Gazit-Globe (GZT) Q4 2018 Earnings Conference Call Transcript

Gazit-Globe (NYSE: GZT) Q4 2018 Earnings Conference CallMarch 18, 2019 9:00 a.m. ET

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Gazit Globe fourth-quarter and full-year 2018 results conference call. [Operator instructions] I advise you that this conference is being recorded today, Monday, March 18, 2019. The presentation that will be used in today's call and the financial statements can be found on Gazit Globe's website at www.gazitglobe.com.

Before we get started, I would like to remind everyone that some of the statements today may be forward-looking in nature. Although we believe that such statements are based upon reasonable assumptions, you should assume that these statements are subject to risks and uncertainties and actual results may differ materially from those expressed or implied in these forward-looking statements. Additional information about the risks and uncertainties could cause actual results to differ may be found in our latest financial statements and our filings with the Israel Securities Authority, the U.S. Securities and Exchange Commission and on SEDAR, operated by the Canadian Securities Administrators. Statements may be made during the call are made as of the date of this call.

Facts and circumstances may subsequently change, which may limit the relevance and accuracy of certain information discussed. Except as required by applicable law, we undertake no obligation to update any forward-looking or other statements made herein, whether as a result of new information, future events or otherwise. I would now like to hand the conference over to Ms. Lisa Haimovitz, VP, global general counsel.

Please go ahead.

Lisa Haimovitz -- Vice President, Global General Counsel

Thanks. Good afternoon. Good morning. Earlier this morning, the company filed a regular tender offer for up to 5.3% of its outstanding shares.

Naturally, the company's managers are now subject to tight regulatory restrictions, limiting their ability to discuss or respond to questions concerning the tender offer as well as the company's future plan on top of information the company furnished in its 2018 annual statement that were released earlier this morning. I'll now pass the call to Chaim Katzman, founder and CEO of Gazit Globe.

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Chaim Katzman -- Founder and Chief Executive Officer

Thank you, Lisa. Good morning, everyone. Thank you for joining our conference call to discuss our first quarter and the year 2018. And I will start with a short review of the business and strategic developments, and then Adi will carry on with the main emphasis of the quarterly results.

And, of course, at the end, we'll open up for your questions. And my presentation is followed by -- with a slide presentation, and I'm referring now to Slide No. 3. And 2018 finished with very good results.

Our properties are producing more rental income, occupancy of our properties continues to rise, average rental income continues to grow steadily and the business is moving forward, firing on all cylinders. I will touch on the results of the entire group, and I will then explain on our product portfolio which this year and in particular, in the fourth quarter, had impressive results. Our same-property NOI increased by 3.1%, as compared with the same period last year. Growth came mainly from the private companies in Brazil and Israel, which grew by 14.3% and 5.1%, respectively. The average occupancy rate grew in our entire properties portfolio by 1% at the end of 2018 and reached 96.6%.

And in each and every territory, we're having better than 96% occupancy. By the way, Israel is living with occupancy of 98.6%. In our properties allocated in urban locations with very strong demographics and continue to produce rental income with increases from quarter to quarter. Our FFO came to ILS 3 and ILS 0.60 per share and the first class, this was kind of modest growth of 0.6%.

But if you take into account the fact that this is the result after the sale of the Regency shares in the period for a number of consideration of close to ILS 4 billion and on the other hand, the acquisition of direct real estate to the tune of ILS 2.3 billion and early repayment of ILS 1.1 billion worth of debt, it's quite an impression performance. No less impressive data is the growth in FFO per share in the period net of Regency that came to ILS 3.3 per share as compared with ILS 2.86 per share in the previous year and that means growth of 15.4%. And Adi will sort a little afterwards detail all the changes in the FFO. On Slide 4, NOI from private companies in the group grew this year by ILS 60 million, growth of 19.7%. The growth comes from the acquisition of 70% of the Internacional mall in São Paulo Metropolitan area, which was completed in April this year.

And to date, has been a success as I will detail later on. As well as from same-property NOI in Brazil and Israel. In Brazil, NOI grew in all properties and especially, at the Morumbi mall that is stabilizing and Top Center, which is apparently the most urban property in our portfolio. In Israel, rental income in Tel Baruch, Tel Aviv continues to grow as well as the Horev in Haifa and G City and Rishon Lezion.

