yield and cost projects. Significant projects with strong customers and very long contracts, up to 16 years, 1-6. Regarding the sale of Compass, a reminder of how it all started. We entered the DC industry with an acquisition of less than 20% stake in Compass in North America, the most advanced and mature markets. We developed the company and increased our holdings to 1/3. We started the industry through our minority holdings. We determined a lockup period of 3.5 years with our partners, after which, our partners had an exit option. We don't -- our nature is not being a minority, so we consider either buying or selling. A bidding contest was held in which we consider taking over the company as part of a consortium we've built with 3 -- with other 2 investors, 1 strategic, 1 financial, international, very big ones or selling the company. At the end of the process and with the current sale price which is higher than we expected, we decided to sell. The transaction improves the group's net debt to assets ratio by 3% to 4%, and it will prove -- and the transaction will improve the group's liquidity. The investment in Compass will give us a yield of 2x to 2.5x on our original investment, which was around NIS 1.2 billion with a duration of 2.3 years and a gross IRR of more than 40%. The sale price, Compass is being sold for $5.5 billion to $5.7 billion, which is around NIS 21 billion. Equity net -- equity value net of debt is around NIS 10 billion. Just to give you a sense of how it works with data center companies and what is a high-growth company. We have the NOI -- the actual NOI, not the contracted, the actual, which is on a growth, very high steep growth pattern. We have an SG&A which support this growth pattern, and we have all the financing that we need to invest. All of this brings us to a high impact on the FFO, which is negative. And in Slide 38, you can see what it means negative. It means that this quarter, if we didn't have Compass, the FFO would have been instead of NIS 357 million, it would have been NIS 370 million, which is 3% -- excuse me, 4% higher than it is today. And from this quarter on, the Compass activity will be on a hold pattern, I would say, and it will not be included in the NOI and FFO. Ariel will go over it later. Regarding Green Mountain, good growth, transactions that will generate income within a short period of time, very long contracts with good volumes and yields with the largest and strongest hyperscalers in the world. There's a strong demand in Green Mountain, which proves 2 main elements. One, Norway. Norway is an island of stability in the world, readily available power, unlimited power -- unlimited redundant power, all this power is real green energy, and the electricity costs are much lower than any market, either Frankfurt or London. And the climate is great for data centers in any sense in terms of low temperatures. This is one element. The second element, the company Green Mountain has a very good management, very high-quality, strong product and robust relationships with the major customers in the market. All this brings us to a very, I would say, a stronger funnel of deals. And when we talk about deals, we signed the TikTok deal back in March 2023. Actually, we're building TikTok's European hub in Norway. We start with 90 megawatts. This is the first stage. And we're -- it's going to start producing income by the end of Q4 this year. We're going to have this project fully finished by mid-2024. And the expected annual average NOI is going to be around $80 million. The total expected investment was originally EUR 750 million, but we reduced it and it's going to be below EUR 712 million. Regarding other developments this quarter, we closed the acquisition in London, 40 megawatts. This is a front post for Green Mountain. We closed the JV with KMW, another 54 megawatts compass in Frankfurt. In total, 94 megawatts in the 2 largest and growing markets in Europe, Frankfurt and London, all with a committed green power already available. As we said, in Green Mountain, we have 100% of the data centers which use green alternative energy. It's important both for us and both to our customers, specifically with the stringent ESG policy both they and us have. In the presentation, we released broader data about the segment and its expected contribution totaling almost NIS 0.5 billion a year starting 2025, excluding new contracts, which I believe will come in during the period. You can see this in Slide 16 in the presentation. To summarize the data centers, we believe in the industry; Compass price, above and beyond expectations. We're continuing to strengthen the development data center -- of Data Center as a key business for Azrieli. We're focusing on developing Green Mountain as the platform in Europe. And we're planning to have a 1-day Data Center seminar during Q4, we will send the invitations. Well, the last thing I will add before handing over to Ariel is the development. We have development in construction according to plan. Lot 21, Check Post, Rakafot senior housing, SolarEdge Campus, and Town E zoning plan for the third tower, the best location in Tel Aviv with more than 90,000 square meters. And of course, the Spiral Tower, which is we see it growing in front of our eyes. We're strictly controlling and managing investments. We're managing project time line in a careful and considered manner and in accordance with demand and making acquisition sparingly, very cautiously. I will summarize by saying that we are pleased that we are moving ahead with cautious. I will now hand over to Ariel, our CFO, for a review of the financial parameters. Ariel has taken up office recently. He has huge experience in the real estate field, immense knowledge and intelligence. And I would like to take this opportunity and wish you, Ariel, much success, please.

