ab Global Equity Research Israel Real Estate UBS Investment Research 12-month rating Buy Azrieli Group Prior: Not Rated 12m price target NIS105.00/US$29.12 - Get real in Israel Price NIS85.00/US$23.57 Initiating on Israel’s leading commercial real estate group RIC: AZRG.TA BBG: AZRG IT We initiate coverage on Israeli real estate group Azrieli with a Buy rating and 6 September 2011 NIS105 price target. Azrieli has occupied a strong position in property development and management since it was founded in 1983, offering exposure to Trading data (local/US$) Israeli shopping centres (60% of its portfolio) and office property (38%). The 52-wk range NIS104.70-84.41/US$29.82-23.37 outlook for Israeli commercial property remains bright overall, but we prefer retail Market cap. NIS10.3bn/US$2.86bn to offices as we expect performance here to be less volatile in the longer term. Shares o/s 121m (ORD) Free float 25% Well placed for growth, with a sound financial base Avg. daily volume ('000) 73 We estimate 13% EPS CAGR from 2011, driven by market demand, indexation Avg. daily value (m) NIS6.5 and high development exposure, though re-financing and a shift to higher-yielding assets could drive it as high as 18%, in our view. Azrieli is relatively strong Balance sheet data 12/11E financially. We estimate current NAV gearing is 55%, rising to c70% on Shareholders' equity NIS11.8bn completion of the group’s NIS2.9 billion development programme (one recent mall purchase remains conditional). Prem (discount) to NAV/Share -23.3% Net Cash (debt) (NIS6.60bn) Non-core holdings add volatility and diminish focus Forecast returns Opportunistic acquisitions have led to non-core investments representing c38% of the consolidated balance sheet. The value of these holdings is currently depressed Forecast price appreciation +23.5% and has created an additional source of NAV volatility. Besides facing regulatory Forecast dividend yield 2.5% and other risks, we believe these investments lower the group’s appeal for property Forecast stock return +26.0% specialists. Market return assumption 9.9% Forecast excess return +16.1% Valuation: Initiating with a Buy at a price target of NIS105 Our Buy rating and PT are based on a 12% discount to our 2012 NAV estimate. On EPS (UBS adj, NIS) this basis the prospective EPS yield is 4.1% and the DPS yield is 2%. The latter 12/11E 12/10 measures are relatively low, but we think the group’s earnings growth potential is From To Cons. Actual attractive. The shares currently trade at a 22% discount to our NAV estimate. Q1 - 1.19 - 1.56 Q2 - 0.77 - 0.63 Q3E - 0.98 - 1.13 Highlights (NISm) 12/09 12/10 12/11E 12/12E 12/13E Q4E - 0.99 - 1.59 Net rental income 785 882 980 1,092 1,151 12/11E - 3.93 7.20 EBITDA 925 1,041 1,211 1,251 1,296 12/12E - 4.48 5.26 EPS (UBS adj, NIS) 4.55 4.94 3.93 4.48 4.81 fd NAV/share (UBS, NIS) 93.60 103.08 110.84 119.41 128.72 Performance (NIS) DPS (UBS, NIS) 0.00 1.98 2.16 2.42 2.60 Stock Price (NIS) Rel. TA 100 120 120 Profitability & Valuation 5-yr hist av. 12/10 12/11E 12/12E 12/13E 100 100 DPS yield (UBS) % - 2.2 2.5 2.8 3.1 80 80 Prem/disc to NAV % - -11.5 -23.3 -28.8 -34.0 60 60 CEPS yield (UBS) % - 5.4 4.5 5.1 5.4 40 40 EV/EBITDA x - 15.7 15.3 14.4 14.0 20 20 0 0
PE (UBS) x - 18.5 21.7 19.0 17.7 8 8 9 9 9 9 0 0 0 0 1 1 1 /0 /0 /0 /0 /0 /0 /1 /1 /1 /1 /1 /1 /1 7 0 1 4 7 0 1 4 7 0 1 4 7
0 1 0 0 0 1 0 0 0 1 0 0 0 Source: Company accounts, Thomson Reuters, UBS estimates. (UBS) valuations are stated before goodwill, exceptionals and other special items. Stock Price (NIS) (LHS) Rel. TA 100 (RHS) Valuations: based on an average share price that year, (E): based on a share price of NIS85.00 on 05 Sep 2011 07:34 BST Source: UBS www.ubs.com/investmentresearch Ziv Tal Quentin Freeman Darren Shaw Analyst Analyst Analyst [email protected] [email protected] [email protected] +972-99-600 115 +44-20-7568 4414 +972-99 600113
This report has been prepared by UBS Limited ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 48. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Azrieli Group 6 September 2011
Contents page Ziv Tal Analyst Investment Thesis 3 [email protected] +972-99-600 115 — Israel’s leading property company...... 3 Quentin Freeman — The Azrieli family holding ...... 4 Analyst — Strategy ...... 5 [email protected] Valuation & price target basis 7 +44-20-7568 4414 Darren Shaw — Real estate business...... 7 Analyst — Non-core businesses ...... 8 [email protected] +972-99 600113 — Sum-of-the-parts valuation ...... 8 Howard Lesser — Price target ...... 8 Analyst — Peer comparisons ...... 9 [email protected] Management 14 +44-20-7568 4415 Revenue estimates 16 Reinhard Cluse Economist — Real estate business...... 16 [email protected] — Other businesses ...... 20 +44-20-7568 6722 — Dividend policy...... 21 Property portfolio 23 — Israel shopping centres ...... 24 — Israel offices...... 27 — Foreign investments...... 29 — Developments...... 29 Other holdings 31 Debt structure 34 Net asset value 35 Appendix 37 — Israeli property market...... 37 — Rents ...... 39 Azrieli Group overview 41 Israeli economy 43 — Macroeconomic data and forecasts...... 46
We would like thank Naveen Mahajan, an employee of Cognizant group, for his assistance in preparing this research report. Cognizant staff provide research support services to UBS.
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Azrieli Group 6 September 2011
Investment Thesis Israel’s leading property company We initiate coverage on Israeli real estate group Azrieli with a Buy rating and NIS105 price target. Azrieli is the major listed Israeli property company, occupying a very strong position in shopping centres. Its assets are seeing good tenant demand from a relatively strong Israeli economy and new international entrants. The assets are still valued on relatively high net operating income yields (average 7.9%), which we believe are likely to decline over the next few years, supporting potential asset growth.
The group is implementing a significant development programme, potentially representing 25% of the portfolio, of which 45% is retail. All retail projects are due for completion before 2015; the office element has a later completion timetable (2016). Expected cash returns are 12% on retail and 10% on offices. This income represents an important driver of relatively high expected earnings and capital gains growth.
We expect consolidated EPS to post 13% CAGR from 2011, driven by demand, indexation and development. Over time, EPS should also benefit from a reduction in interest costs (some debt is at historically high levels), and a shift from low-yielding, non-core and financial (cash) assets into higher-yielding property. We estimate this could raise EPS CAGR to 18%. Acquisitions should also prove accretive.
The group is relatively strong financially, with interest cover at 2x and dividend cover 1.8x, on our estimates. We estimate current NAV gearing is 55% (consolidated), rising to 70% proforma on completion of the development programme and assuming no change in values.
However, investors should be aware that the Israeli economy is facing some consumer resistance to pricing currently, and that the group has substantial other activities, including offices in Houston, and investments in holding group Granite, Bank Leumi and Leumi Card. Together these represent 44% of group assets. There is also a minority interest controlled by the Azrieli family. Finally, Israel faces a number of well-known geopolitical risks.
The shares currently trade at a c22% discount to our NAV estimate, or an implied property yield of c9% (global sector averages are 4% and 6%). We estimate the earnings yield is 4.1% and the dividend yield 1.9% (global sector averages 6% and 5%). Although the shares look expensive on the latter measures, relative earnings growth is good. We believe the shares are attractive, giving access to a good business in a sound market still with significant growth potential, hence our Buy rating.
Description Azrieli is a real estate-focused conglomerate. It floated in June 2010, with its Azrieli floated 2010, with significant new shares raisinopg NIS2.5 billion (representing c25% of the enlarged equity). index recognition The new shares were issued at NIS83.25 per share. It is the largest listed real
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Azrieli Group 6 September 2011 estate company in Israel, and a component of the TASE 25, TASE 100, TA Real Estate 15 and EPRA indices.
We believe it has the largest retail portfolio in Israel by value, at NIS9.1 Largest Israeli real estate company, billion/US$2.6 billion. It also owns other properties (predominantly offices), with NIS14 billion portfolio which brings the total portfolio to NIS14 billion (US$4.0 billion). The group is probably best known for its eponymous mixed-use investment, the Azrieli Center in Tel Aviv.
Its other activities, which comprise 38% of consolidated assets, are a majority Significant non-core exposure holding (61%) in holding company Granite Hacarmel (separately listed; (38% assets) GRNT.IT), as well as investments in Bank Leumi (LUMI.IT) 4.8% and Leumi Card (20% private company). These assets have a net book value of NIS2.4 billion, are deemed non-core, and could be sold, circumstances permitting. An overview of the group’s holdings structure is given in the Appendix. We show a summarised breakdown of the group’s assets and liabilities below.
Table 1: Breakdown of group assets (gross and net), June 2011
GAV Liabilities NAV Per share
NIS m % NIS m NIS m NIS % Real Estate NAV 13951 62% 5015 8936 74 70% Granite 5226 23% 4467 759 6 6% Bank Leumi 1130 5% 1130 9 9% Leumi card 498 2% 498 4 4% Balance 1660 7% 1660 0 0 0% Capital & reserves 22465 100% 11142 11323 93 89% Minorities -54 0 0% Shareholder's funds 11269 93 89% Deferred tax 1463 12 11% EPRA NAV 12732 105 100%
Source: UBS estimates The Azrieli family holding The free float is 25%, with the rest held by the Azrieli family. The company was Family own 75%, founder David Azrieli founded in 1983 by David Azrieli, a Canadian real estate developer and philanthropist born in 1922. His property business spans Canada, the US, Europe and Israel. Mr. Azrieli continues to play an active role in the management of firms companies in both countries. According to the company's prospectus Mr. Azrieli intends, in the future, to transfer his holdings, in whole or in part, to charity foundations in Canada or Israel. He has a wife and four children.
Post-IPO, Mr. Azrieli owns 30% and his four children each own 11%; 32 group executives received phantom stock options (entitled to monetary compensation, not shares) with a value of cNIS30 million.
The Azrieli family also hold substantial North American real estate interests (estimated at cUS$600 million) outside the Azrieli Group.
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Azrieli Group 6 September 2011
According to the TASE register, the main other shareholders are: Bank Other declared shareholders make up a Hapoalim (5.4%), Amitim pension fund (3%) Psagot pension funds (3%), and further 13% Clal Insurance (2%).
Chart 1: Ownership structure Chart 2: Free float
Free float = 25%
Azrieli Holdings (Owned by Azrieli Family) = 75%
Source: UBS, company data Source: UBS, company data
Strategy The group’s core focus is the real estate business, which represents over 80% of Real estate-focused conglomerate net assets (EPRA definition).
Over time we expect the core business to expand as it remains the focus of acquisition and development activity. The group intends to sell the non-core activities; we expect sales of its holdings in Bank Leumi and Leumi Card to precede Granite, which is a longer-term turnaround story.
The group is the leading owner of Israeli malls, where we estimate it has a 20% Israeli retail dominance market share. It prides itself on having the best centres and tenants, which helps drive footfall, retail sales and ultimately rental income. We expect the group to build on its dominant position in the Israeli real estate market through further acquisitions and development.
The group has a significant development programme (one of the largest Development has been a major route to development exposures in our EMEA coverage), on which it expects to spend expansion NIS2.5 billion over the next five years, or NIS2.9 billion assuming the conditional purchase of a shopping mall in Netanya goes ahead. It targets cash returns of 10-12% on cost, although this is unlikely to be achieved at Netanya, where the project is already well progressed. Including land, the programme represents an exposure of NIS3.5 billion, or c25% of the current investment portfolio. The future capex split is approximately 40% retail and 60% offices (30%/70% excluding Netanya). Although there is a bias towards offices, the retail pipeline is front-end-loaded with the larger office projects South Hakirya and Holon not due for full completion until 2016. Assuming that the full programme is crystallised (at cost) the portfolio retail weighting would slip from 65% to 60%. A number of projects (c33%) are still conditional (for full details see below).
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Azrieli Group 6 September 2011
Chart 3: Relative development exposure
35%
30%
25%
20%
15%
10%
5%
0%
E e io S d P e re ail S and IT oup g ties r ade nda RO don ties v r E SC en tl N ri c SP Lan PS ie mmo D C ad or u Co itycon I erson EG on dha U i Gr Fabe c C m h Spo S oun ep Unib ini tesbury el m itis C astellum Kl of mmercial af udst zri a r ent L C C h reat P A H B w l & Werel co S Kungsleden G a ro Hufv Land Se it u Der ap E C
Current Promised Pre-sold
Source: UBS estimates
The group also looks to acquire assets where it believes it can add value. This Acquisition policy can be in the form of completed properties such as Givatayim and Haifa, or assets under development, such as the recently announced conditional purchase of Netanya. These acquisitions produce slightly lower returns. We estimate the Netanya net operating income (NOI) yield at 7.4% adjusting for full costs. Nevertheless, these returns are still accretive and should involve less risk (planning/construction/letting).