Without extremely healthy operational parameters, growth in sale in the period of 9.9% in Brazil and 1.8% in Israel and growth in average rental income as well. Growth in NOI comes as I show in two examples from proactive management by our local management in each territory. Our management in the fourth quarter created an increase in the value of investment property in the private companies of ILS 431 million. The increased value of the real estate spans from several key properties: Internacional, you can see it on Slide 5.

The property was acquired in April 2018 and since then, in a period of eight months, we've added 87 tenants, 54 of which are kiosks and 33 stores. We renewed leases for 7,000 square meters with leasing spread of almost 20%. Rental income increased in the property by BRL 9 million that is what really created the increase in value in this property. And do not forget that in this property, our additional building rights for another 200,000 square meters that have not been accounted for in the value. On Slide 6, we have -- our showing Ceasar's Bay in Brooklyn.

We purchased this shopping center -- our share in the shopping center 41% in June of 2018, as part of their bankruptcy proceedings of Toys "R" Us. The cap on entry was about 4.1% and occupancy was 73.5%. We have leased out a number of stores since then, but the main value was created in January 2019, half a year after the acquisition, we managed to get back some of Kohl's footage in order to create a larger -- a large enough box together with the available Toys "R" Us box for Target. And so in February 2018, a lease agreement for 90,000 square feet was signed with Target.

Rental income in the property doubled, the quality of the tenants was upgraded and our value increased by USD 90 million. By the way, in this property, too, there was still enormous potential in the land in such a dense location in Brooklyn. And these are the sole of investment we are looking for at the Gazit Horizons portfolio going forward. In Germany, we have also created growth in real estate value in the period.

A settlement of legal claims on a property we own that is up for sale in Munich raised the offers for its purchase by several tens of millions of euros since the start of the year. I can carry on and explain one property after another, but I want to stop and emphasize two main messages: number one, the growth in the value of the properties is derived from asset management and increased rental income in the properties and not from cap rate compression. Two, we create value in the private real estate companies we own through proactive asset management and improvements and no trickeries. And I'm moving now to Slide 7.

During the fourth quarter of 2018 and until today, we have continued to carry out the strategy to increase the private real estate element and are focusing on dominant properties in key locations. Acquisition of investment properties in our private real estate portfolio during the quarter and until the publication date came to ILS 533 million. At the same time of these acquisitions during the quarter and until the publication date, expansion and renovation were completed over an area of 9,000 square meters in 2019. Development of approximately 15,000 square meters will be completed, and we have additional 91,000 square meters of projects in different planning stages.

In Israel, as we have already reported, in the month of September and October, we acquired several very interesting properties that are strategic acquisitions and a foothold in the center of Tel Aviv. We invested $75 million in Boston for two properties in Newbury Street and a ground lease in Harvard Square. We are buying in a super-urban area in Boston with strong demographics, over 0.5 million people in the 3-mile trade area with average household income of -- in excess of $115,000 per household. Recently, we purchased another 10.1% of the Internacional property in Brazil for BRL 155 million.

We are very pleased with the performance of the property and it really improves our managerial flexibility concerning the improvement, we will want to carry out in the future in the shopping center. I want to say a word about developments in the private company. After the reporting date, we completed the expansions of Mais Shopping center in Sao Paulo. From 14,000 square feet to 23 -- sorry, from 14,000 square meters to 23,000 square meters, an addition of 9,000 square meter, which among other things, we'll add the property, the offices of the government agency that issues identity cards, passports, driving license, etc., which is expected to increase the foothold in the shopping centers by tens of thousand people per day.

In Israel, during 2019, the construction of the property in the Kochav Hazafon neighborhood in the north part of Tel Aviv is expected to be completed, 2,200 square meters at an overall investment of ILS 105 million, and we already applied for an expansion of another 1,500 square meters. In addition, the expansion of G City and Rishon Lezion 13,000 square meters for a total investment of ILS 158 million. Together, those developments are expected to increase the NOI of Gazit Israel by ILS 22 million annually. In addition, we are currently working on the zoning and permitting of 91,000 square meters in Israel.

Firstly, in two office buildings, one on the G Kfar Saba of 27,000 square meters, for which an application has been submitted to the town planning. And the second at G City Rishon Lezion for 50,000 square meters, for which this month plans are being submitted by town planning for the public to review. These investments together with development on land we purchased close to the G Kfar Saba property to put up a branch and head offices of Decathlon and expansion of the property in Savyon, another high-end suburb of Tel Aviv, will increase investment in Israel by about ILS 1 billion. And these represent much more significant components of the group's portfolio.

