2023-10-20 07:00:00 ET
Summary
- Deutsche Post DHL is one of our favorite transportation stocks on the market and offers consistent dividend growth and capital gains.
- But in our search for the best logistics investment, we turned up an even better option.
- Prologis is the world's largest industrial REIT and allows investors to benefit from secular growth without exposing them to elevated risks.
This article was coproduced with Leo Nelissen.
To be completely honest, this particular article wasn't supposed to be about Prologis Inc. (PLD) . No, this article was supposed to be about Deutsche Post AG (DHLGY).
Deutsche Post (which, as one might guess, stands for German Post) is a German multinational package delivery and supply chain management company headquartered in Bonn, Germany.
Nowadays, the company is known as DHL Group, with massive exposure in a wide number of activities that dominate global supply chains. In 2Q23, the company generated roughly EUR 1.7 billion in pre-tax earnings. The express business generated EUR 900 million. Global forwarding operations accounted for almost EUR 400 million in EBIT. Supply chain operations were the only segment with growth, generating close to EUR 300 million in pre-tax income.
The German Post and Parcel business accounted for roughly EUR 120 million.
In 2007, this segment accounted for more than half of the company's EBIT! This is no surprise, as DHL Group is the successor of the German mail authority, Deutsche Bundespost. This business was privatized in 1995. The German government still owns a fifth of DHL Group.
Since then, the company has evolved into a giant in its industry. It's now the largest global Time Definite International express company, the second-largest air freighter, the second-largest ocean freighter, the largest contract logistics company, and the largest parcel company in Germany.
It also has an A-rated balance sheet (from Moody's) and a current dividend yield of 4.8%.
Since 2008, the company has grown its dividend by 8% per year, maintaining a payout ratio between 40% and 60%.
Since Dec. 28, 2007, and March 8, 2023, the company has returned 8% per year. During this period, which includes the Great Financial Crisis, the DAX has returned 4% per year.
We're bringing all this up for two reasons.
- We believe Deutsche Post DHL is one of the best transportation stocks on the market. It benefits from strong secular growth, a footprint that can be expanded through market share gains, and the ability to reward investors with consistent dividend growth and capital gains. In other words, our goal was to introduce people to this company.
- We also believe there are better options on the market.
So, in addition to telling you that Deutsche Post DHL is a great company, we want to tell you that while we were researching this company, we changed our mind.
We didn't change our mind about the company. Deutsche Post DHL is still one of the best transportation companies in the world.
No, we changed our mind about where we are going to invest our money.
One major drawback that comes with investing in companies like DHL and its peers FedEx (FDX) and UPS (UPS) is that their businesses are so darn cyclical.
So, after thinking for a bit, we decided to look into who owns DHL's assets. After all, by investing in these companies, we still benefit from secular growth, just from a different position in the supply chain.
That's where Prologis comes in.
What Makes Prologis So Powerful
Founded in 1983, Prologis has become the world's largest industrial REIT.
With close to $200 billion in assets under management, it has more than 6,700 customers. Most of them are multi-billion corporations that most readers may be familiar with.
For example, the company's largest tenant sectors are transportation/freight, consumer goods, food and beverage, and multi-customer third-party logistics providers. This includes FedEx and DHL. In fact, these two companies are PLD's third and fifth largest customers, respectively.
Its largest tenant is Amazon (AMZN), which uses a lot of warehousing space. The company accounts for 5.1% of Prologis' net effective rent, as it leases close to 44 million square feet.
The top 10 of its tenants together account for 14.6% of net effective rent, meaning PLD maintains a well-diversified tenant portfolio.
Prologis is so large that the economic value of goods flowing through its buildings is estimated to be $2.7 trillion. That's 2.8% of the world's GDP and 4% of the GDP of the 19 countries it does business with.
It's also 36% of U.S. goods consumption!
Moreover, roughly 1.1 million people are employed by the companies renting PLD buildings.
With regard to its geographical footprint, close to 90% of the company's net operating income is generated in the United States.
Its largest markets are California, the U.S. Midwest, and the United Kingdom.
While some people want to avoid California (for political reasons), California is still the place to be. Supply growth is very limited. Tenants have a massive customer base, and it has some of the biggest ports in North America, which requires storage for transportation to other destinations.
One of the biggest benefits of buying PLD is the fact that it focuses on highly advanced buildings. Prologis not only rents to the biggest retailers in the world but also to third-party logistics providers that require large, modern buildings.
On top of that, 38% of its customers focus on daily basic needs, which tremendously lowers economic risks for PLD. About 34% of its customers focus on secular growth like e-commerce.
Only 28% of its customers are pure-play cyclical companies.
Having that said, the company just reported its quarterly results, which allows us to take a closer look under the hood.
3Q23 Was A Huge Success!
As most readers will know by now, the economy is hitting a few bumps. Inflation has turned out to be sticky, economic growth is slowing, and rates are expected to remain elevated.
Hence, during the 3Q23 earnings call, the company noted that central banks' hawkish posture and geopolitical uncertainties have caused delayed decision-making and expansion space uptake.
Nevertheless, the company remains focused on owning assets critical to the supply chain with long-term secular drivers intact. Structural barriers to future supply are expected to drive occupancy, rents, and values.
Furthermore, while market vacancy in the U.S., Mexico, and Europe is rising, it remains historically low.
With regard to potential headwinds, Prologis expects completions to outpace net absorption in the U.S. and Europe over the next three quarters but anticipates the trend reversing with demand exceeding supply in subsequent quarters.
The company also believes its portfolio will outperform the market in the long term due to its location, quality, relationships, and operating platform.