In March 2011 the group’s US exposure rose with the acquisition of three office Houston offices towers in Houston, Texas (90% interest) for US$176 million (NIS616 million). Foreign real estate assets account for 6% of the firm’s total investment portfolio. Activity is opportunistic and, to date, focused on Houston, a market with which we understand the Azrieli family is very familiar. The only other asset is a modest office property in Leeds, UK. We would not be surprised to see further international acquisitions, but expect the vast majority of the group’s real estate exposure to remain in Israel. We believe REIT specialist investors would currently like to see this activity limited.
David Azrieli has made no major real estate disposals since starting the group in Limited sales 1983. Azrieli Group believes part of its strength lies in the critical mass it has in the market – particularly with its shopping mall portfolio.
At the time of the listing, the group also included amongst its goals: portfolio Other property goals diversification; increased presence in the north of Israel (since secured); and increased office and high tech exposure in the Gush Dan region (Greater Tel Aviv and surrounding areas). Financial goals were to ensure the group cost base became more efficient, and to maintain its high financial strength with low leverage
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Azrieli Group 6 September 2011 Valuation & price target basis As discussed above, c60% of the group’s assets are invested in real estate, while A well financed real estate specialist, 40% is currently invested in other activities. These latter are non-core and could but with significant other interests provide a source of significant financial liquidity. The basic financial position is very sound with the group having comparatively low levels of debt.
Azrieli favours a focus on the real estate business as a standalone entity, with the Group focuses on a number of metrics non-core assets treated as investments at value. The numbers it focuses on are consolidated net profit, net operating income (NOI) from the investment properties, FFO (funds/cashflow from operations) attributed to the real estate business, and the valuation of the property portfolio.
We have adopted a similar approach, but using metrics common to our analysis We use our own metrics of other property investment companies. We use net profit, but adjust for revaluation gains and losses to produce a recurring EPS (consolidated basis). In this case we have also calculated a recurring EPS number for the property business alone. We prefer to the recurring EPS calculation as it allows for deferred interest charges which are incurred in the period but which have no immediate cash impact. We use the same valuation/EPRA NAV approach as the group itself. Real estate business We look at three key metrics when looking at real estate companies globally. We discuss each in turn below.
(1) NAV: We estimate that the EPRA-adjusted NAV of the group’s property We estimate standalone NAV at cNIS90 business was about NIS 85 per share in June. We expect the group’s per share investment portfolio to grow at a good pace helped by the fact that we believe current group property yields at c7.9% are undemanding, and rents are likely to grow through a mixture of indexation and demand. We assume medium-term rental growth rates of 5% for retail and 2.5% for offices. In addition, growth will likely be enhanced by the group’s significant development activity, which, given 10%+ cash returns, should produce significant capital gains on completion. We are assuming H2 valuation surpluses of NIS627 million, which would take the real estate NAV to NIS90 per share.
(2) Real estate earnings: UBS uses its own definition of recurring earnings. We We estimate real estate 4-year EPS exclude revaluation gains/losses, but include non-cash interest costs. The CAGR from 2011 at 13% latter can be excluded from FFOs as they do not create a cash cost in the reporting period. On our estimates the group will report a real estate recurring EPS of NIS3.7 in 2011, rising to NIS6.5 in 2015 (CAGR 13%) driven by rental growth (30%) and developments (60%). The initial earnings yield is relatively low, but the growth is attractive.
(3) Dividend: We believe share price performance could be improved – We estimate DPS growth at 6% per particularly with respect to international investors – if the group articulated annum a sustainable progressive dividend policy. We estimate the dividend will grow from NIS1.98 in 2010 to NIS2.71 in 2015 (CAGR 6%)
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Azrieli Group 6 September 2011
Non-core businesses Of Azrieli’s three major investments, UBS only currently researches Bank Non-core business now Leumi. For the purposes of this exercise we have valued the assets at book value worth NIS1.9 billion less costs, but also recognising that Granite comes with considerable additional assets and liabilities. At 30 June the book value of these assets was NIS2.25 billion (cost NIS1.84 billion). These assets are relatively low-yielding and currently a significant source of additional NAV volatility. Their current value, adjusted for the share prices (August 2011), is NIS1.89 billion Sum-of-the-parts valuation (1) NAV: At the half-year stage, inclusion of the non-real estate activities raised Other businesses have a book value of the NAV by NIS20 to NIS105 per share. We expect this to rise by NIS5 per cNIS17 per share (adjusted) share in H2 due to revaluation gains. Adjusting for the market value of Granite and Bank Leumi shares reduces the NAV by NIS350 million (NIS3 per share), but this is offset by H2 earnings retentions. Our forecast for reported NAV is NIS111 per share.
(2) Income: We give a more detailed breakdown under revenue below. The impact Minimal impact on EPS on the other businesses is marginally accretive to EPS in the current year and flat thereafter (we assume Bank Leumi’s dividend is lower). Overall, the non- core businesses are likely to be a drag on revenue growth, and revenue returns on invested capital are relatively low. Our estimates might be marginally lower as we deduct minorities from this part of the business.
Table 2: Real estate recurring EPS and consolidated EPS
NIS/share 2011E 2012E 2013E 2014E 2015E
Real estate EPS 3.70 4.48 4.83 5.88 6.50
Consolidated recurring EPS 3.93 4.48 4.81 5.88 6.50
Source: UBS estimates
(3) Dividend: We believe that the dividend policy should be based on the group’s recurring property income (see above). Price target We arrive at our price target of NIS105 per share by applying a 12% discount to Good earnings growth, and an our December 2012 NAV estimate. Given the portfolio’s superior growth attractive relative discount potential due to its valuation, development exposure and current financial structure, we would expect the discount to be narrow. At this price the EPS yield is 4.1% and the dividend yield 2%. This is below average for investment companies, but in line with developers. We expect the growth rate to be superior, driven by market conditions, relative development exposure and structural issues working in the group’s favour.
Sensitivity analysis We have neither assumed significant rental growth nor yield compression in our Current gearing impact is minimal estimates. We show the impact of property capital growth/falls on the NAV in the table below. The current real estate business is relatively modestly geared so that the impact of leverage on NAV growth is also relatively modest. We currently assume c7% capital growth in 2012 to get to our estimate of NIS119 per share.
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Azrieli Group 6 September 2011
Table 3: Impact of portfolio growth on NAV on 2011E NAV
-15% -10% -5% 0% 5% 10% 15%
Group NAV per share consolidated 94 99 105 111 117 122 128
Source: UBS estimates
We alluded above to additional potential EPS growth due to structural issues Shift in asset balance could enhance working in the group’s favour. These are the fact that cNIS3.5 billion is invested revenue in lower-yielding assets, and that there is a potential debt cost-saving. We show the impact in the table below, which shows the potential CAGR EPS growth rate rising from 13% to 18%.
Table 4: Potential impact from structural change
Net profit sensitivity NIS m NIS per share 4 yr CAGR
UBS 2015E 788 6.5 13%
Assume reinvestment of low-yielding assets @7.5% 88 0.7
Assume 50 bps debt cost-saving 32 0.3
Add potential structural gains 907 7.5 18%
Source UBS estimates
Consensus expectations A limited number of other EPS estimates appear significantly higher than ours Limited sample and could be focused (NIS3.9 per share in 2011). Potential explanations for the difference include: (1) on different metrics other analysts may be more positive than us; (2) other analysts could be using a different EPS methodology (incorporating revaluation gains, or only focused on the real estate part of the business).
Table 5: EPS consensus (from company website)
Number of Year estimates High Low Mean
2011 2 8.1 6.3 7.20
2010 2 8.8 7.7 8.25
Source: Azrieli Group Peer comparisons The table below provides some numbers regarding other quoted real estate Largest quoted Israeli real estate stock companies in Israel. We would make the following observations. First, Azrieli is with lowest leverage significantly larger than its local peers. Secondly, it has substantially lower leverage. However, it has a narrower discount and offers a lower dividend yield than most.
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Azrieli Group 6 September 2011
Table 6: Israeli real estate companies
Market cap Mkt cap/net Net debt/yotal Company (NISm) debt assets NAV/share P/NAV Dividend yield
AZRIELI GROUP 10,507 1.68 0.28 105 0.83 2.3
GAZIT GLOBE LTD 5,646 0.16 0.61 106 0.35 4.3
MELISRON 1,497 0.67 0.43 81 0.81 8.0
AMOT INVESTMENTS LTD 2,146 0.65 0.52 10 0.91 6.1
ALONY HETZ PROPERTIES & INV 2,103 0.37 0.56 31 0.56 3.9
NITSBA HOLDINGS (1995) LTD 1,936 0.92 0.35 42 0.78 0.0
INDUSTRIAL BUILDINGS CORP 1,829 0.24 0.65 8 0.75 21.8
BRITISH ISRAEL INVESTMENTS 2,084 0.37 0.57 15 0.86 4.0
BAYSIDE LAND CORP (1) 1,459 0.67 0.41 985 0.74 7.4
PROPERTY & BUILDING CORP LTD 1,074 0.15 0.56 429 0.40 8.7
NORSTAR HOLDINGS INC 1,690 0.05 0.64 610 0.12 2.1
AL-ROV (ISRAEL) LTD 1,148 0.27 0.47 214 0.39 0.0
ALROV PROPERTIES AND LODGING 1,331 0.32 0.54 102 0.57 2.2
AFRICA ISRAEL PROPERTIES LTD 805 0.23 0.49 98 0.29 0.0
KARDAN ISRAEL LTD 290 0.13 0.51 11 0.34 0.0
ASHTROM PROPERTIES LTD 537 0.40 0.48 11 0.63 7.2
Source: Bloomberg data with UBS calculations (where applicable). Priced as of 01 Sep 2011.
We show Azrieli below compared to other major retail-focused property shares Lower income, higher discount and globally. These show below-average income returns (due to higher development gearing in line with International peers and non-real estate exposure), but much higher discounts and property yields. In a global context its “low” gearing is closer to the average.
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Azrieli Group 6 September 2011
Table 7: International peers
EBITDA/ Net Mar. Cap EV '11E EPS Yld P/NAV Stated Implied debt/EV Security Price (Local) (USD) (%) 11E DY 11E 11E Cap Cap '11E Azrieli Group 87.56 3,020 6.5 4.4% 2.5% 20.4% 7.9% 9.0% 38.0% Westfield Group 8.22 20,307 4.6 7.8% 5.9% 15.5% 6.4% 7.1% 42.2% Westfield Retail Tst 2.61 8,529 n.a. 7.1% 6.4% -10.9% 6.2% 7.1% n.a CFS Retail Tst 1.81 5,484 6.6 7.0% 7.0% -12.2% 6.6% 7.3% 30.3% Capital Shopping 333.20 4,640 5.8 4.8% 4.6% -11.8% 5.3% 5.3% 51.1% Hammerson 406.20 4,693 5.0 4.7% 4.0% -24.9% 5.2% 5.3% 40.8% Unibail-Rodamco 149.90 19,528 5.1 6.0% 5.5% 11.5% 5.7% 5.1% 38.5% Corio 40.66 5,356 5.3 7.1% 6.7% -13.5% 6.5% 6.6% 43.6% Klepierre 24.18 6,445 6.1 8.2% 5.8% -20.8% 6.4% 6.2% 53.6% Deutsche Euroshop 27.63 2,036 5.3 5.1% 4.0% 0.0% 5.9% 6.1% 42.5% Eurocommercial 31.44 1,830 5.2 6.0% 6.0% -13.5% 5.6% 5.5% 42.1% CMT 1.87 4,929 4.7 4.9% 5.4% 15.8% 5.8% 5.0% 27.0% CapitaRetail China 1.22 634 6.8 6.6% 7.1% -0.8% 6.4% 6.0% 31.8% Link REIT 27.30 7,721 5.9 4.1% 4.0% 9.3% 6.7% 5.4% 16.7% Japan Retail Fund 114600.00 2,516 5.3 6.7% 6.7% -21.7% 5.7% 5.5% 62.1% Frontier Real Estate 707000.00 1,784 6.3 5.3% 5.3% 4.1% 5.8% 5.5% 26.3% Simon 117.50 34,391 6.1 4.7% 2.9% 3.1% n.a. 5.9% 36.1% Macerich 49.04 6,362 3.5 4.7% 4.2% -0.8% n.a. 6.3% 41.1% CBL & Assoc. Prop. 14.71 2,028 9.2 10.7% 5.7% -23.6% n.a. 7.9% 64.8% General Grow th 13.64 4,329 8.8 5.2% 2.9% -6.9% n.a. 6.2% 81.6% Taubman Centers 57.63 3,131 7.8 4.1% 3.1% -4.5% n.a. 5.8% 44.4% Fraser Centrepoint 1.45 921 4.4 5.0% 5.7% 7.0% 5.8% 5.3% 28.7% CapitaMalls Asia 1.77 5,798 2.7 4.5% 1.1% 6.5% n.a. 5.4% n.a Average 153,392 5.2 5.8% 4.6% 0.9% 5.8% 6.0% 36.4%
Source: UBS estimates NB Average/total excludes Azrieli
Risk analysis The region harbours above- Q Geopolitical risks: Any investor in Israel faces geopolitical risks. We believe that deterioration in the geopolitical landscape could have a negative average risk impact on the commercial real estate sector. Commercial real estate retreated in 2001-04 due to the second intifada as well as the situation in Iraq. Conversely, prices stayed resilient during the 2006 second Lebanon war and throughout the two-month Gaza conflict in 2009.
