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

Good day, and thank you for standing by. Welcome to Azrieli Group Second Quarter 2024 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 a slide presentation. It can be found on Azrieli site, www.azrieligroup.com, on the Investor Relations page under Media Room, Presentations, and the financial reports can be found on the website as well. I'd 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.

Good afternoon, and thank you for joining the Azrieli Group earnings call to summarize the second quarter of this year. I'll start with an update about my transition to managing the Data Centers company. The Data Centers segment is growing significantly, and has potential to become a business under the scale and strength of even the Azrieli Group and even more. This industry requires massive investments on the one hand, and presents tremendous opportunities on the other hand. We are considering introducing a strategic partner or partners and later, maybe in an IPO. We built a solid structure in London, which is efficient, both with partners, finance, M&A, tax, future IPO, et cetera. Danna Azrieli and I have been talking about this since last September. We reached a joint decision that my taking the lead on this business is the correct move. I've been working on Data Center business hands on since its inception. This activity is massive in terms of investments and capital on one hand, and incorporates huge potential on the other. It's well planned and measured strategic move, which will be implemented in a well controlled and monitored process and in a timely manner. I would like to thank our Chair lady, Danna Azrieli, for this opportunity for a confidence in me and for the journey we have traveled together and will continue together. We will find a suitable replacement for this position of CEO in Azrieli and [indiscernible] responsible and thorough handover of my responsibilities before I leave. As for the financial statements, Azrieli Group is continuing to develop and expand. Thanks to the quality of our properties, our financial strength and meticulous management, we are meeting our targets for 2024, such that also in the second quarter of 2024, it seems like we will present good performance and improvement in operating parameters. In the second quarter, we are seeing some slowdown in the market growth rates. Although private consumption per capita calculated annually increased by 10.2% quarter-over-quarter, the increase is only 1.2% year-over-year. However, with Azrieli are ending good 3- and 6-months periods in terms of operating parameters, with strong performance above the targets in all of our areas of operations. The NOI, excluding Compass, is continuing to grow as reflected in a 5% increase year-over-year. Our FFO in the quarter is a record high, with an increase of ILS 62 million, 17% year-over-year and 11% growth, excluding senior housing. We are continuing to invest. In the second quarter alone, we invested ILS 934 million in development improvements and investments, mainly in Green Mountain and properties under construction. In total, in the first half of 2024, we invested ILS 1.8 billion. We are continuing to maintain high occupancy in our malls, offices and senior homes, with an average occupancy rate of about 98% based on a good mix, low leverage and long-term contracts. On the Data Centers space, we are continuing our plans with a very strong pipeline of substantial transactions and signing of significant lease agreements, which are reflected even this year, and will have a positive impact on our results as soon as the next year or 2. The interest rate environment remains high. In January of this year, the Bank of Israel lowered the interest rate by 0.25% point to 4.5%, and has since left the interest rate unchanged. The high interest rate obviously affects our business, too, but we keep the debt ratio low, and about 88% of the debt is linked. Similar to most of our NOI, which is linked to the CPI. In terms of development and construction, the group is continuing its development and expansion in a calculated and balanced manner. On the one hand, we are continuing the development of the projects for the medium and long term. And still, we continue to vigorously advance zoning plans and building rights. While in terms of bricks and mortar, we continue developing in a prudent and cautious manner. The prices. In the second quarter, we reported appraisal profit of ILS 65 million compared to ILS 491 million year-over-year. The difference derives mainly from the CPI difference, the prices of properties in Israel and the Data Centers, as Ariel will detail later. In July 2024, the Bank of Israel updated its focus from April 2024 and represented expectations of an increase in GDP this year and the next year of 1.5% and 4.2%, respectively. It also revised the inflation rate for these years of 3% and 2.8%, respectively. We expect the Bank of Israel interest rate to be about 4.25% in the second quarter of 2025. About the segment, shopping malls. We continued growth in NOI to ILS 249 million, up ILS 5 million year-over-year and ILS 9 million quarter-over-quarter. We maintained full occupancy of 99% throughout the portfolio. During the quarter, we