2023-04-20 05:29:35 ET
Summary
- Investors still aren't sold on industrial giant Prologis, despite blowout results in the first quarter of the fiscal year.
- The company reported 98% occupancy levels, record cash spreads, and record cash NOI growth.
- Low vacancy rates and favorable supply dynamics are likely to keep the good times rolling.
- Given the outlook, I remain broadly bullish on the stock and the sector, in general.
Investors still appear hesitant on industrial giant Prologis ( PLD ). Following their most recently released results, which came in ahead of expectations , shares remained fairly flat.
Seeking Alpha - 5-Day Return Of PLD
And though up 11% on a YTD basis, they are still down over 20% over the past one year.
Seeking Alpha - 1-Yr Return Of PLD
Since my last update on the stock, shares have gained just over 2%, which lags the S&P’s ( SPY ) nearly 4% gain over the same period.
This is despite a blowout quarterly release that included record leasing spreads and same-store net operating income (“NOI”). The fact that they were able to generate these results in the face of a slowing macroeconomic backdrop is even more impressive. Occupancy that continues to hold at 98% on historically low vacancy levels is another anchor to their overall portfolio strength, as is their sizeable liquidity position of nearly +$7.0B. Given the positive outlook, I remain bullish on the stock and view it as worthy of inclusion in any diversified investment portfolio.
Occupancy Remains At Optimal Levels
At period end, both their ending and average overall occupancy landed at 98%. In their largest operating region, Southern California, which accounts for approximately 20% of their NOI, occupancy remained near the 99% mark. And in most other markets, occupancy tracked within the overall portfolio average.
Q1FY23 Investor Supplement - Occupancy Summary By Quarter
In the Asia region, occupancy did dip 140 basis points (“bps”) on a sequential basis. But it’s still up slightly on a YOY basis. Driving the sequential decline was weakness in their China market, which slipped from 94.5% occupied in Q4 of fiscal 2022 to 91.7% in Q1. This is perhaps due to increased nearshoring efforts on the part of countries seeking to reduce their exposure risk to the region.
At any rate, I don’t view the overall occupancy decline in the region as a concern, as it represents less than 2% of their portfolio NOI.
Normalization In Space Utilization Not A Concern
Space utilization did tick down to 85%. But this is more so seen as normalization as opposed to any indication of “shadow space”, which is essentially space that is likely to become vacant upon any downturn in the economy. In my view, utilization would need to fall into the mid-70% range to be seen as a concern.
Q1FY23 Investor Supplement - Graph Of U.S. Space Utilization By Year
But this is unlikely to occur, as demand for their properties and warehouse space, in general, remains robust. Proposal activity, for example, was higher. And about 99% of their units are either leased or in negotiation.
Low Vacancy And Supply Growth Remain Supportive
Furthermore, overall vacancy rates in their U.S. markets stands at just 3.5%. While the rate is expected to tick up to the low 4s towards the end of the year, it is expected to return to the mid-3s by late 2024.
This is due to the current drag in financing markets, where new liquidity for less capitalized competitors is essentially frozen, as in the case of construction-specific loans. The challenging conditions, therefore, create a headwind on new supply. And this would be at a time when demand remains elevated.
Another notable takeaway from their results is their e-commerce leasing activity, which increased to 19% of all new leasing during the quarter. The increase, in turn, resulted in total e-commerce activity more in-line with their five-year average, a surprising finding, given the fears regarding a pullback in the sector.
Positive Revisions To Guidance
Looking ahead, management provided positive revisions to 2023 guidance . Average occupancy, for example, is now expected to be up 25bps at the midpoint to a range of 97% to 97.5%. In addition, same-property cash NOI growth at share is projected to be up 37.5bps at the midpoint to 9% to 9.75%.
Core funds from operations (“FFO”) was also narrowed higher from the low end of their range. 2023 core FFO, excluding net promote income, is now expected to be $5.06/share at the midpoint.
Final Thoughts
Many are rightly cautious about the macroeconomic outlook. And in two prior analyses on two bellwether stocks, J.B. Hunt ( JBHT ) and Fastenal ( FAST ), I highlighted recent results, which affirmed the cautious view held by many. FAST, for example, cited a softening manufacturing environment on their release, while JBHT outright acknowledged that they are in fact in a freight recession.
These observations are pertinent to PLD, as the company is an industrial landlord. If the environment is slowing, then, why shouldn’t we be concerned about PLD and the industrial sector at-large? For one, vacancy is still holding at historically low rates and demand remains elevated, despite the softening macroeconomic environment.
Continued near-shoring efforts and U.S. expansion plans by recipient companies of recently passed legislation should keep demand for industrial properties at healthy levels in 2023 and beyond. Evidence in this demand is exhibited in PLD’s recently released results, which highlighted record cash spreads and NOI growth.
At 42% cash rent growth on occupancy levels of 98%, it’s hard to foresee a slowdown anytime soon. And in fact, management expects their lease mark-to-market to end the year at a whopping 70%. Furthermore, they see rent growth exceeding 85% in 2024, even without continued market rent growth.
Utilization did decline during the quarter, as did customer retention. And absorption across the U.S. market is on the softer side. While these metrics are worth additional attention, the declines are not viewed by me as significant concerns. I view them, instead, as a normalization.
As long as the company can continue maintaining current occupancy levels, while simultaneously driving rents at spreads well in excess of sector averages in the broader REIT indexes, I will maintain a bullish outlook on PLD. Consistent with my prior view, I don’t view PLD’s current forward multiple of 22.5x as overvalued. In fact, I view the premium as warranted, given their leadership position in the sector, as well their favorable sector dynamics.
For investors seeking new or further positioning, I believe PLD presents upside potential of about 20%, excluding dividends. And, as an industry giant, the stock could serve as a solid anchor to any diversified investment portfolio for years to come. For these reasons, I am maintaining a “buy” position on PLD stock.
For further details see:
Prologis: No Signs Of A Slowdown Just Yet