Q Social unrest in Israel: Over the last two months, there has been public Despite strong economy, signs of outcry accompanied by protests against the rise in living costs in Israel. This consumer pain has dominated the media, with the majority of the population feeling the protests are justified. The argument is that, despite the strong economy and record low unemployment, the middle class is struggling to maintain its standard of living. Although headline CPI is c4%, key elements such as food and fuel prices, and child care costs are rising, there is a lack of affordable housing, rents are rising strongly above CPI, and there is a more general sense of unfair distribution of wealth as income tax/national insurance equates to up to 60% of gross pay. As a result, we note a slowdown in consumer spending. Inflation has also come down (-0.3% in July) and we expect further deceleration due to reduced deal activity in residential real estate, as well as a "militant" consumer approach towards conglomerates by
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Azrieli Group 6 September 2011
utilising social media to boycott food retailers and manufacturers, which have so far been quick to reduce prices in response.
Q Possible changes to corporate and dividend taxes: The magnitude of the Government might change protest is clearly placing the government under enormous pressure to make current tax plans significant changes in its fiscal policies to ease the burden on the large middle-class segment of the population, and to attempt to redistribute wealth to some extent. We believe the government may pull its plan to lower corporate tax to 18% by 2016 and instead maintain the current 24% level.
Q Regulatory changes could stimulate non-core asset disposals: The Israeli Government is considering impact of government is examining the impact of the high concentration of corporate concentration of corporate ownership ownership by a few individuals/conglomerates on the wider Israeli economy. Media reports suggest that one of its recommendations could be to restrict individuals/conglomerates from owning significant stakes in real estate companies as well as in financial institutions. This could potentially mean that the group is forced to dispose of its stake in Leumi Card or Bank Leumi, although the latter case is less likely due to the relatively small 4.8% stake.
Q The group has significant non-property interests following opportunistic Significant non-property interests purchases. The major investments comprise a majority interest in Granite, and the holdings in Bank Leumi and Leumi Card. As at June these were valued at NIS2.2 billion. Two of these investments are quoted, and following recent share price moves the value has fallen to NIS1.8 billion. These holdings add significant additional volatility to NAV.
Q Non-core assets face regulatory headwind:
— Bank Leumi: We believe there is a risk that Bank Leumi dividends will Lower dividends? be lower in the current year as the bank seeks to build its capital. See UBS report Bank Leumi Le-Israel-Regulation could drive lower payout, published 6 July 2011
— Granite: The government is planning to mandate a c25% decrease (NIS Lower margins? 0.15/litre) in the fuel marketing margin, effective September 2011. We believe this will have a material negative impact on Granite's profits and dividends and factored this into our Azrieli estimates.
— Leumi Card: The Anti-trust Committee proposed a 0.64% cut in cross Lower charges? credit card transaction clearing charges from November 2011, which may have a negative effect on Leumi card's revenue and profitability.
Q The group’s dominant position particularly in the retail market may make it Limits to domestic market share? hard to find suitable acquisitions and could raise competition issues.
Q The various holdings add an additional level of complexity to the group Complexity/conglomerate discount? when comparing it to many other non-domestic real estate companies.
Q Investors are buying into a minority interest. Overall group strategy is likely Group is family-controlled to be controlled by the dominant shareholder, the Azrieli family
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Azrieli Group 6 September 2011
Q Our valuation is based on the assumption of a progressive dividend policy We assume a change in dividend policy driven by growth in underlying recurring profits, an approach common to many real estate companies worldwide. The group has yet to adopt this approach, and its current dividend policy is based on net profit, a number that includes revaluation gains/losses.
Q The group has significant development exposure, which brings with it Development risks planning, construction, financing and letting risks. The future pipeline includes significant potential office projects (South Hakirya, and Holon). We believe these are likely to prove more risky than the group’s retail schemes, as they are in potentially more volatile markets. We note that many of the retail projects are already significantly pre-let.
Q At IPO, a listed company releases a considerable amount of information and Need to maintain current transparency provides significant transparency. We believe it is important that Azrieli not standards to woo International only maintains these standards but looks to build on them to continue to investors broaden its international standing.
Corporate governance We note that 75% of the shares are held by Azrieli Holdings. Therefore, it is important that its aims are aligned with those of other investors. Global corporate governance ratings provider GMI does not cover the Azrieli Group.
Forthcoming catalysts Q3 will provide an update on the Q Q3 results (expected November) will contain an update on revenue performance as well as a revaluation of the recently completed projects at business and an indication of capital Akko and Kiryat Ata. We expect the NAV to rise to NIS106 per share, with gains on two recent developments portfolio growth undermined by the fall in the value of quoted investments.
Q The group recently announced the NIS410 million purchase (including costs Netanya purchase remains conditional and future capex) of a 50% interest in a shopping mall development in Netanya, subject to three conditions being met. We assume the transaction completes in October 2011.
Q The group has a major development programme, but over one third of group Progress on developments projects are awaiting planning consent. We assume that these are resolved and that the developments start on schedule.
Q The group still has considerable financial capacity with which to fund Additional acquisitions should be acquisitions. These are likely to be accretive on current market pricing. accretive
Q Longer term, the group expects to sell its non-core assets. Disposals could Over the longer term the group plans to represent a substantial increase in financial liquidity and crystallise capital shift into higher-yielding assets gains and losses. The disposal of the interest in Granite would significantly change the consolidated numbers.
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Azrieli Group 6 September 2011 Management Azrieli Group’s Board of Directors is led by Chairman David Azrieli (a The Azrieli family and its long-standing controlling shareholder, whose family owns a 75% stake), Executive Vice associates dominate the board… Chairperson Menachem Einan (formerly CEO), and Executive Deputy Chairperson Danna Azrieli (David Azrieli’s daughter). We list the other board members in the table below.
The two external directors are Efraim Halevy, who is currently head of the …with two external directors, and one Shasha Center for Strategic Studies at the Hebrew University of Jerusalem, and independent director Niv Ahituv, who is Academic Director of the Netvision Institute of Internet studies, Tel Aviv University, Director of the Henry Crown Institute of Business Research in Israel, Tel Aviv University and a member of the Investment Committee of Migdal Insurance. In addition, Joseph Ciechanover has been an independent director since May 2011.
Table 8: Board of directors
Name Other Position External Citizen Birth Comment
David Azrieli Chairman No Canadian 1922 Founder
Menachem Einan Executive Vice Chairperson No Israeli 1939 Previous CEO
Danna Azrieli Executive Deputy Chairperson No Canadian 1967 Daughter of David
Sharon Azrieli None No Canadian 1960 Daughter of David
Naomi Azrieli None No Canadian 1965 Daughter of David Yosef Ciechanover Financial Committee/Independent No Israeli 1933 Yossi Kuchik None No Israeli 1951 Efraim Halevy Financial Committee/External Yes Israeli 1934 Niv Ahituv Financial Committee/External Yes Israeli 1943
Source: Azrieli
Shlomo Sherf replaced Menachem Einan as the group’s CEO on April 1, 2011. New CEO effective April 1, 2011: He previously worked at Electra Group for twenty years, where he was Shlomo Sherf responsible for developing the real estate business, holding the post of CEO of Electra Real Estate for the last five years. We list the senior staff below.
Table 9: Senior staff
Name Position Birth
Shlomo Sherf CEO 1949
Yuval Bronstein CFO 1969
Peer Nadir CEO Azrieli malls 1956
Arnon Toren Chief Marketing officer & CEO Azrieli Center, Tel Aviv 1957
Israel Keren CEO of several subsidiaries 1947
Avraham Yaakovi Controller Azrieli Group 1954
Michal Kamir General Counsel and Company Secretary 1967
Eyal Iohan Construction Manager 1973
Rafi Wunsh Business Development Manager 1971
Gali Gana Internal auditor 1965
Source: Azrieli
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Azrieli Group 6 September 2011
We show the total number of group employees, excluding the Granite shareholding, below:
Table 10: Total employees (excluding Granite)
2009 2010
Management HQ 32 33
Shopping Centres 102 113
Offices and other 57 63
Total 191 209
Source: Azrieli
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Azrieli Group 6 September 2011 Revenue estimates Our revenue growth estimates are shown in the tables below. We divide our Our analysis is focused on the real analysis into two. First, we focus on the Real Estate business to come to an estate business estimate of recurring EPS. We then fold this into our estimates for the Granite holding to produce a consolidated result. This is similar to the group’s own approach, which provides standalone numbers and a real estate FFO and NAV alongside the consolidated numbers.
Rental income is driven by annual growth and completion and letting of Development completions expected to developments. Interest costs rise with capex spend and inflation estimates. We be an important driver of growth estimate the resultant EPS growth at 13% CAGR from 2011. Real estate business Table 11: Azrieli Group – recurring EPS estimates for the real estate division
Azrieli Group - Real Estate only 2009 2010 2011E 2012E 2013E 2014E 2015E
Rental income from commercial and shopping 665 759 800 902 958 1,110 1,216
Rental income from office space and others 319 332 419 456 472 518 537
Total rental income 983 1,091 1,219 1,357 1,431 1,628 1,752
Growth (%) 11.0% 11.8% 11.3% 5.4% 13.8% 7.6%
Cost of rental income from commercial and shopping 130 141 138 155 165 191 209
Cost of rental income from office space and others 68 68 102 111 115 126 130
Total cost of rental income 198 209 239 266 279 317 339
NOI from real estate 785 882 980 1,092 1,151 1,312 1,413
Growth (%) 23.8% 12.3% 11.1% 11.4% 5.4% 13.9% 7.7%
Net interest expense (real estate) -273 -193 -346 -311 -323 -329 -345
Administrative expenses -64 -69 -73 -75 -77 -80 -82
Funds before tax 513 620 561 705 750 903 985
Current taxes -32 -70 -113 -162 -165 -190 -197
Recurring net profit 481 550 449 543 585 713 788
Recurring EPS 3.97 4.54 3.70 4.48 4.83 5.88 6.50
Growth (%) 14.4% -18.4% 21.1% 7.8% 21.8% 10.6%
Source: UBS estimates. Data in NIS millions, except per share data
Recent NOI growth trends are shown in the following chart. The contribution from retail has stagnated at cNIS160 million for the last three quarters. This is explained by rental gains being offset by initiatives to improve the Hanegev mall and to create the new Forever 21 store at the Azrieli Center.
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Azrieli Group 6 September 2011
Chart 4: Azrieli Group NOI progression
300
250
200 Offices 150 Malls 100
50
0 2009 Q3 2009 Q4 2010 Q1 2010 Q2 2010 Q3 2010 Q4 2011 Q1 2011 Q2
Source: Azrieli
The following table shows the main drivers of our rental progression estimates. We have divided this into three components: organic growth, acquisitions and developments.
Table 12: Top-line rental growth estimates
2011 2012 2013 2014 2015
Start rent 1091 1219 1358 1430 1628
Organic growth 42 47 57 52 55
Acquisitions 69 26 0 0 0
Developments 17 66 15 146 69
End rent 1219 1358 1430 1628 1752
Source: UBS estimates
Q Organic growth is driven by indexation and rental growth and we show our We assume 5% rental growth for retail inflation estimates below. We are more positive on the long-term rental and 2.5% for offices prospects of retail over offices and are therefore assuming 5% rental growth for retail and 2.5% for offices over the medium term. For more detailed market analysis please see the Appendix. Organic growth represents over a third of our rental growth estimates.
Table 13: UBS Israel inflation assumptions
Q1 11 Q2 11 Q3 11E Q4 11E 2012E 2013E 2014E
Inflation assumptions 0.70% 0.90% 1.30% 0.40% 2.60% 2.60% 2.60%
Source: UBS estimates
Q Acquisitions could be a source of accretive gains given current NOI yields (>7%) are significantly above borrowing costs (<5%). Our numbers only include the acquisition of an office complex in the US (Houston, Texas). We treat the Netanya acquisition as a development. These represent c13% of our rental growth. This growth may also come with additional property and interest costs so the net impact is lower. For instance, the recent Houston purchase (US$177.4 million) has been financed with US$130 million of debt
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Azrieli Group 6 September 2011
fixed at c6% and a US$5 million guarantee. The group estimates NOI at US$14 million in 2012, following the letting of 18,000 sq m), so the net profit gain after interest is cUS$6 million (NIS 21 million).
Q Developments. These provide over half our estimated rental growth in the next three years. 2012 is boosted by the recent Netanya acquisition (which is still conditional), and 2013 is a relatively lean year. On our estimates, retail rents represent c60% of the upside, and the 40% office upside is heavily concentrated in 2014 and 2015. 2014 benefits from the assumed opening of malls at Ramala, and Rishonim.
Voids are currently low (occupancy is close to 100%) so letting vacancy is Lease expiries could become an issue unlikely to prove a big driver of future profits (a timetable of lease expiries is in an environment of increased office shown below). Currently, this is not an issue as both retail and offices appear to supply let readily. However, this may become more of an issue in later years, particularly given our expectation for office supply increases.
Table 14: Lease contracts expiry, assuming non-exercise of lessees’ option periods
Revenues from Number of Area Period of Income Recognition Fixed Components Contracts Ending (sq m in thousands) Q1 2011 268,278 100 10,851 Q2 2011 257,154 217 20,668 Q3 2011 249,690 144 15,810 Q4 2011 237,011 198 15,820 Y 2012 835,387 602 103,724 Y 2013 581,893 643 118,820 Y 2014 374,545 307 55,729 Y 2015 & beyond 632,716 591 198,600 Total 3,436,674 2,802 540,022
Source: Company data, UBS
We assume a constant portfolio cost margin of 17% for retail and 23% for Our estimates assume a constant offices, although we note that one of the group’s goals is to reduce costs. In our portfolio cost margin of 17% for retail model portfolio costs rise with income. and 23% for offices
We have assumed that the real estate business bears the full group administration cost, which rises by inflation.