signed contracts of approximately 30,000 square meters, which are around 8% of the installed base. During the quarter, we signed several large contracts, in most cases with higher rent per square meter, especially in Eilat and in Rishonim. We are starting to see beginnings of renewed interest on the part of foreign chains to open branches in Israel. In terms of store revenues, we are 10% up in the second quarter, and we're seeing July with an increase of 14%. There is a high increase in store revenues in the areas of [ culture ] and leisure, cosmetics, lingerie and fashion accessories. Just to summarize the shopping mall part, positive trend, we have an NOI in growth, maintaining high occupancy of 99.3%, 10% increase in store revenues in the quarter and 14% in July alone compared to July last year. Larger ticket size, an increase in store revenues due to an increase in overall travels in Israel. Regarding offices, I'll start with the fact that targets are being met, NOI increased by ILS 7 million in quarterly year-over-year and ILS 11 million in the half year-over-year. Most of the increase derived from rent increases in tenant turnover and CPI increases. Same property also rose 3% in the quarter. We continue to maintain full occupancy in the Group's properties, which are concentrated in high demand areas. There is a deal flow, although not at the previously seen levels. At the same time, the uncertainty in the market is still creating loan negotiations, although there are large deals. In terms of customer mix, our customer mix is unchanged, namely technology companies and liberal professions where technology companies remain 40%. During the quarter, we signed agreements covering an area of about 34,000 square meters, which is around 5%. In Lot 21 and Modi'in, already at the end of the first quarter, we began populating the commercial flows in office towers in Lot 21. In May, we began populating the rental apartments in Modi'in. To remind you, the lot covers an area of 5,300 square meters, of which a GLA of 31,000 square meters, multiuse offices, retail, a hotel and rental housing. For the offices, we are at 50% occupancy and are in advanced negotiations for another 3,100 square meters, such that the total occupant sales of these negotiations will be finalized, will reach 75%. On the retail, we have occupancy of 82% in this new asset. Regarding the SolarEdge campus, there is no change in plans. We are monitoring the company regularly. There may be some adjustments to the project, but nothing substantial when both parties are fully committed for the project. We see this asset as an excellent one in a prime location with high-end design. To summarize offices, ILS 7 million increase in NOI in the quarter year-over-year, maintaining high occupancy of 98%, diverse customer mix and long-term contracts, bridging the current environment of uncertainty, although to a certain extent, it is such a challenging situation, there is still a healthy deal flow. Lot 21 launched on end of Q1, good lease-up rates. Regarding senior housing, NOI in the quarter amounted to ILS 22 million compared with ILS 18 million year-over-year, an increase of 22%. We have significant improvement in the operating performance. Though the leasing term continues to be longer than usual in view of the difficulty in sales on the secondhand apartment market, we are still growing occupancy, where we grew to 97%. We are nearing exhaustion of our inventory in the leasing -- in the existing houses, and are working on the construction of the home in Rishon LeZion expected to open in late 2025 and continue to look for development opportunities elsewhere. The Lehavim house, which is the recent one we occupied, including the second stage, we are now at 91% occupancy rate. Data Centers. AI and cloud continued to develop and a significant trigger for the surge in demand for storage and processing capacity for servers and consumption of infrastructure as a service, IaaS. These factors have a positive effect on the industry, leading to massive growth and boosting the demand for Data Centers. Added to this is the trend of substantial power shortage in the flat [ deep ] hubs that is only getting worse and challenging as demand rises and data centers are built. Keep in mind that in London, there is already a move from West London to the East, where the Romford site is located. And in mind, Germany, New Frankfurt, environmental regulation is eliminating future data centers that were marketed on paper, but do not comply with the regulations. The electricity shortage only underlines our advantage in operating in the Nordic market. In general, in the Norwegian market, in particular, in addition to the other advantages that we talked about extensively, green electricity, cheaper electricity prices than in Europe, lower operating costs, a wider range of land properties and uncomplicated statutory process and little sensitivity by [ AI delatency. ] If you have heard the recent NVIDIA earnings calls, you will identify that the biggest challenge of NVIDIA today is neither R&D, nor CapEx, nor development, nor market demands, nor manufacturing. It's solely data centers and power, which reflects how -- what's the demand and what's the supply in this space. Reflecting