The depth of their leasing pipeline remains consistent, and customers plan to expand, albeit at a slower pace, due to economic uncertainties.
Looking at the company's leading indicators and proprietary metrics, it's seeing stable lease proposals but a decline in U.S. space utilization for the first time since the peak in global economic growth in 2018.
Having said that, rents increased in most of Prologis' markets, with the strongest growth in the Sunbelt, Mid-Atlantic, and Northern California regions.
Europe and Mexico also performed well, while Southern California saw a 2% decline in rents due to higher vacancy levels. We expect this to be due to a much lower container intake in the ports of Los Angeles and Long Beach.
The good news is that Prologis expects continued market rent growth in the U.S. and globally over the coming year, albeit at a slower pace.
U.S. values declined approximately 3%, whereas European values remained stable. The difference was attributed to factors like the Fed's language on inflation and the economy affecting U.S. capital markets more than Europe.
The company was also able to maintain a high occupancy rate and customer retention.
As a result, the third quarter was a financial success, as it reported core funds from operations ("FFO") excluding net promoter income of $1.33 per share. The result included $0.03 of one-time items related to interest and termination income and the timing of expenses.
Notably, they anticipate continued growth, with core FFO projected to range between $5.08 and $5.10 per share, indicating an approximate 10.5% growth rate.
The company also displayed tremendous financial power during the quarter as it raised approximately $1.4 billion in new financings at an average interest rate of 3.2%, increasing aggregate line availability.
3.2% is a terrific, almost mind-blowing number in this environment, where most companies are financing operations at >5% yields. This will likely give PLD an advantage over its peers as it has lower relative spending on interest.
Combining this with their cash position, Prologis ended the quarter with a record $6.9 billion of liquidity. The debt-to-EBITDA ratio remained low and stable in the mid-4x EBITDA range throughout the year despite increased financing activity, reflecting the growth in their nominal EBITDA.
It also helps that the company has a weighted average remaining maturity of 9.8 years and a weighted average interest rate of just 2.9%. This protects the company against elevated rates - even on a prolonged basis.
Hence, it's no surprise that the company has one of the healthiest balance sheets on the market with an A-credit rating. In other words, PLD has one of the healthiest balance sheets in the entire REIT space!
Looking forward, the company not only expects more than 10% core FFO growth, but it also raised the average occupancy outlook to a range between 97.25% and 97.5%, indicating confidence in demand and occupancy levels.
Furthermore, guidance for same-store growth on both net effective and cash bases was increased, underlining the company's positive outlook on rental income.
This brings me to the next part of this article.
The PLD Dividend and Valuation
Unlike 6%-yielding Realty Income (O), PLD does not come with an elevated yield.
PLD currently pays a $0.87 dividend per share per quarter. This translates to an annualized yield of 3.2%.
While this may be too low for some, bear in mind that it comes with a 61% 2023E core FFO payout ratio, a top-tier balance sheet, and a business model capable of high growth.
Over the past five years, PLD has compounded its dividend at 12.6% per year.
The most recent hike was announced on Feb. 24, when the company hiked by 10.1%.
Seeking Alpha
PLD is trading at 23.1x adjusted FFO. Since 2013, the average valuation was 28x AFFO. If it returns to that valuation while incorporating 0% expected AFFO growth in 2024 and an uptick to 17% growth in 2025, the company could return 20% through 2025.
However, please note that we're not promising these returns. Economic growth is weakening and elevated rates may keep REIT investments from returning to pre-pandemic valuations.
PLD's stock price fell after its strong earnings, suggesting that investors aren't yet buying the good news, as fears of a bigger slowdown in 2024 are prevailing.
We see PLD as a terrific fit in our portfolio.
Our strategy is to buy gradually on weakness. We believe that economic growth could deteriorate even further as sticky inflation is keeping the Fed from lowering rates.
While PLD will be fine, it could lead to lower valuations in the next few months. We're likely to start buying then, followed by gradual buying to boost our stake in the company. If it keeps dropping, we can average down. If it suddenly takes off, we have a foot in the door.
We believe that PLD is truly one of the best REITs money can buy. Its assets are next level, it has the most reliable customers an industrial tenant could wish for, and most of its tenants benefit from anti-cyclical or secular growth demand.
On top of that, PLD has a better risk/reward than most of its customers, which is why we brought up Deutsche Post DHL.
PLD lets investors benefit from secular growth without exposing them to elevated risks.
When adding its consistently growing, well-protected dividend, we're dealing with an industry juggernaut that we like to see in our portfolio.
Takeaway
In our search for the perfect logistics investment, we started with Deutsche Post DHL and its promising prospects. It's undoubtedly one of the best transportation companies globally, offering consistent dividend growth and capital gains. However, the cyclical nature of businesses like DHL made us reevaluate this investment strategy.
Enter Prologis, the world's largest industrial REIT. This powerhouse boasts a diversified tenant portfolio, with giants like Amazon, FedEx, and even DHL on board. Prologis operates in highly advanced buildings, primarily serving businesses with steady demand, such as e-commerce.
Despite economic uncertainties, Prologis delivered a strong Q3, projecting more than 10% core FFO growth and confident occupancy levels. Its remarkable financial health, including a low debt-to-EBITDA ratio and stellar balance sheet, make it a standout in the REIT space.
While Prologis offers a modest yield, it's complemented by exceptional dividend growth.
With the potential for a 20% return by 2025, it's a strategic addition to our portfolio, allowing us to benefit from secular growth with lower risks.
In summary, Prologis is an industry juggernaut that we're excited to own in our investment mix.
Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
For further details see:
All Roads Lead To Prologis: Why We Love This Industrial Juggernaut