Rising interest costs reflect higher levels of debt, principally from developments Inflation has a significant impact on (we assume capex of cNIS2.5 billion over the next five years), and we assume debt costs an annual cost of debt of c8% in 2011, and 7.7% (including inflation) thereafter. The actual level of interest rates depends on inflation given the significant proportion of indexed debt. We assume that NIS1.2 billion of debt relates to the non-real estate investments (based on 65% LTV to initial cost). The impact of the increased debt cost will be lowered by capitalised interest. We assume cNIS25 million per annum over 2012-14. Based on current interest costs, debt costs will decline as older loans are refinanced.
We assume a declining tax rate of 24% in 2011 and reducing thereafter. That Impact of tax said, we believe that rates could remain stable going forward as result of recent social unrest in Israel. We present the impact on our estimates of net income if corporate taxes are maintained at 24%. A corporate tax freeze may also result in
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Azrieli Group 6 September 2011 a one-time negative charge of NISc400 million/US$115 million on net income as result of previously lower deferred taxes attributed to revaluation gains.
Table 15: Estimated Impact on Group Profits if tax rate is frozen at 24%
NIS millions 2012E 2013E 2014E 2015E
PBT 1,488 1,606 1,861 1,879
Tax expense 357 386 447 451
Tax on Pre-exceptional profits 183 201 249 276
Tax on exceptional profits 174 184 197 175
Total Net profit 1,131 1,221 1,415 1,428
Less Minorities -19 -15 -15 -15
TO THE SHAREHOLDERS 1,113 1,206 1,400 1,413
Change (%) -1.3% -2.6% -3.8% -5.0%
Source: UBS
On our estimates, we expect to see strong earnings growth from the current year Good earnings prospects on the back boosted by successful completion of developments. We believe that it is this of successful completion of strength that will support a progressive dividend model. developments
Azrieli does not report a recurring EPS for the Real Estate division, but it does Our numbers are conservative report an FFO for the income-producing property business. In H1 11 this was compared to the group’s FFO targets reported as NIS328 million (NIS2.7 per share), see table below. This compares to our real estate earnings estimate of NIS215 million for the same period. The main difference (c70%) can be explained by the treatment of non-cash finance expenses (NIS77 million/NIS0.6 per share). We understand that these relate to the indexed portion of the debt, while we accept that these are non-cash items during the reported period, they do represent future cash liabilities and therefore we would adjust for them. Another explanation of the difference is probably in the allocation of other income from financial assets.
Table 16: Azrieli Group H1 11 FFO
NIS m Q1 Q2 H1
Net profit 162 383 545
Granite -18 3 -15
Property values -16 -337 -353
Depreciation 1 1 2
Net non-cash finance expenses 32 45 77
Deferred taxes -1 49 48
Adjustment for equity invests 1 0 1
Income from assets held for trade -19 -16 -35
Impairment 22 43 65
EOP 3 2 5
Dividend from BLL -24 -19 -43
Interest paid for real investments 15 14 29
FFO 160 168 328
Source: Azrieli
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Azrieli Group 6 September 2011
Other businesses The Azrieli Group has significant non-real estate investments (Granite, Bank Leumi, Leumi Card) and is the majority owner of industrial holding company Granite Hacarmel, which represents a less arms-length business. However, the group believes a standalone accounting approach is the valid one.
(1) Treatment as an investment. The table below shows the group has Azrieli’s investment in its non-real invested NIS1.8 billion in its three major non core investments. These estate businesses produces an currently have a market value just above cost. In the first half of 2011, the annualised return of 4.6% on the June group received dividends of NIS52 million (predominantly tranches of the 2011 book value Bank Leumi 2010 dividend). This represents an annualised return of 4.6% on the June 2011 book value. We believe that there is a risk that the Bank Leumi dividend will be lower in the current year as the bank seeks to build its capital. See UBS report Bank Leumi Le-Israel-Regulation could drive lower payout, published 6th July 2011.
Table 17: Value and dividends of three major non-real estate investments (NISm)
Market values
Holdings Costs 2010 Q1 11 Q2 11 Today
Granite 740 715 616 616 454
Bank Leumi 742 1,285 1,260 1,132 933
Leumi Card 360 498 498 498 498
Total 1,842 2,498 2,375 2,246 1,885
Cost 1,842 1,842 1,842 1,842
Surplus 656 533 404 43
Dividends received 41 24 28
Granite 15 0 9
Bank Leumi 24 24 19
Leumi Card 2 0 0
Source: Azrieli/UBS estimates
(2) Consolidated approach. An alternative is to use the consolidated approach Lowers revenue returns on invested and this shows that, for most of the period, the revenue impact of the other capital businesses on our estimates is neutral after the current year. This is because we assume the Bank Leumi dividend falls. However, the revenue return is lower than for investment properties, and on our estimates dilutes growth. .
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Azrieli Group 6 September 2011
Table 18: UBS estimated impact of other businesses on consolidated profit (NISm)
2011 2012 2013 2014 2015
Net profit 1,294 1,146 1,253 1,471 1,503
Real estate net profit 449 543 585 713 788
Revaluation 984 758 838 939 874
Reval tax -199 -174 -184 -197 -175
Other profit 60 19 14 15 16
Turnover 6,042 6,272 6,523 6,784 7,055
Other income 90 37 37 37 37
JVs -10 0 0 0 0
Costs -5,819 -6,075 -6,337 -6,598 -6,869
Other costs -2 0 0 0 0
Other income -7 0 0 0 0
Financial income 85 85 85 85 84
Financial costs -303 -294 -290 -288 -287
Tax -15 -6 -4 -4 -4
Net result 60 19 14 15 16
Minorities -33 -19 -15 -16 -16
Attributable 27 0 -2 0 0
Source: UBS estimates Dividend policy The company has a stated annual dividend policy of a 35% payout of net profit The group targets a payout ratio of 35% subject to any law, cash flow, the group’s financing needs, at the directors’ of net profit discretion, and subject to change. This is a broad definition, but we believe that it should be based on some measure of recurring real estate profit rather than net profits, which could include significant revaluation gains or losses.
In March 2011 the group distributed NIS240 million (NIS1.98 per share). This Last year’s dividend was 20% of net represented 20% of 2010 net profit, or 45% of net profit less property profit revaluations and deferred tax.
We believe the group has ample dividend cover from recurring income and We think Azrieli has ample dividend should be able to adopt a progressive dividend based policy. As a result, we cover and should adopt a progressive have raised our estimate for the current year’s dividend, despite assuming flat dividend based on recurring profits net profits. Our dividend cover estimates are shown in the following table.
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Azrieli Group 6 September 2011
Table 19: UBS dividend cover estimates
Actual Estimates
NIS millions, except cover ratios 2010 2011E 2012E 2013E 2014E 2015E
Dividend 240 262 294 315 342 394
Net profit (NP) 1,255 1,294 1,146 1,253 1,471 1,503
NP dividend cover 5.23 4.94 3.90 3.97 4.30 3.81
Estimated Consolidated Earnings (ECE) 533 476 544 584 713 788
ECE Dividend Cover 2.22 1.82 1.85 1.85 2.08 2.00
Real Estate Recurring earnings (RERE) 550 449 543 585 713 788
RERE dividend cover 2.29 1.71 1.85 1.86 2.08 2.00
Source: UBS estimates
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Azrieli Group 6 September 2011 Property portfolio The Azrieli Group’s real estate business principally comprises investments in Two-thirds retail exposure, with 8% shopping centres (two-thirds of the portfolio) and offices and other. We estimate development exposure that residential and industrial property represent under 2% of the portfolio. At 30th June, c8% of the portfolio was categorised as under development or land, and c6% is foreign, principally the offices in Houston, Texas.
The group’s principal property (c30% of the portfolio in June 2011) is the The Azrieli Center is the group’s largest Azrieli Center in Tel Aviv (mixed use shopping centre, offices, hotel and other development, with 45% office income uses). We show the breakdown of income in the chart below. One interesting and 34% retail income… feature is 5% of group income is derived from its margin on management costs and electricity supply. The Mall was completed in 1998, and two towers in 1999 and 2000. The third and final tower was completed in 2008. The property is a well known landmark with its geometrically-shaped towers slightly east of the old city centre, and is well placed for transport links between the Menakhem Begin Road and the Ayalon North and South Highways, and linked into the Ha- Shalom railway station. There are 3,200 car parking spaces.
Chart 5: Sources of income from the Azrieli Center, Tel Aviv, 2010
Electricity margin Storage Management profit 1% 1% 4% Hotel 4% Parking Retail 11% 34%
Offices 45%
Source: Azrieli
On 30 June, 2011 the property’s fair value was NIS4,133 million. The office …representing 30% of the group’s towers alone were valued at NIS2,358 million and represented 48% of the non- portfolio and 48% of the office retail portfolio. exposure
We discuss the retail and office elements in more detail below.
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Azrieli Group 6 September 2011
Israel shopping centres We show Azrieli’s retail portfolio below. The group owns seven shopping Seven major shopping centres, with centres (larger than 20,000 sq m), is currently acquiring a 50% interest in one two under construction; three major more and is developing two more for completion in 2013/14. The largest is in centres in the Greater Tel Aviv area Jerusalem, and the second-largest is at the Azrieli Center in Tel Aviv. Azrieli’s four largest shopping centres represented over 60% of its 2010 retail portfolio.
Table 20: Shopping centre portfolio
Rental area Rev. 2009 Value 2009 Rev. 2010 Value 2010 Property City (m2) Ownership (NISm) (NISm) (NISm) (NISm) Occup.
Azrieli Jerusalem Jerusalem 39,000 100% 108 1447 116 1608 100%
Azrieli Center Tel Aviv 32,000 100% 96 1366 102 1456 100%
Azrieli Ayalon Ramt Gan 23,000 100% 87 1156 91 1240 100%
Azrieli Modi'in Modi'in 22,000 100% 72 662 100%
Azrieli Negev Beer Sheba 22,899 100% 67 778 97%
Azrieli Holon Holon 16,640 100% 48 489 100%
Azrieli Givatayim Givatayim 20,500 100% 45 800 62 876 100%
Azrieli Haifa Haifa 25,824 100% 26 312 100%
Azrieli Hod Hasharon 6,865 100% 19 153
Azrieli Herzlia Outlet Herzlia 5,961 100% 12 104
Azrieli Or Yehuda Outlet Or Yehuda 5,296 89% 4 39
Total 219,985 616 7306 616 8240
Source: UBS estimates
The Azrieli Center shopping mall (32,452 sq m) is on three floors and is let to Average rents of NIS270 per month for 178 businesses. Large units are let to retailers Shufersal, H&M, Hamashibir, the Azrieli Center Mall Superpharm, Mango, GAP, Zara, and Toys “R” Us. In November 2011 US clothing retailer Forever 21 will open a 1,500 sq m store, its first in Israel.
In December 2010 retail rents ranged from NIS60 to NIS3,400 per sq m per month. The average rent including large units was NIS270/US$77.15 per sq m per month. The space breakdown is as follows:
Table 21: Space use at Azrieli Center Mall, Tel Aviv (December 2010)
Sq m %
Large units 11,424 35%
Shop units 17,072 53%
Public floor 3,956 12%
Total 32,452 100%
Source: Azrieli
The group owns three major Greater Tel Aviv centres in total, the other two being Herzlia (north east) and Givatayim.
Its other major centres are the recent development at the new town of Mod’in, A broad spread of other centres the recently acquired centre at Haifa, and a shopping centre at Be’er Sheva. The Haifa Mall was acquired for NIS300 million in Q1 10, and was revalued at NIS395 million in December 2010.
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Azrieli Group 6 September 2011
Figure 1: Locations of Azrieli Malls
Source: Azrieli Group presentation. (1) Acquisition of land in Ramla: closing scheduled for Q2/2011
The Group owns one mid-size mall (17,000 sq m) associated with its business Three mid-sized malls (two under park development south of Tel Aviv (see below). It is developing two more construction) medium-sized malls for completion in 2011 (see below). Both of these are in the North of the country. There are three smaller properties, of which two are outlets.
The group’s malls are modern and we believe they are relatively high quality. The malls are of good quality, although Azrieli Ayalon is one of its oldest centres, but is well placed and there are plans Be’er sheeva may prove a competitive to expand it by 40% (see below). Azrieli Hanagev is currently subject to some market works and may face competition from Melisron’s Be’er Sheva Mall (44,000 sq m/250 shops due to open in 2013.)
The group has a significant development pipeline under construction with five A substantial pipeline, with five new projects (including the recently secured Netanya project) and three new projects and three extensions extensions/renovations. /renovations
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Azrieli Group 6 September 2011
Table 22: Shopping centre development programme
GLA Book value June 2011 Cost to complete Property (Sqm) Completion (NIS millions) (NIS millions) Pre-let %
Azrieli Akko Shopping Mall 12,406 Q3 2011 90 40-45 95%
Azrieli Kiryat Ata (shopping mall) 9,000 Q3 2011 79 25-30 90%
Azrieli Rishonim (shopping mall) 16,000 Mar-14 30 150
Azrieli Mall Ramla 22,000 2013 106 204-224 50%
Azrieli Hanegev Mall (Renovation) 2,570 Completed 13
Azrieli Ayalon Mall –additional floor 9,500 N/a 5 120-150
Azrielli Center Southern Hakirya 12,000 2013 0 175
Ir-Yamin Mall, Netanya 24,000 2012 N/a 410 68%
Total 71,476 178 952-1188
Source: Azrieli/UBS estimates
Q Azrieli Akko Mall (Acre) 12,400 sq m-95% pre-let, opened in August. The Completion 2011 total investment will be cNIS135 million, and the NOI is estimated at NIS19.7 million (up 4% since March). The land was acquired from a subsidiary of Granite in 2007.