on the several sources predicted by 2030, almost 40% of all the growth in the data center industry will go to the Nordic market in Europe. I remind you that as of Q3, we stopped including the results of Compass, which were on the second quarter of last year, more than ILS 32 million, which was -- the Compass was sold very successfully in October 2023. NOI, excluding Compass, increased by 60% to ILS 43 million in this quarter and by 34% compared to the previous quarter. TikTok. The site is already connected to the Central Power Grid. We handed over to TikTok Building 1 earlier this quarter and are at final stages in the construction and handover of the other 2 buildings. We have -- we experienced very high growth in deals that will yield income in the short term, long-term contracts, high capacities, good returns and significant hyperscalers. From here on out, we are moving ahead with the development and expansion of the East London data center campus, and are beginning construction of the first phase of the project in Frankfurt under the JV of Green Mountain and KMW. The negotiations for the 120 megawatt we reported on -- are moving along very well, and we are negotiating with several more companies as we reported in July of this year. Expanding the DC -- the data center business is very capital intensive, and we are working and exploring various options for collaborating with additional investors and various alternatives to fund the business. According to the growth rate, and I believe that by the end of the year or first quarter of next year, we'll have more to report on this front. To summarize the data center experience, an industry with a very high growth potential, strong demand, continuing to strengthen and develop. We focus on developing Green Mountain as a European platform in the existing markets and sites, namely Nordics, the Northern Europe and the whole continent. NOI is growing according to the targets, advanced negotiations with several hyperscalers, and we're exploring various options for collaboration with additional investors and other alternatives to fund the business due to the high growth rate. We are proceeding to the horizon with caution and are managing the investments with close attention and the project schedule in a balanced manner according to demand. I will now give the floor to Ariel for the financial review.

Thank you very much, Eyal. Let's go over the key financial parameters from the financial statements. The quarter, the same-property NOI is ILS 553 million, reflecting an increase of 5% year-over-year, excluding ILS 32 million recorded in the same quarter last year from the company's share in results of Compass, who's sale was closed in October 2023. The increase in the NOI of ILS 26 million, excluding the results of Compass, is mainly from the increase in the DC segment through Green Mountain, is the amount of about ILS 16 million, mainly due to the completion and handover of projects totaling 16 megawatts in 2 international customers in Norway. Next quarter, we will record full impact of the increase following the gradual addition of 10 megawatt in this quarter, plus another handover of 2.4 megawatt made in August. The office sector contributed about ILS 7 million to the increase and about ILS 5 million of the increase is from the malls and commercial space sector. In both sectors increased [indiscernible] from an increase in rental income. An improvement in the operating profitability and the high occupancy rate in the senior housing sector contributed about ILS 4 million to the increase. The increase in NOI is offset by decreasing the results of operations in the U.S. office sector in Texas of ILS 6 million. After the end of the quarter, the company handed over the first TikTok building, 30 megawatts. By the end of the year, we expect that the company will gradually complete the handover of TikTok of the 2 additional buildings of 60 megawatts. The completion of TikTok campus will significantly increase the company's current NOI. In the FFO parameter, the company present significant growth. The FFO, including senior housing, totaled about ILS 419 million, an increase of 17%. The company's FFO, excluding senior housing, totaled ILS 379 million, up 11% year-over-year. The increase in FFO, including senior housing, in the amount of ILS 62 million is from increase in the company NOI, excluding senior housing and excluding Compass, of ILS 26 million, an increase in FFO over the senior housing sector of ILS 25 million, a decrease in net financing expenses of ILS 2 million, mainly due to an increase in financing income from company's financial results and exclusion of the FFO from Compass, following itself last year, which presented a negative figure in the same quarter last year of about ILS 13 million, offset an increase in expenses of about ILS 4 million. Let's move on to the balance sheet data. As of the end of the quarter, the investment properties and investment properties under construction totaled about ILS 46.7 billion, up about ILS 2 billion in the report period. The increase is due to continuing investment in income-producing properties and properties under construction totaled about ILS 406 million in Israel. This includes the Spiral Tower, the