On Slide 9, we summarized the main actions of the company strategy in 2018. And during the year, we continue to carry out a strategy we had announced two years ago, to increase the share of our private property portfolio, by acquiring irreplaceable assets, while actively realizing our mature holdings in some of the public companies we invest in. And delivering the company's implementation of the strategy was expressed in three main processes: one, in July, we completed the sale of our holdings in Regency for an overall consideration of -- in 2018 of approximately ILS 4 billion. The proceeds from this disposal serves to reduce the company's debt on the expanded solo level by ILS 1.2 billion.

Number two, up until publication date, we increased our portfolio of private properties by ILS 2.3 billion and our holdings in European companies we own by about ILS 300 million, approximately EUR 75 million. The percentage of private holdings after these actions represents 39% of the company's properties portfolio as compared with 20% in 2015. While leverage the company only level came down to 53.9% as compared with 63.6%, when we started this strategy. In parallel, with these actions, the company's equity had grown over the last three years by ILS 10.6 per share, a rise of over 27%.

And three, in February 2019, we announced entering into a conditional agreement for a strategic transaction, in which we had realized if completed, most of our holdings in FCR for a consideration of ILS 3.3 billion in cash. The transaction if completed reflects an annual IRR of 20%, which highlights the enormous value that Gazit Globe has created in the 19 years since it created and developed FCR. If the transaction is completed, the company's net debt-to-total assets on the expanded solo is expected to drop significantly and to be under 45%, while total privately held properties are expected to be at around 46% of the total value of the company properties. The company today is financially much stronger than it was at the beginning of the year and is ready to carry out the steps for the implementation of its strategy.

I will conclude with Slide 10, which illustrates we believe in one slide what Gazit Globe actually is. Currently, 75% of the value of our properties is -- as against 68% at the beginning of the year, is located in growing, heavily populated metropolitan areas, Tel Aviv, Stockholm, Warsaw, Prague, São Paulo, New York and so on. The locations are rich experience in the management of the commercial properties and the local knowledge of the company's teams will continue to lead the creation of significant value in the properties in every territory. And at that point, I'm handing over the call to Adi.

Adi?

Adi Jemini -- Chief Financial Officer and Executive Vice President

Thank you, Chaim, and thank you all for joining us. As Chaim noted, we had a strong quarter and very strong year, and we are very pleased with our results. The results, of course, as is the theme of this call were driven by the performance of our private subsidiaries. And with that, I'd like to start our results on Slide 12.

As I mentioned in the previous calls, we believe the proportion in NOI metric give us more color on our results as we continue to progress with our strategic plan of increasing our private platforms. The proportionate NOI excludes Regency, which was fully disposed in July. Proportionate NOI increased in the period by 5.8% and totaled ILS 1.68 billion compared with ILS 1.58 billion in the same period in 2017. Proportionate NOI in the quarter increased by 9% and totaled ILS 435 million compared with ILS 399 million in the same quarter in 2017.

The growth is coming mainly from our private subs in Brazil and Israel and was offset by the decrease in NOI and H&M as a result of the disposal of noncore assets. Same-property NOI came strong at 3.1% compared with the same period in 2017. Brazil had an impressive year with an increase of 14.3%, coming mainly from Morumbi shopping center, Top Center and Cidade Jardim. In Israel, the same store same-store NOI increased by 5.1%, mainly to G Tel Baruch and Horev Center in Haifa.

In Central Europe, Russia had some negative impact on the overall performance. However, in Prague and Warsaw, which account today to about 85% of interim income-producing portfolio, we witnessed an increase of same-store NOI of 2.7% and 1.4%, respectively. The occupancy rate increased by 100 bps to 96.6% compared with prior year. Overall, in all of our territories, occupancy is above 96%.

Moving to the next slide. I'd like to present our business plan in progress in the past three years in terms of strengthening our balance sheet and further deleveraging. I will also comment on the operating cash flow on the solo level, which we disclosed for the first time. In 2018, the company's net debt decreased by 10% from ILS 12.5 billion to ILS 11.2 billion, the sum of the proceeds from the Regency disposal were allocated for early loan repayments in their aggregate amount of ILS 1.1 billion.