Q Azrieli Kiryat Atta (9,100 sq m mall, and 4,000 sq m offices). The mall is Completion 2011 70% pre-let, and is due for completion in September. The total investment will be cNIS105 million (commercial only), and the NOI is estimated at NIS 17 million (down 1% since March) The land was acquired from a subsidiary of Granite in 2009.
Q Ir Yamim Mall, Netanya (24,000 sq m) On 15 August 2011 the group Completion 2012 announced that it had conditionally agreed to buy a 50% interest in the Ir Yamim Mall, Netanya. This project is under development for completion in early 2012. It is 69% pre-let (estimated NOI of NIS42 million) The group estimates the NOI on full letting at NIS 61 million. The purchase price for the 50% interest is NIS350 million plus NIS20 million costs, and NIS40 million future capex to complete the scheme, which in total represents an NOI yield of 7.4%. The group is also paying NIS20 million for its share of future rights. This sum is returnable plus 7% interest if these rights are not forthcoming. The vendor is Shikun U-Pitach, and the JV partner is Shikun & Binui. The purchase is conditional on (a) the partner not exercising its option to match a sale by its partner (b) competition authority approval and (c) Bank Leumi approval as provider of the development finance.
Q Azrieli Mall Ramla (22,000 sq m). The Group acquired 31,650 sq m of land Completion 2013 in Ramla for NIS100 million in May 2011. It will now construct a mall for completion in 2013. The mall is already 50% pre let and the total cost is expected to be NIS320 million. Construction approval is still pending.
Q Azrieli Rishonim. Subject to final approvals, the group expects to build Completion 2014 48,000 sq m mixed use commercial scheme at Rishon Lezion. The total cost of the scheme is cNIS500 million, and we estimate the retail element at NIS180 million, which represents the group’s second-largest future retail development exposure. The mall is due for completion in 2014. This approval is subject to an appeal from a number of local parties.
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Azrieli Group 6 September 2011
Israel offices Around 40% of the Group’s office exposure comprises the three towers at the The Azrieli Center in Tel Aviv eponymous Azrieli Center, Tel Aviv. The Group has created a business park to comprises 40% of the group’s office the north of Tel Aviv at Herzlia, which is now virtually fully let following the exposure completion and letting of the latest building (Building E: 13,000 sq m) in 2011.
Azrieli Center, Tel Aviv. As discussed earlier, the non-retail element of this property was valued at NIS2.6 billion in June 2011. This breaks down as follows:
Table 23: Non retail element of Azrieli Center, Tel Aviv
Sq m Income Value Yield
Offices 150,704 147 1903 7.7%
Hotel 18,000 14 181 7.5%
Storage 2,500 2 27 7.8%
Parking 34 434 7.8%
Profit on electricity 4 31 12.0%
Profit on management charge 13 123 10.5%
Contingencies -69
Total 214 2638 8.1%
Source: Azrielli
The three towers breakdown as follows:
Table 24: Azrieli Center, Tel Aviv offices
Sq m Type Comment
Round Tower 59,475 Offices 1% empty, 2.6% for own use
Triangular Tower 48,059 Offices 46% let to Bezeq
Square Tower 25,171 Offices
Square Tower 18,000 Hotel
Source: Source: Azrielli
The only office vacancy is in the Round Tower (790 sq m). In addition, the top floor A modest void is used by Azrieli Group, and therefore no value has been attributed to this space.
The main tenant in the Triangular Tower is Bezeq (22,300 sq m). Their space is Bezeq, one of the centre’s main described as “average”, and in a recent lease agreement Azrieli has agreed a rent tenants, appears to enjoy special terms reduction and to pay for renovation works of cNIS660 per sq m (cNIS15 million) to be paid over five years.
Thirteen floors in the Square Tower are let to Crown Plaza City Center Hotel (273 rooms). The other 18 floors are offices. The hotel is let at an average rent of NIS62 per sq m per month with the lease expiring in October 2020.
Excluding the Bezeq space, the average office rent is NIS94 per sq m per month. The Bezeq space was let at NIS62 per sq m per month. As of December 2010 Bezeq has signed a new five-year lease whereby it will pay NIS69 per sq m per month (linked to CPI) for two years rising to NIS72.4 per sq m per month for the next three years. Bezeq is building a new office campus for its own use so we would expect it to vacate this space at the end of the lease.
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Azrieli Group 6 September 2011
Herzlia Business park (27 hectares, eight office buildings and underground car park. The Azrieli Herzlia outlet (see above) is also part of this site.
Table 25: Office investments
Rental area Rev. 2009 Value 2009 Rev. 2010 Value 2010 Property City (m2) Ownership (NISm) (NISm) (NISm) (NISm) Occupancy
Azrieli Towers offices Tel Aviv 150,704 100% 149 2313 152 2476 100% Azrieli Herzlia Business Park offices Herzlia 68,544 100% 52 761 100% Azrieli Jerusalem offices Jerusalem 3,030 100% 3 28 90% Azrieli Hanagev offices Beer Sheba 8,111 100% 6 49 99% Azrieli Modi'in offices Modi'in 16,056 100% 4 82% Azrieli Givatayim offices Givatayim 1,254 100% 1 100% Caesarea Industrial Park Caesarea 18,617 100% 7 75 100% K.M.T Petach Tikva Petach Tikva 9,003 50% 6 52 100%
Average/Total 275,319 228 3237 259 3501 94%
Source: Azrieli
In addition to the investment portfolio the Group owns the following development sites:
Azrieli Center Holon: The group now plans to build a business park south of Completion 2016 Tel Aviv. In 2008 the group signed an agreement with the City of Holon on 34 dunams (8.4 acres) to build a business park in no more than four phases. The City of Holon will retain a 17% interest. The total project comprises 120,000 sq m with the first phase due for completion 2013/4, and the whole project timed to complete in 2016.
Azrieli Center, Southern Hakirya. In H1 the group acquired the lease to a land Completion 2016 (latest) plot at Southern Hakirya for NIS588 million. The lot is designated for offices and commercial totalling 125,000 sq m of which the majority (c110,000 sq m) will likely be offices. There is an additional 61,000 sq m of underground space. The group estimates the additional cost of cNIS900-950 million. We assume that there is a 12,000 sq m retail component. The contract stipulates that the project will be completed within five years.
Table 36: Key office development programmes in Tel Aviv
Project/Developer Locaction GLA (Sq m)Description
Azrieli - South Kirya Kirya, Tel Aviv 125,000 2 office towers
Tnuva - Eurocom, Electra, Pangeya (*) Kirya,Tel Aviv 90,000 2 office towers
Haarba - Hgag and Private Kirya, Tel Aviv 75,000 2 Office towers
Haargaz - Insurance companies Kirya, Tel Aviv 80,000 2 Office towers
Sapir Tower - Private Ramat Gan 60,000 1 tower
Atidim North Tel Aviv 80,000 2 office towers
(*) Also includes designated residential space Source: UBS
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Azrieli Group 6 September 2011
We note the growing potential competition in the Azrieli Center/southern Kirya Significant potential development in area. During the past year a number of sites have been acquired by various Kirya area developers. According to MAN Properties, part of the CBRE affiliate network, existing Tel Aviv office space totals 3 million sq m and annual demand is c100,000 sq m. MAN properties estimates 15 new projects representing an additional c600,000 sq m, will be delivered between 2014-17, thus generating c200,000 sq m annual supply during the period. We believe Azrieli is well placed to start before some of the competition. That said, we do not rule out the risk of higher vacancy rates and price pressure during 2015-16.
Table 26: Key Office development programmes
Book cost June 2011 Cost to complete Property GLA (Sqm) Completion (NIS millions) (NIS millions)
Azrieli Center Holon (83% interest) 120,000 2013-2016 57 590-630
Azrielli Center Southern Hakirya 125,000 2013-2016 588 900-950
Azrieli Rishonim (offices) 32,000 Mar-14 51 250-280
Azrieli Givatayim –additional office floor 1,916 Completed 14 7-9
Total 245,000 557 1490-1630
Source: Azrieli Foreign investments The group has a number of foreign office investments principally in Houston, The Lone Star portfolio was Texas. This exposure was significantly increased with the acquisition of three significantly expanded in 2011… office towers in February 2011 (90% interest).
Table 27: Foreign investments
Rental area Rev. 2009 Value 2009 Rev. 2010 Value 2010 Rev/sqm Property City (m2) Ownership (NISm) (NISm) (NISm) (NISm) (NIS) Occup.
One Riverway Houston, US 14,902 33% 14 92 1,067 90%
Three Riverway Houston, US 16,656 45% 15 97 1,079 85%
Southern House 529 York Road Leeds, England 3,116 100% 3 42 933 100%
Galleria(3 office towers) Houston, US 99,000 90% 94 616 945 91%
Total 32 231
Source: Azrielli
The three offices (25-floor Galleria 1, 21-floor Galleria 2, and 12-floor …and could result in an 8% yield on Galleria Financial Center) extend over an area of 99,000 sq m and are leased investment to Merrill Lynch, Citi Group, UBS and large energy corporations. The towers are located above Houston’s largest shopping mall (not part of the deal) which is one of the top five shopping malls in US. Azrieli estimates US$14m of NOI in 2012 from the three offices, which puts this investment on an 8% yield. The acquisition has been funded with a US$130 million US loan with a cost of c6%.. Developments Development margins still appear very attractive in Israel, particularly for Shopping Centre development margins shopping centres. The group will complete two northern shopping centres this are in the mid-teens quarter. We show our estimates below. On these numbers we expect the group to make cash returns of 15% and 16%, respectively, and we are estimating a
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Azrieli Group 6 September 2011 revaluation gain on completion and full letting of cNIS200 million, which is virtually double the value of the cost and reflects the fact that we are assuming an 8% valuation yield on completion. However, some of this profit has already been taken as these properties were revalued for an undisclosed sum in June.
Table 28: Potential surpluses on 2011 developments
NIS(m) Akko Kiryat Ata
NOI 19.7 17.0
Book cost 90 75
Construction cost 45 30
Total cost 135 105
Return on cost 14.6% 16.2%
Value @8% 236 210
Surplus 101 105
Source: UBS estimates
The group has a number of smaller schemes that should prove highly profitable as these represent additions to existing properties, where there are no incremental land costs.
We have discussed the scale and mix of the programme above. We show the A major development programme, with numbers behind our comments in the table below. a modest office bias
Table 29: Azrieli’s development programme (developments at cost)
Current Proforma
NIS(m) 30/06/11 03/03/11 Portfolio Netanya Capex Total Portfolio
Malls-investment 9088 8751 63% 8751 52%
Malls-development 337 2% 370 707 1414 8%
Offices-investment 4889 4193 30% 4193 25%
Offices-development 696 5% 1800 2496 15%
Total 13977 13977 100% 370 2507 16854 100%
Source: UBS estimates
We show the timing of the future projects (total commitment including land of NIS 3.3 billion) in the chart below. The conditional acquisition of the development at Netanya will provide a significant completion in 2012 (the group’s share will be 12,000 sq m). There are also significant completions in 2013 and 2014, which shows the significant front end loading of the retail projects.
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Azrieli Group 6 September 2011
Chart 6: Azrieli – timing of project completions
250000
200000 Netany a S.Hakiry a 150000 Holon
100000 Ramla Rishonim 50000 Kiray at
0 2012 2013 2014 2015 2016
Source: UBS estimates
The Group is confident of its plans, although currently a third of the programme We estimate a third of development is conditional (see table below). plans are still conditional
Table 30: Conditional/modified projects
Location Type Sq m Interest Comment Total cost
Netanya Retail 24,000 50% Conditional purchase 410
Rishonim Mixed 48,000 100% Subject to final approval 500
Ramla Retail 22,000 100% Subject to modifications 320
Ayalon Retail 9,500 100% No start date 150
Total 103,500 1380
Source: UBS estimates
If we assume a 20% developer’s margin, capital profits could be in the order of We estimate potential capital surpluses NIS700 million (cNIS6 per share), and given market conditions and the group’s of over NIS1 billion track record, this may prove conservative. The group suggests that its target cash returns on retail are 12% and 10% for offices. This future commitment is predominantly offices, and all the retail exposure is likely to complete before 2015. Using the group’s target cash returns would produce additional rents of NIS348 million, and assuming this income is valued on an 8% yield produces a potential capital surplus of NIS1,000 million (NIS 8 per share). Other holdings Other holdings for the group include a 61% stake in Granite Hacarmel Other holdings include stakes in (marketing and sales of fuel and related products as well as desalination), a 5% Granite Hacarmel, Bank Leumi and stake in Bank Leumi and a 20% stake in Leumi Card (giving exposure to Israel’s Leumi Card fast-growing credit card market). These three holdings account for ~19% of the group’s NAV. Granite Hacarmel and Bank Leumi (15% of the NAV) are listed on TASE, while Leumi Card is a private business. We believe Azrieli Group has an opportunistic strategy on exiting Bank Leumi and could sell it at a 3-5% discount any time given it is merely a financial investment and not a strategic one. Leumi Card, we believe, is a strategic investment given the group’s operation of shopping malls and use of credit cards by consumers. That said, we
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Azrieli Group 6 September 2011 believe an IPO of Leumi Card could be possible in the medium term, which could provide Azrieli with an exit route and possibly further upside. We believe Azrieli Group would wish to sell its controlling stake in Granite Hacarmel in the medium to long term when it finds a targeted buyer.
We value Granite and Bank Leumi at market value and Granite and Leumi Card at book value according to Azrieli’s book value as of June 2010.
Granite Hacarmel – 60.7% stake; c5% of NAV Granite Hacarmel (“Granite”) is traded on Tel Aviv Stock Exchange. Azrieli Azrieli has a controlling stake took a controlling stake in 2006 and has invested NIS740m for a 60.7% stake. The company operates in four operating segments (1) direct marketing of oil distillates; (2) oil distillates sold at refuelling and commercial complexes; (3) paint and building finishes; and (4) other.
Its headquarters are in Netanya, where the group has made a conditional offer for a 50% interest in a new shopping centre.
Granite reported a profit of NIS15 million (NIS 9 million) in H12011. The improvement was explained by the positive impact of rising petrol prices at Sonol (229 chain of filling stations), improved sales at the Sogood convenience chain and improved sales of diesel oil, LPG, and paint. In addition, there was a full year’s contribution from the gypsum and Via Maris businesses. The latter is involved in a desalination project at Palmachim.
As result of spike in fuel prices as well as recent social unrest the government is planning to mandate a c25% decrease (NIS0.15/ litre) in the fuel marketing margin, effective September 2011. Consequently, S&P Maalot rating agency placed the sector, including Granite, on Credit Watch until a final and formal government announcement is made regarding this issue. In our view the planned cut in marketing margins will have a negative impact on Granit's profits and dividend payout. We have lowered our 2012 estimates.
Figure 2: Granite’s principal holdings
Source: Company data
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Azrieli Group 6 September 2011
Bank Leumi – 4.8% stake; c10% of group NAV During the 2009 financial crisis the Azrieli Group opportunistically invested Bank Leumi brings exposure to NIS742m (cNIS10.5/share) for a 4.8% stake in Bank Leumi. The group is up diversified sectors 30% on its investment (including dividends).
Bank Leumi is Israel’s oldest banking group, with a 30% market share in most traditional banking activities. In the past few years, the bank has implemented cost control measures and gradually improved the quality of its loan book. Leumi is controlled by the Israeli government, although we expect it to sell its remaining 6.5% stake in 2011-12.
In addition to the fundamentals for Leumi, we see possible upside from a controlling shareholder group forming within the next two years, which once again, could provide an exit route and upside for Azrieli.
We believe there is a risk that the Bank Leumi dividend will be lower in the current year as the bank seeks to build its capital (see UBS report Bank Leumi Le-Israel-Regulation could drive lower payout, published 6 July 2011).
Leumi Card – 20% stake; c4% of group NAV Azrieli Group invested NIS360m for a 20% stake in Leumi Card. As of Azrieli received NIS2m dividends in December 2010, Azrieli Group commissioned an independent valuation of 2010 from its stake in Leumi Card Leumi Card which gave a fair value of its investment at NIS498m (NIS453m at December 2009). For FY 2010, Leumi Card reported NIS158m in net profits (+15% y/y) and Azrieli received NIS2m in dividends in 2010. In H1 it reported a +20% y/y increase in profits to NIS87m
We note that the Israeli Anti-trust Committee has proposed a 0.64% cut in cross credit card transaction clearing charges in order to stimulate competition in this fairly concentrated market. This is due to come into effect from November 2011 and may have a negative effect on Leumi card's revenue and profitability going forward, in our view.
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Azrieli Group 6 September 2011 Debt structure At 30th June debt totalled NIS7.8 billion, and cash and equivalents NIS1.5 billion leaving net debt at NIS6.3 billion (up 24% or NIS1.1 billion in six months). Treating Granite as an investment reduces total debt by NIS 2.8 billion to NIS 5 billion, and given that only 9% of the cash/trading financial assets (NIS1.5 billion) are associated with Granite net debt associated with the property arm is only NIS3.6 billion (up 38% or NIS1 billion in H1).
The structure of the property division’s debt was as follows:
Table 31: Real estate division debt structure June 2011
Fixed Fixed Fixed Variable
Indexed US$ No link £ No link Total
3711 608 34 23 633 5009
Source: UBS estimate
At 30 June of the NIS5 billion real estate debt (64% of consolidated debt) 40% Average cost of debt 5% was long term (repayable after five years), and the average duration was 3.1 years. The average interest rate was 5%. The Israeli indexed debt cost 5.03%, and the variable 4.1%. The US debt was fixed at 5.8%, and the UK variable rate was 3.125%.
Assuming the Netanya acquisition completes, the group has c NIS 2.9 billion of Gearing is not particularly high, but potential development commitments. We show the impact on group gearing Azrieli has traditionally had a less below. These costs compare to current cash/financial assets of NIS1.4 billion, geared approach than some of its peers and the NIS1. 8 billion currently invested in the three non-core investments. In addition, it has unsecured property with a value of NIS8.5 billion. The graph below shows group gearing will not be particularly high, but traditionally this is a group that favours a less geared approach than some of its peers.
Chart 7: Azrieli gearing
80% 70%
60%
50% RE LTV 40% RE NAV Gearing 30% Group NAV Gearing 20% 10% 0% 2010 2011 Q1 2011 Q2 Proforma
Source: UBS estimates
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Azrieli Group 6 September 2011 Net asset value The Group’s portfolio is independently valued by Greenberg Olpiner & Co. Biannual independent valuations twice a year, although it can revalue parts of its portfolio at other times. In Q1 there was an uplift on the Houston purchase, and in Q3 there is expected to be an uplift on the two northern shopping centres due for completion in the next few weeks. Its policy allows for more frequent development revaluations if major development thresholds have been secured.
The group reports that in H1 yields did not move so that the improvement was Yields flat in H1 based purely on lettings and NOI growth. We estimate H1 growth was 2.6%, which compares to the 7.9% growth in 2010. We also show our estimate of the surplus on developments, which appears to have fallen in H1.
Table 32: Portfolio valuation (NISm)
31/12/10 30/06/11
Property value 12137 13951
Surplus 890 356
Portfolio gain 7.9% 2.6%
Of which developments 257 1076
Of which surplus on developments 63 43
Source: Azrieli/UBS estimates
The following chart shows the last reported yields on the group’s major assets. Yields appear high, but… We believe that these appear to be on the high side. We think that there are a number of explanations for this:
Q Most Israeli properties are leaseholds
Q NOI yields are not the same as yields based on net rents as it includes income of varying quality including profits from same property management and the provision of utilities For instance the average yield on the Azrieli Center is 7.7% (see below), but the mall element is valued c50 bps lower at 7.25%.
Q Israeli investors are used to much higher levels of inflation and debt costs and as a result mentally they are still likely to expect higher returns. The unusual fact that much debt is index linked may also lead to different investment behaviour.
Q Israel’s geopolitical risks are well known. This has not discouraged a currently vibrant economy and a broad based domestic property market. However, compared to some developed markets the International element is likely to be more limited. Of course, Israel does have significant foreign investment, but typically this has come from foreign investors with close cultural connections. This may be beginning to change as demonstrated with continuing inward investment particularly in the high tech sector and the increasing numbers of foreign retail chains entering the market.
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Azrieli Group 6 September 2011
Chart 8: Capitalisation rates based on appraisals as of December 2010
Source: Azrieli/UBS estimates
As a result, providing there is no major political upset, we would expect yields …we expect property yields to decline to harden over the next few years as investors are attracted to the relatively high growth and high yields of some good quality retail assets. We remain more cautious about office yields, as we believe that over the medium term increased supply is likely to restrain growth unless demand grows significantly.
UBS is estimating a year end NAV of NIS110 per share. This includes an H2 We assume 3% portfolio growth in H2 revaluation gain of NIS418 million (c3%. We assume this is driven by H2 rental growth boosted by the completions at Akko and Kiryat Ata. We think the current global uncertainty may reduce the likelihood of a positive yield re-rating in the short term.
One unusual influence on the Group’s NAV progression is the significant Listed holdings add considerable investment in the two listed entities representing 16% of NAV. We have valued volatility these at current market value (NIS1.4 billion), which represents a fall of cNIS 500 million from the June book value (NIS4 per share).
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Azrieli Group 6 September 2011 Appendix Israeli property market Population Since Israel’s foundation in 1948, the population has increased 900% from Growing population 806,000 to over 7.5m. The biggest change occurred following the dissolution of the Soviet Union in 1990, when 1.2m generally well educated people (representing c30% of the Israeli population at the time) immigrated to Israel. Between 1990 and 2003, total population growth was 42.5%. In the early years of huge waves of immigration, there was a heavy economic burden of absorbing such a large number of newcomers. Subsequently, however, the standard of living in Israel has improved significantly in the last two decades. In recent years, population growth has been 1.8%, which is above that of the developed markets.
Shopping malls 2009-2010 saw a major transformation and consolidation in the ownership of Consolidation of ownerships Israeli malls, of which Azrieli was not the major player. Previous holding companies such as The Delek Group and Africa Israel have largely exited the space and Melisron (controlled by the Ofer Family) and British Israel (until recently controlled by UK investor Leo Noe) stepped in to form the two other leading shopping center competitors to Azrieli. In October 2010, Melisron and British Israel agreed to merge creating the largest shopping center operator in Israel (by number)
Investment market The investment market has been relatively strong and there has been notable cap An active market rate compression. The low interest rate environment, economic growth and decreased risk aversion have supported the recovery. Most of the main income- producing property companies are longstanding with larger properties with high occupancy rates. Alongside them, the insurance companies, mainly Clal, Migdal and Harel, and investment funds such as REIT 1, are also active in the market.
We mention below a few recent transactions in the Israeli commercial real estate segment:
Q Ramat Aviv Mall, Tel Aviv and Savyonim Mall, Yehud – On April 7, 2009 Melisron acquired these properties from Africa Israel Properties. Ramat Aviv Mall was sold, according to the report for a total value of NIS1,574 million (7.5%), and Savyonim Mall for NIS 193m (8.25%).
Q In February 2010, Azrieli Group acquired Haifa Mall for approx. NIS315m (including purchase taxes). In 2010, Haifa recorded NOI of approx. NIS30m (NOI yield 9.5%).
Q On March 28, 2010, British Israel Investments Ltd. Acquired Sirkin Mall, Petach Tikva for NIS 85m (c10.5% NOI yield) from the receiver who was appointed for the property. As of the date of execution of the sale agreement, the property yields an annual income in the sum of approx. NIS 9 million (after maintenance and operating expenses).
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Azrieli Group 6 September 2011
Offices
Q According press reports an office area of 600 sq m on the 23rd floor in the Museum Tower in Tel Aviv was recently leased for rental fees of approximately NIS 120 per sq m per month.
Q According to press reports, in the course of 2010 the following areas were leased in Electra Tower (nearby the Azrieli center in Tel Aviv):
(a) 3,000 sq m, on floors 18-19 was leased to A.B., fully finished at rents of NIS 100 per sq m per month.
(b) 750 sq m, on the 40th floor, was leased, fully finished, for rental fees of NIS100 per sq m per month.
(c) 4,125sq m on floors 34-36 was leased, fully finished, to Beit HaPraklitim for rents of NIS100 per sq m per month
(d) In the Africa Tower on Ahad Haam St. floors 1-17 are rented for average rents of approx. NIS105 per sq m month
(e) In the Platinum Tower on Haarbaa St. areas were rented in the course of 2010 according to NIS90 per sq m per month
Property yields and bonds The chart below compares bond yields, base rates and property yields. It demonstrates that the current margin between property yields has been fairly consistent since 2003, although currently it is slightly wider than the recent past (2004-07).
Chart 9: Israeli bond yields, base rates and property yields
16% 14% 12% 10% Average y ield 8% Base rates 6% 10 y ear bond y ield 4% 2% 0% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Reuters/NATAM
Supply Elco Tower (Yigal Alon Street, Tel Aviv) is due to complete this year. Natam (real estate agency) stated that of the 63,800 sq m of space, 32% had been pre- let. Tenants include Google Israel.
• Vision Tower located in Ramat Hahayal industrial zone
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Azrieli Group 6 September 2011
Rents The Israeli property market was affected by the global economic crisis and rents Since H1 09 retail rents have risen by fell from H1 08 to H1 09. However, rents have since recovered driven by strong 34% and office rents by 29% economic growth in Israel, with retail and office rents rising by 34% and 29%, respectively. We show retail and office rents in the charts below.
Chart 10: Retail rents (US$ per sq m)
Source: MAN Properties part of the CBRE Affiliate Network
Chart 11: Office rents (US$ per sq m)
Source: MAN Properties part of the CBRE Affiliate Network
Land ownership/transaction taxes Israeli Government (Israeli Land Administration) and municipalities own c90- 93% of all land in Israel, and freeholds are rare. Typical government leases are 49+49 years (with renegotiation at 49 based solely on the land element). These government leases can be longer. The purchase tax is 5% and disposal profits are subject to capital gains.
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Azrieli Group 6 September 2011
Lease structures Typical retail leases are 3+3 years, or 4+4. Anchors can be 10+10. Rents are inflated by CPI and there is often a “bump” of 5-10% at year 3 or year 4. Triple net rents i.e. tenant liable for maintenance costs and local taxes. Local taxes are calculated per sq m.
Rents paid in NIS, although two years ago it was common to have USD leases. This change appears to have been landlord driven and provoked little opposition. Some foreign office tenants are still insistent on USD leases.
Supply Planning is complex and difficult described as “very bureaucratic”, it can take anything from 3 to 20 years. Municipalities can charge a betterment tax (c50% uplift on planning). Banks are reluctant to lend on land or to lend non recourse. However, there appears to be significant development activity and potential for retail extensions.
Shopping Centre trends There has been increasing dominance of Large Malls. The typical Mall hours 9.30-22.00 and they are usually closed on the Sabbath. There has been significant growth in the number of Retail Parks (known in Israel as Power Centers).