Thank you, Eyal. We will now go over the key financial parameters. This was another quarter with continued growth in all of the operating parameters. The NOI is NIS 559 million, which is up 18%. There was a total increase of NIS 86 million. The NOI increase mainly derived from the Retail segment, which contributed NIS 39 million. A large share of this increase derived from the acquisition of Mall Hayam Eilat and the rest from an increase in rent. NIS 40 million derived from the increase in the Office segment mainly due to increasing rent. There was another NIS 3 million increase in the Rental Housing segment, mainly due to the progress in marketing and occupying the Azrieli Town project in Tel Aviv and NIS 2 million from an increase in the Senior Houses segment due to the occupancy of the Stage B of the Lehavim Home. The Data Center segment contributed NIS 27 million. NIS 22 million of the growth is due to the completion of the construction of data centers and the handover to customers in Compass. Our data center company in Norway, Green Mountain, contributed NIS 5 million mainly due to the inclusion of the first time in the quarter of the data center company acquired in England. The same-property NOI was NIS 509 million, which is up 9%. The gap between the company's same-property NOI growth and NOI growth is mainly derived from the exclusion of the acquisition of Mall Hayam Eilat, the exclusion of the increase in the Compass data centers' income production and the exclusion of the results of the acquisition of data center company in England. The company's FFO excluding senior houses totaled NIS 342 million, which is up 11%. The total FFO, including senior houses, was NIS 357 million, which is up 8%. The increase in the FFO was partially offset by the increase in interest expenses and NIS 7 million decrease in the FFO for the senior housing operation. In the previous quarter, in the second quarter of 2022, we had significant increase in resident deposits, and Stage B of the Lehavim project was being occupied with residents. As Eyal mentioned, the total quarterly FFO, including senior houses and net of the Compass results, were NIS 370 million compared with NIS 337 million year-over-year, which is up around 10%. At the end of the quarter, reinvestment properties and investment properties under construction totaled around NIS 42 billion. Reinvestment in Compass is presented in this quarter as a noncurrent asset held for sale in amount of NIS 1.9 billion, following the engagement of the company partners in an agreement to sell all the holding in Compass and the company joining in on the sale. In the report period, the real estate properties increased by NIS 2.7 billion mainly due to the purchase of data center companies in England, the continuing investment in income-producing properties and properties under construction in the sum of around NIS 489 million, and continuing investment in data centers of around NIS 769 million through Green Mountain in Norway, and NIS 843 million in revaluations during the report period. The increase of NIS 492 million in the value of our properties in Israel is derived from the increase in rent prices. In our properties in Israel, there was no change in the cap rate compared with the valuations carried out last year. In the Data Center segment, there was an increase of NIS 361 million in the value of Green Mountain. The increase derived from the signing of significant leasing agreement and the progress in carrying out the TikTok project. The weighted cap rate of the income-producing properties excluding the data centers in Azrieli report is about 6.81% only. The gross financial debt was around NIS 19.7 billion with the company's net debt at NIS 18.5 billion, which constitute only around 37% of the total assets of the company. The company's average effective interest rate is 2% with a duration of 5.5 years. The company has high financial flexibility, which is derived from the existence of unpledged properties in a significant amount of around NIS 35 billion. And cash and cash equivalents balance of some NIS 1.3 billion. The company also holds Bank Leumi shares totaling around NIS 965 million. In view of the expected consideration from the sale of the company holdings in Compass, we have worked to raise debt with a short average duration. And accordingly, in July, after the end of the quarter, we expanded the Series B bonds for a net consideration of NIS 850 million with effective interest of 3.1%. The net profit in the quarter totaled NIS 490 million compared to NIS 803 million year-over-year. The decrease in the net profit mainly derived from reduction in the fair value adjustment of the investment properties in this quarter compared with the same quarter last year. The total revaluation against this quarter was NIS 491 million compared to NIS 601 million last quarter. And you can notice on our P&L financial statement that there is a decrease in the company shares in Compass results this year compared to last -- the quarter of -- in 2022, which was included as associated company, where we booked last year value adjustments for Compass. That didn't happen this year. Now we will move on to the Q&A session.

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

Congratulations on the Compass transaction. I just had 2 questions. The first one is on offices. It sounds like your comment is maybe just a little bit more prudent than in the past. You say that the market is not what it was and it is taking a little bit longer to lease. To what extent does it also, let's say, lead you to think differently about the development pipeline in terms of the share of offices on some of the mixed-use projects, for example? And the second question is on Green Mountain. So you mentioned that it was revalued due to TikTok and to the development progress. Is it fair to deduce that there has been not really yet a revaluation due to the higher multiple we are seeing in data center transactions since the start of the year? So of course, Compass deal, but more generally, with AI, it seems like data center as a product is on a higher multiple than it was maybe 6 or 9 months ago?

Okay. We will -- thank you, Charles, and thank you for the questions. I hope I will answer the second question appropriately. If I'm missing, please correct me with what's exactly the question. Regarding development of offices, you are right. In the projects that we have today with anchor tenants, like the full campus of SolarEdge, we're moving full thrust ahead. With the new deal with Clalit -- Clalit is, by the way, it's the second largest medical entity in the world. They have something like 4 million members. So with Clalit, which is a very strong, 25 years lease agreement, we move full thrust ahead. Other projects, for example, the new building in the Town E building, Azrieli Town E, which is at the center of the CBD of Tel Aviv on the light rail which was opened with a delay of -- as I see it, tens of years, but it was open today, by the way. And the main station is below this building. We are not unusual -- in regular times, we would already do the digging and excavation. This time, we didn't touch. We just take care of the zoning. We're going to finish it, then the permitting. And then we're on hold. We have the entire rights to build the building, but we're on hold. Once we see that the economy is going to the right way or path or we have an anchor tenant, we go forward. So to answer you, this is our approach today compared to 2 years ago, for example. So this is one. Regarding Green Mountain, if I understand, you asked about the appreciation of the land, specifically TikTok. Today, the cap rate of TikTok is around 11%, and it's going down 0.5% each quarter. Where is the base? I suppose it will be between, let's say, 6 to 7. This is where we are aiming to. So it's going down 0.5% each quarter, which brings us approximately NIS 250 million in terms of -- between NIS 200 million and NIS 250 million in terms of appreciation each quarter. If Ariel, you would like to add something?

I would like just to talk about the difference between multipliers and valuation in our financial statements. In valuation of financial statements, valuators taking into consideration this year is, at the end of the day, takes the cash flow -- the expected cash flow and gives to this cash flow a value and multiply in transactions. It's a going concern value, which is going into the calculation, not just this year of the expected cash flow of the company, it is the ability of the platform to produce more cash flow in the future. So it seems to be different. So in our books, the valuation is based on DCF method.

[Operator Instructions] Dear speakers, there are no further questions. I would now like to hand the conference over to your speaker, Eyal Henkin, for any closing remarks.

Yes. Thank you. So to summarize, we are pleased with the group's results and position. We're ending the period with record results for the group. The rest of the year appears to be continuing this trend. We have strong progress in all of our current parameters with a strong and stable portfolio, offices, malls and senior housing. We are maintaining full occupancy, a healthy mix, good -- very good footfall and good store revenues in the malls. We're cautiously developing our core business in Israel, and we have a very good trend in terms of NOI and FFO. Nevertheless, we are living in challenging times. So this requires cautious. Finally, regarding data centers. We have great faith in the Data Center segment, strong industry, the largest and most important and strongest companies in the world. The 2 drivers, AI and the cloud, appear to be here to stay and will continue to develop in the coming years. We developed know-how. We made connections. We built -- we developed knowledge. We have proven our capabilities. We sold Compass at a huge profit over and beyond expectations. In the near future, we will focus on developing our European platform through Green Mountain, realizing the funnel and continuing to sign significant contracts. We will hold a 1-day data center seminar in Q4, and we will send you our invitations. Thank you very much for listening, and we'll see you in the third quarter of 2023.

That does conclude our conference for today. Thank you for participating. You may now all disconnect. Have a nice day.