In 2015, our solo LTV was 63.6% and over the past three years, we delever the company by approximately 10%, while at the same time, our equity per share increased by ILS 10.6 per share. Furthermore, we were able to be -- to more than double our cash flows or even triple, if we include the special dividends we received from Atrium. If we look at the year-over-year comparison, our operating cash flows increased by 26%, which is driven by the shift from public subs to the private subs and the reduction in our financing costs as we continue to delever as well as a reduction in our G&A. We disclosed the operating cash flow on a solo basis for the first time, which is the cash flows from the dividends we receive from our public subs, the free cash flows from our private subs, net of the capex, less the expenses, G&A and taxes.

In line with our strategy to divest our mature public investments, on February 28, we entered into agreements related to the stake of First Capital, which was subject to certain conditions, including the approval of the majority of FCR shareholders, excluding Gazit to sell 58 million shares of FCR at a price of 26 -- CAD 20.6 per share for an aggregate consideration of approximately CAD 1.2 billion. If completed, our ownership and interest in FCR will be reduced from approximately 31.3% to approximately 9.9%, while our expanded solo LTV will reduce to 43.5%. Moving on, just wanted to give a little bit color on our private arms. In terms of Brazil, the NOI in Brazil increased by 77% in the quarter and by 25% in the period, mainly due to the acquisition of Internacional, but also due to the growth in the same-property NOI.

The acquisition of Internacional was complete in April 2018 and since then, their manager has been able to increase their NOI by approximately BRL 9 million. In Israel, NOI increased by 5.1% in the quarter and by 4.6% in the period. And we expect this growth to continue in the following quarters, with the completion of the redevelopment in G City and the development of Kochav Hazafon in Tel Aviv, which will contribute about ILS 22 annually to the NOI. As Chaim mentioned, we see a strong growth in our private subs in all key of the fundamentals in the same-property NOI, in the occupancy level and the growth in the same-property sales, of which Brazil experienced 9.9% growth and Israel 1.8% growth.

This is yet another proof that the business is doing great, and it's a testament to our quality of -- to our portfolio quality. Moving to FFO per share. As mentioned in recent quarters, due to the disposal of Regency shares, which was fully realized in July, we provided the FFO excluding Regency to better reflect the performance of our portfolio. FFO per share for the quarter, excluding Regency, increased by 35.5% and totaled ILS 0.92 per share, compared with ILS 0.68 per share in the same period in 2017.

FFO per share for the period, excluding Regency, increased by 15.4% and totaled ILS 3.3 per share. The organic growth FFO is mainly coming from Brazil and Israel this quarter and also from the Gazit Horizons, which we expect to contribute more to our growth in the future. All in all, we reported ILS 3.6 per share FFO per share for the period, an increase of 0.6%, which is due to our private subs, reduction of financial costs and G&A savings. Moving on to the FFO bridge.

As illustrated in the FFO bridge, the Regency disposal results in a decrease of ILS 0.47 per share compared with the same period in 2017. On the other hand, the decrease in FFO due to Regency was offset by the increase in the FFO from the company's private subsidiaries, the decrease in financial costs and the reduction in G&A expenses. I'd like to take a moment to discuss our G&A. Our G&A at the parent level company decreased by approximately 11% to ILS 66 million compared to ILS 74 million in 2017.

Since 2015, we reduced our G&A cost by approximately 35%. The saving in the G&A doesn't take into account the additional cost reduction from the Toronto Stock Exchange and the New York Stock Exchange delisting and furthermore, we announced the merger of our private arm in Israel within the parent company. In aggregate, all these actions will lead to further reduction in our G&A. In terms of the public subs' FFO, we expect our public subs' FFO to grow in 2019, taking into account the completion of 26,000 square meter development in Warsaw and the opening of Mölndal Galleria in Gothenburg, Sweden.

Moving on to Slide 17. Liquidity and financial strength. In 2018, we refinanced approximately ILS 2 billion debenture with a weighted average interest rate of about 5.5% to utilization of our bond buyback program, specifically buying bond Series 14 and Series 4 and Series 10 debentures for a total consideration of approximately ILS 1 billion and the repayment of Series 3 and Series 9 debentures in the amount of ILS 1 billion. On the other hand, we raised 1.8 billion Series M debenture, which bear an interest rate of 2.78%.

These actions will save us about ILS 40 million of interest expense annually, but at the same time, increasing our bonded weighted average duration from 4.1 to five years. By 2022, we expect an additional financial cost saving of approximately ILS 21 million annually through refinancing of the ILS 3.6 billion, which bear weighted average interest rate of approximately 5%. In addition, we released unencumbered assets in the aggregate amount of ILS 1.6 billion or $426 million. As of December 31, 2018, the company had its wholly owned subsidiaries have unencumbered real estate assets in the amount of ILS 6.2 billion, which compromise about 77% of the company's and private subs' properties.