The recent trend has been of increasing concentration of ownerships of Large Malls. Relatively recently foreign brands have been introduced (Gap, H&M, Zara, Forever 21 and American Eagle). The aim has been to increase fashion content at expense of food & leisure. In general rents represent 11%-13% of retail turnover (including anchors).
There has been growing Mall use by Orthodox, and Arab communities. In addition there has been medical services demand for adjacent offices.
Office trends Office rents are believed to be more volatile than retail. The hierarchy is (1) CBD (s), (2) Inner Perimeter and (3) Outer Perimeter. Growing high tech and R&D sectors are driving increased demand for business parks. Outer Perimeter municipalities often provide tax breaks to attract business.
The pipeline is not very transparent (ie significant range of estimates).
There are significant costs (time) added with underground car parking, which is becoming increasingly important - now typically one car space for 30 sq m.
Bank lending to real estate
Israel’s banks have remained liquid throughout the financial crisis and have been wiling and able to lend for commercial lending and residential mortgages. Debts linked to CPI .Building loans c70-80% of cost (2-3 years) and allow for 2 years rent free. Investment loans c65% LTV, income cover 1.2x, “not less than” 4% amortisation. Debt costs currently c6%.
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Azrieli Group 6 September 2011 Azrieli Group overview Figure 3: Azrieli Group holdings and businesses
Azrieli Group
Commercial & shopping center segment Office and other rental space Others
100% 100% 60.7% 100% Azrieli shopping Azrieli shopping 100% Azrieli Towers Azrieli Rishonim Granite center Center Holon Hacarmel
100% 100% 100% 83% Petroleum Ayalon shopping Ayalon shopping Jerusalem offices Holon tender center center Haifa distillates mktg
100% 100% 100% 100% Fueling and Jerusalem Azrieli shopping Hanegev offices Kiryat Ata shopping center center Kiryat Ata commerce area
100% 100% 100% 100% Painting & Hanegev Azrieli Mall Akko Modi’in offices Southern Hakirya shopping center and residences const finishing
100% 100% 100% Water and Modi’in shopping Azrieli shopping Givatayim offices center center Rishonim International Sewage
100% 100% Givatayim Azrieli Mall 100% Caesarea Three Riverway 45% Investments shopping center Ramla Industrial Park (Houston Texas)
100% 50% 33% 20% Azrieli Herzlia KMT Petach One Riverway Leumi card OUTLET International Tikva (Houston Texas)
89% 100% 100% 4.8% Azrieli Or Yehuda Northchase Plaza Herzliya offices Southern house 100% Houstan Texas 529 (England) Bank Leumi
100% Hod Hasharon 100% Hakrayiot Northchase 100% shopping center Junction (Land) (Houston)
Three Galleria 90% Development properties (Houston Texas)
Source: UBS, Company data
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Azrieli Group 6 September 2011
Table 33: Azrieli Group consolidated income statement
NIS millions, except EPS and number of shares 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E
Rental income from commercial and shopping 466 533 665 759 800 902 958 1,110 1,216
Rental income from Office space and others 218 269 319 332 419 456 472 518 537
Total rental income 684 802 983 1,091 1,219 1,357 1,431 1,628 1,752
Revenues from Granite Hacarmel 5,209 6,117 4,547 5,252 6,042 6,272 6,523 6,784 7,055
Other income 42 12 28 56 90 37 37 37 37
Associates 16 -29 -6 -21 -10
Total Revenues 5,951 6,902 5,552 6,378 7,342 7,666 7,990 8,449 8,844
Cost of revenues from rental 141 168 198 209 239 266 279 317 339
Cost of revenues from sales 5,069 6,024 4,365 5,075 5,819 6,075 6,337 6,598 6,869
Other costs 14 16 9 4 2
Administration 63 60 64 69 73 75 77 80 82
Adjusted Operating profit 664 634 915 1,021 1,208 1,251 1,296 1,455 1,554 margin (%) 11.2% 9.2% 16.5% 16.0% 16.5% 16.3% 16.2% 17.2% 17.6%
Profit (loss) from fair value adjust. Of properties 753 748 218 891 984 758 838 939 874
Financing income 110 89 67 152 91 91 91 91 91
Financing expenses -413 -673 -492 -514 -666 -631 -644 -650 -656
Interest capitalized on development 11 20 25 27 17
Other income (expenses) -9 11 3 -2 -7
Profit before tax 1,105 809 712 1,547 1,620 1,488 1,606 1,861 1,879
Tax expenses (benefits) 275 215 -288 292 326 342 353 391 376
25% 27% -41% 19% 20% 23% 22% 21% 20%
Net profit 831 594 1,000 1,255 1,294 1,146 1,253 1,471 1,503
Less: Minorities -27 24 -44 -31 -33 -19 -15 -16 -16
Net profit for the shareholders in the parent co. 804 618 956 1,224 1,261 1,127 1,238 1,455 1,488
Weighted average shares: basic 90.942 90.942 90.942 108.07 121.27 121.27 121.27 121.27 121.27
Basic EPS 8.84 6.80 10.52 11.33 10.40 9.30 10.20 12.00 12.27
Source: UBS estimates
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Azrieli Group 6 September 2011 Israeli economy The Israeli economy is in fundamentally sound condition. Following 4.8% GDP growth in 2010, we expect the economy to grow by 4.5% in 2011, slowing to 3.5% growth in 2012 amid a weaker global environment. Given lower inflation expectations and a weakening growth outlook, expectations of interest rate hikes by the Bank of Israel have recently been scaled back. Israel’s current account balance is likely to remain in surplus and constitute a source of strength, including for the shekel.
Thanks to sound fundamentals, the Israeli economy suffered only a short and We expect GDP growth of 4.5% in 2011 mild recession in late 2008 and early 2009, and enjoyed a robust recovery with and 3.5% in 2012 4.8% growth in 2010. Israel is closely integrated into the international economy, which means it cannot entirely decouple from global events, and external headwinds mean growth has started to decelerate in recent quarters. We continue to forecast 4.5% growth for 2011, but recently cut our 2012 growth forecast to 3.5% from 4.0%. Nevertheless, we remain convinced that Israel will master the coming global economic challenges relatively well.
Chart 12: GDP growth and contributions to growth Chart 13: Quarterly GDP growth (% y/y and % q/q ann.)
15 8 5.3 9.1 5.1 5.7 0.8 10 4.7 4.5 3.5 6 -0.1 4.9 4.2 5 -0.6 1.5 4 0 2
-5 0 -10 -2 2000 2002 2004 2006 2008 2010 2012F -4 Household consumption Govt consumption Fixed investment Exports Q1-02 Q2-03 Q3-04 Q4-05 Q1-07 Q2-08 Q3-09 Q4-10 Imports GDP growth GDP (% y/y) GDP (% q/q ann)
Source: UBS estimates Source: Bloomberg, UBS
Household consumption has been a key driver of GDP growth over the past two Household consumption has been a years, and since 2010 with increasing support from fixed investment. A number key driver of GDP growth of factors have supported household consumption: the labour market has recovered relatively quickly after the crisis and the unemployment rate has returned to pre-crisis levels; nominal and real wages have grown respectably; and, very importantly, consumer confidence has been boosted by a boom in the Israeli real estate market (Charts 14-16).
The strength of the economy has also supported public finances, as the Public finances sound, despite still- government has enjoyed strong revenues and could reduce anti-cyclical spending. high debt stock Last year, Israel had a budget deficit of 3.8% of GDP, well below initial targets. For 2011, the government is targeting a reduction to 3% of GDP, which we regard as realistic given its solid track record in public finances. As a result, Israel’s public-sector debt stock – still pretty high in a regional context – should decline from c76% of GDP in 2010 towards 71-72% of GDP by 2012.
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Azrieli Group 6 September 2011
Chart 14: Unemployment and change, y/y (ppt) Chart 15: Nominal and real wage growth, % y/y
12 15 10 10 8 6 5 4 0 2 0 -5 -2 -10 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-03 Apr-04 Jul-05 Oct-06 Jan-08 Apr-09 Jul-10 Change in unemployment rate, y/y, ppt Unemployment rate % Nominal wage (monthly av.), % y/y Real wage, % y/y
Source: Central Bureau of Statistics, Haver, UBS Source: Central Bureau of Statistics, Haver, UBS
Chart 16: Private consumption and consumer confidence Chart 17: Average price of owner-occupied dwellings
8 140 1200 60 50 6 130 1000 4 40 120 800 30 2 110 600 20 0 10 -2 100 400 0 -4 90 200 -10 Q2-02 Q4-03 Q2-05 Q4-06 Q2-08 Q4-09 Q2-11 0 -20 Real private consumption, % y/y (lhs) Q1-1987 Q3-1991 Q1-1996 Q3-2000 Q1-2005 Q3-2009 Consumer confidence (rhs) NIS 000 (lhs) % y/y (rhs)
Source: Central Bureau of Statistics, Haver, UBS Source: Central Bureau of Statistics, Haver, UBS
Chart 18: Budget balance and public sector debt, % of GDP Chart 19: Components of current account, % of GDP
0 120 7 -1 100 5 -2 80 3 -3 60 1 -4 -1 -5 40 -3 -6 20 forecast -5 -7 0 % of GDP -7 2000 2002 2004 2006 2008 2010 2012F Central govt budget balance, % of GDP (hs) Q1-00 Q3-01 Q1-03 Q3-04 Q1-06 Q3-07 Q1-09 Q3-10 C/A Trade Services Pulbic sector debt, % of GDP (rhs) Income Transfers
Source: Central Bureau of Statistics, UBS estimates Source: Central Bureau of Statistics, UBS
UBS 44
Azrieli Group 6 September 2011
A great source of macroeconomic strength and resilience in recent years has Current account surplus to remain a been Israel’s current account surplus. After a surplus of 2.9% of GDP in 2010, source of strength (also for the shekel) we expect external surpluses of 1.5-2.0% of GDP in 2011-12. This should also support the shekel (see charts below).
Chart 20: Shekel against USD, EUR, USD-EUR basket, REER Chart 21: Shekel against USD and level of Israeli FX reserves
6.0 70 5.0 90000 depreciation 80000 5.5 75 70000 80 4.5 5.0 60000 85 50000 4.5 4.0 90 40000 4.0 95 30000 3.5 100 3.5 20000 3.0 105 10000 3.0 0 Jan-99 Dec-00 Nov-02 Oct-04 Sep-06 Aug-08 Jul-10 ILS/US$ (lhs) EUR/ILS (lhs) Jan-97 Jul-99 Jan-02 Jul-04 Jan-07 Jul-09 Basket (50/50 USD/EUR) REER, inverted (rhs) ILS/US$ (lhs) FX reserves, USD mn (rhs)
Source: Bloomberg, IIF, UBS Source: BoI, UBS
Inflation – at 3.4% y/y in July – is currently above the Bank of Israel’s 1-3% Additional interest rate hikes by the target corridor. Yet the inflation outlook has improved recently, thanks to a much Bank of Israel now appear less likely lower-than-expected July CPI print and lower commodity prices. As a result, we than previously now expect headline inflation to fall back inside the target range in Q4 11, earlier than previously anticipated. The improved inflation outlook, combined with increased concerns about the global outlook and signs of a deceleration in the real estate markets, means that the Bank of Israel will be under less pressure to hike rates than previously assumed. We previously expected the Bank to hike rates from the current 3.25% to 3.75% by end-2011 and to 4.5% next year. Now, however, we believe the risk to this forecast is clearly skewed to the downside. In the event of a further worsening of the global economic outlook, we would not even rule out rate cuts. Chart 22: Inflation and interest rate outlook
7 6 UBS forecast 5 4 3 2 1 0 -1 -2 -3 Jan-04 Apr-05 Jul-06 Oct-07 Jan-09 Apr-10 Jul-11 Oct-12 CPI (%, y/y) BoI target corridor Policy rate Real interest rate (simple)
Source: Bloomberg, Bank of Israel, UBS estimates
UBS 45
Azrieli Group 6 September 2011
Macroeconomic data and forecasts 2004 2005 2006 2007 2008 2009 2010 2011F 2012F Economic Activities GDP (NISbn) 567.3 601.2 648.2 686.5 723.6 766.3 813.0 880.2 932.9 GDP (USDbn) 126.6 134.0 145.5 167.1 201.7 194.8 217.8 251.5 272.0 GDP per capita (USD) 19,256 20,019 21,356 24,007 28,348 26,802 29,313 33,116 35,043 Real GDP growth (%) 4.8 4.9 5.6 5.5 4.0 0.8 4.8 4.5 3.5 Business sector product (%) 6.6 5.9 6.8 6.1 4.5 0.3 5.8 4.8 3.8 Private consumption (%) 5.3 3.1 4.2 6.3 2.8 1.4 5.3 5.0 3.8 Government consumption (%) -1.6 2.0 3.0 3.3 1.9 2.4 2.5 2.3 2.0 Fixed investment (%) 0.0 3.5 13.1 14.6 4.2 -4.1 13.6 12.0 8.0 Exports (%) 17.5 4.5 5.5 9.2 6.6 -12.6 13.4 6.5 5.8 Imports (%) 12.0 3.6 3.2 11.7 2.3 -14.0 12.6 9.0 7.5 Industrial production (%) 6.9 3.6 9.9 4.4 7.4 -6.0 7.8 5.0 5.5 Unemployment rate (average, %) 10.4 9.0 8.4 7.3 6.2 7.6 6.6 6.4 6.3 Prices, Interest Rate and Money Consumer price inflation (average, %) -0.4 1.3 2.1 0.5 4.6 3.3 2.7 3.6 2.4 Consumer price inflation (year-end, %) 1.2 2.4 -0.1 3.4 3.7 4.0 2.6 2.6 2.6 M2 money supply (average, %) 4.2 6.1 4.9 15.3 9.8 17.7 3.9 7.5 8.0 Benchmark rate (year-end, %) 3.9 4.5 5.0 4.0 2.5 1.0 2.0 3.75 4.50 Long-dated ILS bond yield* (year-end, %) 5.62 5.54 5.61 6.17 4.72 5.11 4.75 5.00 5.00 Exchange Rates USD/ILS (average) 4.48 4.49 4.46 4.11 3.59 3.93 3.73 3.50 3.43 USD/ILS (year-end) 4.31 4.60 4.23 3.85 3.80 3.78 3.55 3.45 3.40 EUR/ILS (average) 5.58 5.58 5.62 5.63 5.27 5.47 4.95 4.62 4.46 EUR/ILS (year-end) 5.86 5.43 5.57 5.65 5.28 5.44 4.74 4.49 4.42 ILS against basket USD/EUR (50/50 basket) 5.03 5.04 5.04 4.87 4.43 4.70 4.34 4.06 3.94 REER (2000=100) 79.6 78.4 78.6 80.1 90.2 87.6 93.5 101.3 104.8 Balance of Payments Exports, fob (USDbn) 36.4 39.8 43.3 50.3 57.2 45.9 55.7 58.0 59.0 Imports, fob (USDbn) 39.5 43.9 47.2 56.0 64.4 46.0 58.0 63.0 64.5 Trade balance (USDbn) -3.1 -4.1 -3.8 -5.7 -7.2 -0.1 -2.4 -5.0 -5.5 Current account balance (USDbn) 2.3 4.2 7.4 4.9 1.5 7.1 6.4 4.8 4.5 as a % of GDP 1.9 3.2 5.1 2.9 0.8 3.6 2.9 1.9 1.7 FDI, net (USDbn) -1.6 1.9 -0.2 0.2 3.7 2.7 -2.8 2.3 2.3 Foreign exchange reserves excl. gold (USDbn) 26.6 27.9 29.1 28.6 42.5 60.6 70.9 73.0 78.0 Import cover (reserves/months of imports) 5.5 5.2 4.9 4.0 5.3 6.9 7.0 6.8 6.6 Fiscal Accounts Central government budget balance (NISbn) -23.3 -15.0 -7.1 -4.1 -16.6 -40.6 -30.9 -25.5 -22.4 Central government budget balance (% GDP) -4.1 -2.5 -1.1 -0.6 -2.3 -5.3 -3.8 -2.9 -2.4 Primary balance (% GDP) 2.6 4.0 5.3 5.3 3.2 0.1 1.4 1.7 2.1 Public sector debt (% GDP) 97.4 93.5 84.3 77.7 76.7 79.2 76.2 73.6 70.9 Domestic debt (% GDP) 70.9 67.5 61.7 58.7 60.2 63.2 61.9 61.6 59.6 External debt (% GDP) 26.5 26.0 22.6 19.0 16.5 16.0 14.3 12.0 11.3 External Debt and Debt Service Total foreign debt (USDbn) 78.5 78.2 87.4 90.5 88.4 93.3 106.0 90.0 95.0 as a % of GDP 62.0 58.4 60.1 54.1 43.8 47.9 48.7 35.8 34.9 Short-term foreign debt (USDbn) 27.0 28.0 32.0 36.2 33.3 31.9 33.2 34.0 35.0 Total debt service (USDbn) 6.7 7.5 8.9 14.9 7.6 8.0 8.6 9.0 9.3 as a % of foreign export receipts 12.1 11.9 12.5 18.1 8.6 11.3 11.7 11.0 10.5 Interest payment (USDbn) 2.9 3.3 4.0 4.3 3.5 3.3 3.5 3.6 3.6 Amortization (USDbn) 3.9 4.2 4.9 10.6 4.1 4.7 5.1 5.4 5.7 Credit Ratings (year-end & latest) Moody's A2 A2 A2 A2 A1 A1 A1 A1 (sta) n/a S&P A- A- A- A A A A A (sta) n/a Fitch A- A- A- A- A A A A (sta) n/a
Source: Bank of Israel, Central Bureau of Statistics, Ministry of Finance, Bloomberg, IIF, Moody's, S&P, Fitch, UBS estimates. Note: *Currently Shahar 1/2016
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Azrieli Group 6 September 2011
Azrieli Group Per share (NIS) 12/09 12/10 12/11E 12/12E 12/13E Established in 1983, Azrieli Group is the largest listed real estate EPS (stated) 10.52 11.33 10.40 9.30 10.20 company in Israel. It floated in June 2010 and is a component of the Tel EPS (pre-exceptional) 4.55 4.94 3.93 4.48 4.81 Aviv 25 and EPRA indices. The free float is 25%, with the rest held by CEPS (pre-exceptional) 4.55 4.94 3.84 4.32 4.61 the Azrieli family. Over 80% of the group's NAV is attributable to real Revalued NAV per share 93.60 103.08 110.84 119.41 128.72 estate, while the remainder is 'non-core' energy and financial assets. Profit & Loss (NISm) Some 94% of the group's portfolio is located in Israel, with the balance in Net rental income 785 882 980 1,092 1,151 North America and the UK. The group has a significant development Investment income 67 152 91 91 91 pipeline and expects to spend more than US$700 million on its current Trading income - - - - -development programme over the next five years. Associates & other income 198 206 294 234 222 Total income 1,051 1,240 1,364 1,416 1,464 Interest payable (492) (514) (666) (631) (644) Administration and other (64) (69) (73) (75) (77) Revenue surplus 494 657 625 711 743 Interest capitalised - - 11 20 25 RelativeRelative rating rating - -(discount) (discount) to to to NAV NAV NAV (%) (%) (%) Depreciation & amortisation - - - - - 1204040 Pre-exceptional provisions - - - - - Pre-exceptional pre-tax profits 494 657 636 731 768 1002020 Exceptionals 218 891 984 758 838 80 Stated pre-tax profits 712 1,547 1,620 1,488 1,606 00 Tax 288 (292) (326) (342) (353) 60 Minorities & preference & extraordinaries (44) (31) (33) (19) (15) -20-20 40 Attributable net profits 956 1,224 1,261 1,127 1,238 Cost of dividend - (240) (262) (294) (315) -40-4020 Retained profits/earnings 956 984 1,000 834 922 -600 Pre-exceptional cash flow 414 533 465 524 559 -60 20072007 2008 2008 2009 2009 2010 2010 2011 2011 EBITDA 903 990 1,130 1,214 1,259 EBIT 903 990 1,130 1,214 1,259 AdjustedAzrieli price (local) DiscSector to NAV Cash flow (NISm) EBIT 925 1,041 1,211 1,251 1,296 Depreciation & amortisation 136 146 70 - - Company vs sector 12m PXCEPS growth(%) Working capital movement 282 (2,088) 1,079 - - 1 Other (operating) 75 (147) (544) (688) (697) Operational cash flow 1,418 (1,049) 1,816 563 599 0.8 Net interest paid (425) (363) (575) (540) (553) 0.6 Dividends paid - - (240) (262) (294) Tax paid (37) (92) (127) (168) (169) 0.4 Net (acquisitions)/capital expenditure (2,765) (815) (2,123) (581) (620) Equity issued - 2,484 - - - 0.2 Other items 1,828 (73) 1,488 978 1,019 Movement in (net debt)/net cash 19 92 238 (10) (17) 0 2010 2011 2012 2013 2014 Balance sheet (NISm) Book value investment properties 10,869 12,210 15,306 16,644 18,102 Azrieli Sector Other fixed assets 4,189 4,769 4,398 4,398 4,398 Total book value of fixed assets 15,058 16,979 19,703 21,042 22,500 Book value trading properties - - - - - SectoralGeographic breakdown breakdown Cash & deposits 336 2,537 1,532 1,522 1,505 Other current assets 1,827 1,828 2,258 2,258 2,258 Provinces Total book value of assets 17,221 21,343 23,493 24,822 26,263 Debt (6,924) (6,908) (8,132) (8,402) (8,700) Other liabilities (2,983) (3,334) (3,533) (3,726) (3,926) RetailCapital cityOffices - centre Book ordinary shareholders' funds/NTA 7,314 11,101 11,828 12,693 13,637 Surpluses over book value - - - - - Revalued shareholders' funds/NTA 7,314 11,101 11,828 12,693 13,637 Capital city - periphery Fully diluted shareholders' funds/NTA 8,512 12,501 13,442 14,481 15,610 Other Profitability North America Recurring income cover of expenses 1.9x 2.1x 1.8x 2.0x 2.0x Interest cover 2.0x 2.3x 1.9x 2.1x 2.2x Total value (NISm): 12,210.3 Headline stated net dividend cover NA 5.1x 4.8x 3.8x 3.9x Total value (NISm): 12,210.3 Pre-exceptional cash dividend cover - 2.5x 1.8x 1.8x 1.8x Productivity Pre-exceptional tax rate 7.4% 14.0% 20.0% 23.0% 22.0% SectoralGeographic breakdown breakdown Net debt/revalued net assets 77.4% 35.0% 49.1% 47.5% 46.1% Net debt/(revalued gross assets-cash) 36.4% 21.6% 28.0% 27.4% 26.9% Provinces Net debt/EV NA 28.2% 37.7% 38.9% 40.3% Momentum Capital city - centre Growth in pre-ex. pre-tax cash flow 709.9% 32.9% (4.7%) 13.6% 4.6% Retail Offices Growth in pre-ex. net cash flow per share 762.8% 8.5% (22.3%) 12.6% 6.7% Growth in revalued NAV per share 23.3% 10.1% 7.5% 7.7% 7.8% Capital city - periphery Value Core EBITDA/EV NA 6.4% 6.4% 6.9% 7.1% North AmericaOther Pre-ex. cash earnings yield NA 5.4% 4.5% 5.1% 5.4% Average yield on appraised values 7.2% 7.2% 7.0% 7.2% 7.2% Total value (NISm): 12,210.3 (Discount) to revalued NAV NA (11.5%) (23.3%) (28.8%) (34.0%) Total value (NISm): 12,210.3 Gross dividend yield NA 2.2% 2.5% 2.8% 3.1% Source: UBS estimates, * Historical valuations are based on an `average for the year' share price. Current & future valuations are based on a share price of NIS85 on 05/09/2011
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Azrieli Group 6 September 2011
Q Azrieli Group
Established in 1983, Azrieli Group is the largest listed real estate company in Israel. It floated in June 2010 and is a component of the Tel Aviv 25 and EPRA indices. The free float is 25%, with the rest held by the Azrieli family. Over 80% of the group's NAV is attributable to real estate, while the remainder is 'non- core' energy and financial assets. Some 94% of the group's portfolio is located in Israel, with the balance in North America and the UK. The group has a significant development pipeline and expects to spend more than US$700 million on its current development programme over the next five years.
Q Statement of Risk
1) Geopolitical Risks: We believe that deterioration in the geopolitical landscape could have a negative impact on the commercial real estate sector 2) Slowdown in the growth of consumer spending in Israel 3) Inflationary and interest rate risk: c.47% of the group's debt is linked to CPI, fluctuating CPI has impact on company’s financing expenses and hence cash flow projections. 4) The Group's non property interests add significant additional volatility to NAV 5) The Group has significant development exposure, which brings with it planning, construction, financing and letting risks. 6) Potential over supply risk in the Tel Aviv office market starting 2015.
Q Analyst Certification
Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.
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Azrieli Group 6 September 2011
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For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission.
UBS Investment Research: Global Equity Rating Allocations
UBS 12-Month Rating Rating Category Coverage1 IB Services2 Buy Buy 54% 39% Neutral Hold/Neutral 39% 35% Sell Sell 7% 14% UBS Short-Term Rating Rating Category Coverage3 IB Services4 Buy Buy less than 1% 33% Sell Sell less than 1% 25% 1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months.
Source: UBS. Rating allocations are as of 30 June 2011. UBS Investment Research: Global Equity Rating Definitions
UBS 12-Month Rating Definition Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA. UBS Short-Term Rating Definition Buy: Stock price expected to rise within three months from the time the rating was assigned Buy because of a specific catalyst or event. Sell: Stock price expected to fall within three months from the time the rating was assigned Sell because of a specific catalyst or event.
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Azrieli Group 6 September 2011
KEY DEFINITIONS Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months.
EXCEPTIONS AND SPECIAL CASES UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.
Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows. UBS Securities Israel Limited: Ziv Tal; Darren Shaw. UBS Limited: Quentin Freeman; Howard Lesser; Reinhard Cluse.
Company Disclosures
Company Name Reuters 12-mo rating Short-term rating Price Price date Azrieli Group4 AZRG.TA Not Rated N/A NIS85.00 02 Sep 2011 Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date
4. Within the past 12 months, UBS AG, its affiliates or subsidiaries has received compensation for investment banking services from this company/entity.
This report was sent to the issuer prior to publication, and material changes were made to the content based on the issuer's feedback.
Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.
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Azrieli Group 6 September 2011
Azrieli Group (NIS) Price Target (NIS) Stock Price (NIS) 120
100
80
60
40
20
0 01-Jul-06 01-Jul-07 01-Jul-08 01-Jul-09 01-Jul-10 01-Jul-11 01-Oct-06 01-Jan-07 01-Apr-07 01-Oct-07 01-Jan-08 01-Apr-08 01-Oct-08 01-Jan-09 01-Apr-09 01-Oct-09 01-Jan-10 01-Apr-10 01-Oct-10 01-Jan-11 01-Apr-11
No Rating
Source: UBS; as of 04 Sep 2011
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Azrieli Group 6 September 2011
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