2023-07-14 13:39:42 ET
Summary
- Since the pandemic, deglobalization has been a topic that has further accelerated and could be the next big market factor.
- Prologis is a logistics REIT and with a market cap of $117B, it's the world's biggest REIT.
- Prologis generated significant value for its shareholders since going public, with a total return of 117% in the previous five years alone.
- Some may wonder if a REIT of this size can continue to grow. I think deglobalization could be a reason to answer this question with yes.
- In this article, I will focus less on Prologis as a company or its numbers but more on deglobalization as a potential tailwind.
Introduction
In this article, I want to discuss the effects of a potential deglobalization and what stocks could profit from this development. First, I will explain why I think there should be a discussion about deglobalization, and then I will explain why I think it could positively or negatively affect stocks. The first stock I want to discuss in this regard is Prologis (PLD).
Prologis generates revenue from its activities in logistics real estate, owning and managing a high-quality portfolio in significant markets. They provide various services, including streamlined leasing, property management, development, acquisitions, build-to-suit, speculative development, sustainable development, and strategic capital. Additionally, they have a platform called Prologis Essentials that offers comprehensive solutions for all fulfilment aspects. Prologis strives to deliver exceptional service to its customers while maximizing returns for its shareholders and investors. This is what a logistics center owned by Prologis looks like:
Logistics center owned by Prologis in Neufahrn, Germany (Prologis IR)
I saw these buildings in Person, and trust me. They are huge.
The financials of Prologis appear impressive as well. Still, I will not discuss them now as I focus solely on worldwide developments like deglobalization that could impact Prologis's future growth. If you're interested in a breakdown of Prologis itself, I recommend you read this article by Brad Thomas. But with a market cap of already $117B and $88.5B of total assets, there is only so much more growth. I argue that a coming deglobalization could accelerate the growth of Prologis due to the need for more warehouse capacity.
The history of globalization and the reasons for deglobalization
Globalization describes the increased interconnectedness of world economies, cultures, and populations, spurred by advancements in trade and technology. This process has led to economic growth, cultural exchanges, and the widespread dissemination of knowledge and technology. Countries often specialize in industries that leverage their unique competencies. This global division of labor has significantly increased global trade volumes over recent decades, despite the logistics costs involved.
Global trade value (statista.com)
Supply chains and their disruption
Globalization has sparked the "just-in-time" (JIT) production strategy, streamlining inventory management. JIT champions efficiency by having materials arrive exactly when required, reducing inventory storage. This system, necessitating careful planning with suppliers, is exemplified by companies like Nike (NKE), Zara, and Toyota.
However, the JIT approach has proven vulnerable to external disruptions, as shown in 2022 when supply chains faced major interruptions due to the pandemic, geopolitical tensions, and China's "zero-covid policy". The unexpected surge in consumer demand, partly driven by stimulus checks, along with port closures, halted many JIT productions and fueled inflation rates.
Dependencies on other countries
When Russia began to invade Ukraine, most other countries reacted with sanctions. Rightfully, some of them were very harsh. Consequently, Russia weaponized its energy supplies, which caused an energy crisis in most of Europe. Even though this should have been clear from the beginning, European governments needed such an event to see that a dependence on one country for something so crucial as energy isn't a good idea. This has already and will lead to more self-sufficient countries and fewer imports of energy. This is just one example of (sometimes excessive) dependencies on countries.
Global tensions and trade wars
Rising global tensions could also contribute to deglobalization. The US-China trade conflict, starting in 2018, resulted in significant tariffs and reduced trade between both nations. Despite a phase-one trade deal in 2020, relations remain strained, suggesting further tariff wars are plausible.
Moreover, the longstanding China-Taiwan conflict continues to intensify. It appears China regards Taiwan as its territory and has threatened military action to enforce control. Observers view the Russia-Ukraine conflict as a potential model for a China-Taiwan confrontation, escalating global tensions and prompting further trade restrictions. While other conflicts exist, the China-Taiwan issue remains a primary concern.