Moving on to Slide 20. Our debt schedule is well staggered and our absolute debt level decreased to ILS 9.5 billion and will be further reduced. The average annual interest rate decreased by 100 basis points to 3.96% compared with 4.96% at December 31, 2017. In February 2019, we announced entering into conditional agreement for a strategic transaction in which we will realize if completed, most of our holding in FCR for consideration of ILS 3.3 billion in cash.

If the transaction is completed, the company's net debt-to-total asset is expected to drop significantly to 43.5%. This is a 20% decrease in LTV since 2015, while our equity per share will increase by 20% to ILS 46.3 per share. I think that to conclude this year, our balance sheet is much stronger. We increased our liquidity.

We reduced our cost of debt, and we today, have the financial flexibility to continue to carry out our business plan. With that, we can now move to the Q&A session.

Questions and Answers:

Operator

[Operator instructions] The first question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner -- Barclays -- Analyst

Hi, thanks for taking my questions. Adi, you just mentioned the large decrease in the LTV over the years, which would reach 43% post the FCR transaction. I was wondering is that level enough for you guys to achieve investment-grade rating with international credit agencies?

Adi Jemini -- Chief Financial Officer and Executive Vice President

Thanks, Tavy, and thanks for your question. I'll be very cautious over here again as you know, and then we gave the further disclosure, this transaction is still pending. But assuming the transaction will close, there's no question that we've made some leap steps over here to further strengthen the balance sheet. So it's not just the LTV.

It's also the ICR which has been improved, the level of our liquidity, the level of our encumbered assets that increased. So I think this is -- there's no doubt that this puts us closer to become IGV. We, obviously, don't have anything to disclose right now. We're, as you know, continuous discussion with the rating agencies.

But I think we're making the right steps to achieving our goals and the byproduct of that eventually will be to get an international assessment grade credit rating in an effort to further reduce our cost of capital.

Tavy Rosner -- Barclays -- Analyst

That's very helpful. And I guess, just a more broader one. We think -- assuming the transaction closes, it's just significant proceeds coming your way, so something you often touch on is about investments in private assets deleveraging, today you introduced the concept of buybacks, you have the dividend. So I guess when you touch on those four areas, is there a priority in terms of where you see yourself kind of recycling the proceeds that you -- will be coming your way?

Chaim Katzman -- Founder and Chief Executive Officer

Tavy, Chaim, we stated that before and I'll reiterate it that we view as -- North America and Israel as our target market for further investments in the coming months. Israel is delevering the company. So I believe, this will be the two pillars of the strategy. We're going to keep developing our assets in Brazil, and we're going to keep working with our European entities.

And we view that -- the North American market is our target market as well as further growing our portfolio here and Israel, as I mentioned before, we have a quite intensive pipeline, development pipeline and let me say one thing about it, when we talk about development in Israel, most of it is on shopping centers and land we already own. So there is very little if no base in the land for what we are about to develop, mainly when we're talking about office spaces both office space is going to be built over and is a further densification of existing shopping centers we own already.

Tavy Rosner -- Barclays -- Analyst

Great. Thank you very much. I'll go back to the queue.

Chaim Katzman -- Founder and Chief Executive Officer

Thanks.

Operator

[Operator instructions] There are no further questions at this time. Mr. Chaim Katzman, would you like to make your concluding statement?

Chaim Katzman -- Founder and Chief Executive Officer

Thank you very much. Thank you all for attending our call. 2018 was a very active year. Here, we worked, I guess, on many, many fronts.

I believe that the numbers speak for themselves. In an environment where real estate retail companies are considered somewhere between obsolete or dying, I think that the numbers proves us -- prove market sentiment wrong. And we'll be more than happy to keep proving the market wrong in the coming months. Thank you very much for attending, and see you all on our next call.

Thanks.

Operator

Thank you. [Operator signoff]

Duration: 36 minutes

Call Participants:

Lisa Haimovitz -- Vice President, Global General Counsel

Chaim Katzman -- Founder and Chief Executive Officer

Adi Jemini -- Chief Financial Officer and Executive Vice President

Tavy Rosner -- Barclays -- Analyst

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Contents:

Prepared Remarks:

Questions and Answers:

Call Participants: