PLDGP - Prologis: Look To Buy Under $80

2023-09-25 11:00:00 ET

Summary

• Prologis, Inc. is a highly regarded REIT with a strong balance sheet and impressive long-term returns.
• However, three metrics suggest that Prologis may face downside in the bear market.
• We go over outlook and tell you why the worst might be dead ahead for Prologis.

Prologis, Inc. ( PLD ) is a hot favorite amongst the REIT crowd. Fundamentally, from a quality perspective, there is definitely a lot to like. The company has one of the lowest costs of capital amongst REITs and is attached to possibly the best sector, industrial and warehouse. The A rated balance sheet does not hurt the eyes and the longer term returns have been quite amazing. It has taken the Vanguard Real Estate ETF ( VNQ ) to the cleaners and it is one of the rare REITs that has beaten the S&P 500 ( SPY ) over the last decade.

So taking the opposite side of the fan base is not a fun task but we will do it anyway. Because that is what heroes do.

The REIT

A quick introduction on this REIT is best served by using one of its own presentation slides. The company is a global powerhouse but it is heavily tied to fortunes of the US, just by the sheer scale it has here.

It also is here today with an unrivaled ability to handle changes in interest rates. Whether it's counting the liquidity or the interest coverage or even the debt as a percentage of market capitalization, Prologis is the best you can find.

But as an investment opportunity, we would wager that those are the wrong metrics to focus on. We look at three metrics that tell us that Prologis bear market has some downside left.

1) Price To Funds From Operations (FFO)

You will always find some investor who uses the last 10 years of FFO multiples and tells you there is a case for investing in Prologis. The joke here is that argument could be made on almost every REIT when it was trading 20% higher from the price today. If you use the average of the last 10 years, a time that bears zero resemblance to today, everything in REIT land will seem cheap. We will argue that failing to acknowledge that is why investors found American Tower Corporation ( AMT ) cheap even at $300 per share (proceeding to lose almost 50%) and went all in into Crown Castle Inc. ( CCI ) over $200 a share (55% losses from the top). At present, Prologis' multiple of 22X is also in the same category.

The last 10 year run-rate average of 22.69X may help you sleep at night, but is completely irrational for a 5.5% interest rate environment. We would look on the same chart and say that if we can get 15X multiple with 0% interest rates, we can get there today with 5.5% without breaking a sweat.

2) Industrial Supply Still Coming

Developer started 614 million square feet of industrial construction last year and while that pace slowed down remarkably in 2023, a lot of new supply has still to hit.

You can see some impacts on the Prologis occupancy levels beginning to show.

These levels are down just slightly from Q3 and Q4-2022 and we certainly don't think they are alarming. But you will see a big drop off in rent growth at the margins. Of course if we have a "hard landing" then you will see a real impact and that creates the bigger risk in owning it here.

3) REIT-Bond Model Points To More Losses

Prologis has perhaps earned some of its premium valuation but it is not going to rewrite the financial textbooks. One of our favorite models in the REIT world is the comparison of the equity REIT dividend yield to the BAA (last rung of investment grade) bond yields. REITs are not BAA bonds but they do compete for capital in the same space.

We will also argue that a lot of the success of REIT analysts in the past a decade has been a "fooled by randomness" situation where they ran into ZIRP (Zero Interest Rate Policy) and things worked out regardless of how poor the REIT choice was. That also had to do with above model. Getting back to the BAA model, here is a look at the spread between Prologis dividend yield and the BAA yield.

A Y-Charts Bug makes this look "jumpy" but you can still observe the key point. It does not make Prologis look remotely cheap.

Verdict

Since our first article back in 2021 on Prologis ( What Could Derail The Exceptional Returns ), the REIT has underwhelmed.

Back then we had one of the biggest negative outlooks on bonds and bond prices have gone lower than what we expected. But Prologis has held out. In the Bloodbath on REIT street the general has continued to stand while some of the other high flyers of the ZIRP mania have been butchered.

We think that this valuation compression exercise is not close to being over. Your very best case for those who believe there won't be any price losses, is that you will compress into a 15X-17X FFO multiple over 3-4 years, which would still mean very poor returns.

The most likely case is that there will be swift reckoning which will get Prologis down to $80 or lower.

Prologis, Inc. 8.54% PFD SR Q ( PLDGP )

One of the peculiarities of Prologis is that its preferred shares are actually a worse value than the common shares. These sport a very high coupon on par of $50, but unfortunately investors remain blind to the exceptionally poor total returns. Possibly it is bid up by the same crowd that goes gaga buying high yield, poor performing, closed end funds like abrdn Global Premier Properties ( AWP ). At the present price of $56.50, the yield to maturity is under 4%

While the current yield is high, the yield to maturity is abysmally bad. That is thanks to the shares trading well over par.

We will note that Prologis has 3-year bonds that have a better yield to maturity than this poorly priced security.

Hence we would avoid both Prologis and PLDGP

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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