SolarEdge campus, completion of construction of multiuse project in Lot 21 Modi'in and continuing construction of the Harakafot Palace senior home in Rishon LeZion, an investment of about ILS 1.3 billion in the DC sector through Green Mountain, mainly in the continuing construction of 90 megawatts TikTok project as well as a continuing construction of about 7 megawatts, mainly for international customers, of which we completed 2.4 megawatts in August. Revaluations during the report period of ILS 318 million, mainly this sector is mainly for the continuing progress made in the TikTok project in Norway as well as revaluation of properties in [ Iran ] mainly from change in the CPI. The weighted yield of the income-producing properties, excluding data center, senior houses and rental houses is about 6.96%. The weighted yield of the income-producing data center is 6.75%. The company has a low leverage rate. The gross financial debt is about ILS 22 billion, the company's net financial debt is about ILS 20 billion, which is only 38% of the total assets of the company. The decrease of about ILS 1 billion in the gross financial debt from the end of 2023, mainly from the repayment of [indiscernible] facilities of about ILS 0.7 billion, a bond repayment of about ILS 1 million, a net of CPI linkage of the linked liabilities of about ILS 0.3 billion and a new borrowing of ILS 0.4 billion. The company linked debt account for about 88% of the total debt of the company. In July, after the report, the company raised for the first time, commercial papers that were listed on Tel Aviv Stock Exchange in the amount of about ILS 638 million at Bank of Israel interest plus a margin of 0.12% only. The principal and interest will be repaid in July 2025. The company made a hedge transaction to substitute the shekel interest for CPI-linked interest of 1.59% only. The company also raised a new bond series, Series I, for a total of about ILS 990 million, with an effective interest rate of 3.77%. The series has a long duration of about 12.2 years, the second longest corporate bond in Israel, and which enables the company to better spread out the current bond maturities and made further expansion of the series in the future. As part of this debt financing, the company also expanded its Series G by about ILS 250 million with effective interest rate of 3.3%. The average effective interest rate of the company during the report period is 2.4%, with a duration of 5.4 years, while the average interest rate in Israel during the period is about 1.9% only. The company average interest rate in the quarter is raising year-over-year mainly as a result of the company financially runs, which are closing at higher interest rate, reflect the market condition. Let's conclude with a summary of the financial results. The net profit for the quarter amounted to ILS 156 million compared with ILS 419 million year-on-year. The decrease in the net profit of about ILS 263 million is from a decrease of ILS 426 million in revaluation profit year-over-year. The decrease is from lower GM revaluations of about ILS 360 million, mainly foreign exchange rate differences and decrease in revaluations in Israel, totaling about ILS 111 million, including due to an adjustment made in the value of Sarona project in Tel Aviv, a view of a notice of departure of significant tenant, [indiscernible], covering an area of 31,000 square meters. Another reason is an increase in the net financing expenses of about ILS 46 million, mainly due to an increase in the linkage differences year-over-year, 1.6% this quarter compared to only 1.36% in the same quarter last year and an increase in G&A and other expenses of ILS 8 million. These effects were offset by increase in NOI of ILS 26 million, excluding Compass, exclusion of Azrieli [indiscernible] results and the net impact of the gross profit of about ILS 6 million. Excluding of the results of Compass due to itself in the same quarter last year, this business recorded a loss of ILS 37 million and a decrease in tax expenses were ILS 148 million, mainly due to the decrease in total revaluation profit. The comprehensive profit amounted to ILS 430 million in this quarter compared was ILS 512 million year-over-year. We will now proceed to Q&A session.

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

Congratulations, Eyal, for your new position. First 3 questions from my side. First on data center. I think you mentioned at the start of the call, the idea is to introduce new partner or partners and then an IPO. So I was wondering how do you think about the pros and cons of going with partners first and then, I guess, sharing some of the potential profit and then later, an IPO, which potentially would have the benefit of being a larger IPO than if you go early, but I just was wondering if you could discuss at all, maybe it's a bit difficult at this stage, but are you thinking about the sequence of event and also potential timing for it? Second question was on the Spiral Tower. I think the CapEx has increased slightly, so I was wondering what has driven it between your last reporting and your Q2 presentation? And the third is on the new CEO. Will he or she be internal or external candidate? And where is the company in that process?

Okay. Thank you, Charles. I'll start with your concern on the Spiral. The Spiral is up ILS 120 million, you're right. Main price difference or cost difference is the fact that aluminum is going up. Today, it's already almost ILS 400 million in this huge project, and glass as well. These are the 2 major factors. So unfortunately, yes, you're right. Budgets went up in this. Regarding the data center and minority partner, look we -- the potential of this industry has some, I would say, some challenges or risks which are incorporated, mainly you need -- you want growth, you need liquidity. You want liquidity, you take debt. You take debt and you need to inject equity what's going on with your balance sheet and covenants. So this triangle, specifically with a company like Azrieli, where we keep our conservative approach regarding LTV, et cetera, one would say that it's -- although the projects, the IRR is very high and 15 years project yield on cost 12%, 13%. The Googles, Microsofts, Oracles, whatever of the world. At the end of the day, it's a steep curve, steep slope that -- in order to derisk, we find ourselves that in order to keep the same rating, et cetera. For this, we think that it's more appropriate to have a minority partner at the beginning. When I say minority partner, it's between 15% to 30% minority partner. According to our models, just to give you a sense, if we have a minority partner, instead of reaching a peak in 2027 of 47% LTV or whatever, we reached by 2027 with less than 40% LTV. So this is just to give you the spread of what does it mean a partner. And if you look at the flip side on the -- I would say on the evaluation of such a company, if we manage and again, we need to prove it to the market, we need to prove it to you, our shareholders. If we manage to sign these large deals, namely, let's say, this 120 megawatts deal, which we are quite close to this, even though anything can happen, one would say that with something like EUR 135 million to EUR 140 million annual NOI, you pick the multiplier today, the public companies are at [ 21 to 23 ]. Usually, the private markets is higher. CapEx is around EUR 1 billion, you would see that the volume is very high. If you having inject -- to get 20% of such a company after the investment, one should invest between EUR 500 million to EUR 700 million, which means additional investments of around EUR 2.5 billion because it's 30% equity, 70% debt. So what I'm trying to say that once we have a partner, and most of the companies -- most of the investment is primary, not secondary, one would find that at the end of the day, it really doesn't end the partner once you inject the capital, none of these -- of the stakeholders or the shareholders should inject capital for the coming 2 to 3 years in a company with expansion exponential growth. So this is why we are looking for a minority partner. And we think that once we get the right size in terms of the company, this would be the point on the right side to go to maybe to evaluate an IPO, whether it's good or bad, we'll see then. If you're asking about timing, again, just -- it's not -- do not sign on this, but it should take between 3.5 to 5 years from today. It depends on the markets, et cetera. So this is about that. The last thing I would say that our new CEO, we just announced it today, we didn't do anything up until now and we start working on this. So no news at this stage.

[Operator Instructions] As there are no further questions, I would like to hand back to Eyal Henkin, CEO, for any closing remarks.

Thank you. And as an overall, we present improvement in the operating parameters in this quarter, mainly lower leverage and continued with our investments in development cautiously and in consideration of the global circumstances. We continue to present good results against the backdrop of the challenging year. We are proceeding according to our plans, while exercising discretion and maintain a strong and stable portfolio, whether it's offices, malls and senior homes. We maintain very high occupancy rates, a healthy mix, lively customer traffic and good store revenues in the malls. We are keeping the NOI and FFO on the rise, maintaining a low leverage ratio, which is now at the peak, with the handover of the TikTok project, continuing to develop our core business in Israel energetically, although carefully and responsibly. On the data center sector, we have a lot of freight in this industry. There is evidence of high-growth potential and strong demand. We have the advantage of knowledge, connections, location, execution. At the moment, we are concentrating on the European platform, London, Frankfurt and of course, Norway. We are in various negotiations for the significant contracts and working to explore various avenues for collaboration in the business. And finally, about the Azrieli Group, we work in high focus and determination to carefully and responsibly. I will conclude with our hope for the safe and speedy return of all the hostages. Thank you very much for listening and see you to conclude -- at the conclusion of Q3 this year.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.