Big investment companies seem to see this the same way
I work for a German regional bank that works with Union Investment, Germany's biggest and Europe's second-biggest investment company, with assets under management of €427B. At the start of the year, I visited one of their yearly presentations for institutions, and they said that one of the main themes for 2023-2030 is the change from the "Great Moderation" to the "Great Transformation."
Great Moderation to Great Transformation (Union Investment institutional research)
This change was finalized with the Russian invasion into Ukraine. What follows is a time of focus on national security and resilient supply chains rather than supply chain efficiency and corporate interests.
Change to a new world order (Union Investment institutional research)
This chart, also from Union Investment, shows not only what they predict, but also the global ties to the US or China. As you can see, the world is split, with a slight majority having ties to China. A trade war between the US and China could significantly slow global trade.
Union Investment is not the only major investment company that sees it this way. Larry Fink, CEO of BlackRock (BLK), arguably the most significant investment company in the world in my view, has said similar things in a shareholder letter.
First of all, Fink sees globalization as the foundation on which BlackRock was built:
In the early 1990s, as the world [...] welcomed Russia into the global financial system, we benefited from the expansion of globalization. These powerful trends accelerated international trade, expanded global capital markets, and increased economic growth. It was during this time, 34 years ago, that we [...] started to build BlackRock. We saw globalization and the growth of capital markets fueling a need for the kind of technology-driven asset management we believed we could provide for our clients.
Source: Financial Times
But he also thinks that globalization could have ended when Russia invaded Ukraine:
The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades.
Source: CNN
Furthermore, he says what Union Investment says, too:
...is going to prompt companies and governments worldwide to re-evaluate their dependencies and re-analyse their manufacturing and assembly footprints - something that Covid had already spurred many to start doing.
Source: Financial Times
The result of what is described here can already be seen: This is a chart from Union Investment, showing onshoring/reshoring activities of companies and countries until April 2022.
On-shoring announcements (Union Investment institutional research)
Onshoring/reshoring mentions in earnings reports (Statista, Bloomberg)
You can see that these activities have picked up steam since the start of the pandemic and accelerated after Russia invaded Ukraine in February '22.
Significant players like Apple (AAPL) are already moving manufacturing operations. As reported by WSJ, Apple "has accelerated plans to shift some of its production outside China." Recently, they announced a multibillion-dollar agreement with US tech firm Broadcom. This collaboration will see the development of 5G radio frequency and wireless connectivity components, manufactured in American tech hubs like Fort Collins, Colorado. This strategy aligns with Apple's pledge to inject $430 billion into the US economy.
Prologis as a profiteer of this development
One of the main aspects of this is building more resilient supply chains, fewer dependencies on other countries, and onshoring efforts to ensure more production within the country. More production within the country and reverting from the JIT production will inevitably lead to the need for more warehouse and production capacity. Prologis would profit from this as more demand for warehouse and production capacity/logistic centers would increase rents, and more units could be bought and rented out.
Let's put that thought on Prologis growth estimates. Analysts now expect FFO growth of 7.49% until the end of 2025. This would lead to a total return of 11.44% annually if we buy shares at current prices and the valuation reaches the five-year average of 24.5x.
Annual total return until the end of 2025 (fastgraphs.com)
Even though I don't think deglobalization will fuel growth immensely in this time frame, I could see PLD hitting higher P/FFO ratios due to the market realizing the potential deglobalization could bring for PLD. If we estimate that PLD could reach a P/FFO of 35 (it reached 40 in 2022), the annual total return until the end of 2025 goes up to 27.88%.
Annual total return until the end of 2025 (fastgraphs.com)
This uptick in return is just due to the market pricing in more growth without growth itself. It's hard to estimate how growth could accelerate through deglobalization, but let me show you the trend in sales estimates in the last three years. We can see clearly how sales estimates, especially for the longer term, have rocketed since February 2022. They have come down, probably due to the recession fears that kicked in last year, but I think this can give us a feeling of how much more growth this development could bring in for PLD.
The share price sold off tremendously last year, and even though it has recovered a bit since then, the share price still does not factor in the uptick in growth estimates, giving us the potential for more future share price appreciation.
Other reasons to buy PLD
Even if we don't account for more growth due to deglobalization, PLD is still a solid buy if you're okay with returns similar to the market or if you like a relatively high and secure dividend. PLD trades just slightly above its 20-year average P/FFO and could therefore be considered a buy. To be on the safer side, you should wait for PLD to drop to around 22x FFO.
20-Year chart price vs average FFO (fastgraphs.com)
The dividend yield stands at 2.73% at the time of writing, which is close to the mean dividend yield of 2.94%. Since 1996, PLD has paid a dividend in every year, even during the great financial crisis in 07-09. The dividend was reduced by 71% at its lowest point but was raised almost every year since then, and its latest YoY growth is above the mean YoY growth.
PLD dividend history (koyfin.com)
As you can see in the following chart, the FFO per share is 1.37 times higher than the dividend per share. The mean for the last ten years is 2.19, so the current margin of safety for the dividend is below the mean but still reasonable.
Risks
Prologis, the largest industrial Real Estate Investment Trust, manages an extensive portfolio of warehouses and logistics centers across various geographies. Its tenant base comprises primarily large corporations like Amazon. Nevertheless, while Prologis presents a robust investment opportunity, it is not without its risks.
1. Tenant Risk: Despite having a portfolio of largely established corporate tenants, Prologis could face challenges if these businesses experience financial difficulties. Considering the grade of said tenants, I don't think this Risk is high enough to consider it crucial.
2. Economic Risk: The performance of industrial properties like those in Prologis' portfolio is closely linked with the broader economy. In the event of an economic downturn, the demand for logistics space may decrease, impacting occupancy rates and rental income.
3. Market Risk: Prologis is subject to broader real estate market trends. Factors such as changes in interest rates, an oversupply of industrial spaces, or economic recessions can affect property values and rental income.
4. Interest Rate Risk: Like many REITs, Prologis leverages debt to finance acquisitions and property development. Therefore, rising interest rates can increase the cost of servicing this debt, which could cut into profits.
5. Operational Risk: As the manager of a large and geographically dispersed portfolio, Prologis faces operational risks. These could include unexpected maintenance costs, changes in regulations, or the challenges of managing global industrial properties.
6. Technological Changes: The rapid rise of e-commerce and automated warehousing could reshape the demand for industrial spaces. If Prologis fails to adapt to these changes, the demand for its properties could decline.
7. Global Risk: While a geographically diverse portfolio helps mitigate some risks, it introduces others. Global events, geopolitical instability, or local economic downturns in countries where Prologis operates can impact its performance.
These are general risks, valid for any kind of industrial REIT. In Prologis' case, most of these risks are not something you need to worry about since the sheer amount of Prologis' assets, its accessibility to fresh cash and the above-mentioned trend should put most of these risks aside. A lot of investors consider Prologis a "SWAN" investment. SWAN stands for sleep well at night. I think that says it all.
Conclusion
Analyzed for itself, I like Prologis a lot. I believe it's one of the world's greatest REITs and has a wide moat, therefore making it a relatively safe bet. Nevertheless, I would say its growth prospects are relatively weak going forward, considering the size this REIT has already achieved. This could and will likely change, in my opinion, due to a greater need for warehouse, production, and logistic center capacity because of the earlier past and potentially more trade/tariff wars in the future that could pressure countries and companies to reconsider their offshoring activities and lay a greater focus on onshoring. Considering both scenarios (PLD itself and deglobalization), I rate PLD a 'buy'. Considering the current state of the market, I recommend waiting for a cooldown or just investing a smaller portion of the planned position size.
For further details see:
Prologis: Deglobalization Could Be The Next Dominant Tailwind For This REIT