2023-08-14 15:05:30 ET
Summary
- Prologis Inc. is the world's largest industrial REIT with a strong market presence and high environmental standards.
- Over the past ten years, Prologis has outperformed the S&P 500 and its REIT peers in terms of shareholder returns.
- The industrial real estate market is thriving, driven by manufacturing spending and de-risking of supply chains.
Introduction
A few days ago, I wrote an article covering one of my favorite REITs, Rexford Industrial Realty ( REXR ), which I have put on my watchlist to buy when the timing is right.
In that article, I started by discussing the fundamentals of the industrial real estate market, which might be the most fascinating REIT segment right now, as it sees some strong secular trends.
One of the companies I brought up in that article is Prologis Inc. ( PLD ) , the world's largest industrial REIT with a market cap exceeding $110 billion.
Prologis is a heavyweight in leasing buildings to some of the world's largest industrial companies and a pioneer in offering buildings that come with high environmental standards.
The company has been ranked number two in the U.S. for onsite solar installations and is also a top 10% performer in the Dow Jones Sustainability Index. This helps the company to set itself apart by offering buildings that tenants require to achieve their climate goals.
In addition, it has delivered significant shareholder returns.
Over the past ten years, PLD shares have returned 345%, beating the S&P 500 by a substantial margin. Also, PLD has left its (often slow-growing) REIT peers in the dust, as the Vanguard Real Estate ETF ( VNQ ) returned just 84% since mid-2013.
However, cracks are starting to appear. Slower economic growth is hurting occupancy rates. Meanwhile, higher rates are pressuring REITs and similar investments that depend on a healthy debt market.
So, even if you don't care for Prologis, in this article, we'll learn a lot about the industrial market, as Prologis is a valuable source of intel, thanks to its size.
We'll also discuss why Prologis will likely remain one of the best REITs for the future.
However, before we start, I need to give some credit to Brad Thomas, as he's been on top of PLD for a while. He even included the ticker in a recent article titled If I Were To Own Just 3 REITs, It Would Be These . It's a great read, as I also agree with his other two picks.
Now, without further ado, let's dive into PLD!
What's Up With Industrial Real Estate
The industrial real estate market is in an interesting spot, which is why I'll start this article by taking a closer look at the bigger picture - using some of the findings from my recent REXR article.
Essentially, industrial real estate is one of the best places to be.
Using June numbers, we see that industrial real estate is much healthier than office, retail, and hotel real estate, with an average delinquency rate of less than 1% - and no visible uptrend.
Wells Fargo
Industrial real estate benefits from one thing in particular: manufacturing spending.
The chart below displays the significant increase in manufacturing construction spending, which has reached nearly $200 billion.
According to a real estate report from Yardi, several key factors have contributed to this trend in manufacturing construction spending. Recent legislative acts such as the CHIPS and Science Act, Inflation Reduction Act, and infrastructure bill have played a major role by incentivizing spending through tax credits.
However, this trend started prior to aggressive government spending, as companies around the world started to de-risk supply chains after the pandemic.
The war in Ukraine and increasing tensions with China are further fueling this trend.
For example, China's share of U.S. imports has fallen to a 20-year low of just 13.3%.
This trend is also clearly visible when zooming in on construction spending. Most spending growth is driven by tech spending, which is an area that wants to become more independent from China.
Twitter (@JosephPolitano)
Meanwhile, economic growth is in a somewhat tricky spot.
The ISM Manufacturing Index has been in contraction territory for nine consecutive months, with starting downside momentum in factory employment.
Bloomberg
In other words, industrial real estate is the place to be. However, it's not without risks - especially not in light of rising supply and pressure from cyclical weakness.
This finally brings me to the star of this article.
What Makes Prologis So Special
For readers who are new to my articles, I have roughly 50% industrial exposure in my dividend growth portfolio, consisting of transportation, machinery, and defense (a big part of it is anti-cyclical).
The industrial market is fascinating because it is home to some companies with very wide moats.
While Prologis doesn't produce anything, it provides buildings to companies that do.
Founded in 1983, the company has become the largest industrial real estate owner in the world. It has more than $200 billion in assets under management, more than 1.2 billion square feet on four continents, and an A-rated balance sheet, which is also somewhat unique in the REIT space.
Adding to that, as of June 2023, the company estimates that the economic value of the goods flowing through its properties is $2.7 trillion, or 2.8% of the global GDP. Additionally, more than 1.1 million people have found jobs in its buildings.
The company also estimates that 36% of U.S. goods consumption flows through its buildings, which is another number highlighting how important the company behind the PLD ticker has become.
Furthermore, the company's tenants are some of the biggest companies in the world. As of March 31, the company collected 19% of its net effective rent from its top 20 customers. So, while its top customers are important, it does not have customers with so much power over the company that it could come with additional long-term risks.
As we can see below, the company's tenant base is well-diversified. 29% of its customers are 3PL providers (third-party logistics), and 23% are retailers, including Amazon ( AMZN ), Walmart ( WMT ), and Home Depot ( HD ). Manufacturing accounts for just 16%. Transportation accounts for 12%, which includes giants like FedEx ( FDX ) and J.B. Hunt ( JBHT ).
Based on this context, while industrial real estate is certainly more cyclical than residential real estate, the company has only 28% cyclical spending exposure. It has 38% exposure to basic needs products, like fast-moving consumer goods, and 34% exposure to industries with secular growth trends. This includes e-commerce, transportation, and healthcare.
Although some secular trends also have temporary cyclical headwinds, the company's portfolio is well-positioned for potential recessions down the road.
The company believes that e-commerce penetration could exceed 30% by 2026. E-commerce requires 3x as much logistics as brick-and-mortar stores due to higher product variety, more inventory, individual business-to-customer shipping, and reverse logistics, which is an emerging trend, as companies need to optimize the flow of goods from customers to businesses.
Thanks to its portfolio and secular benefits, the company has outperformed its peers and the S&P 500 by a wide margin when it comes to long-term FFO (Funds from Operations) growth. This also allowed the company to generate outperforming dividend growth.
On top of outperforming capital gains, investors have received steadily growing dividends.
PLD currently pays $0.87 per share per quarter. This translates to a 2.8% yield.
While this yield is below the yields of some well-known REITs like Realty Income ( O ), W.P. Carey ( WPC ), or its industrial peer STAG Industrial ( STAG ), the company has higher dividend growth.
Over the past five years, the average annual dividend growth was 12.5%. Earlier this year, the company hiked by 10%.
Furthermore, the dividend is protected by a 62% payout ratio using this year's FFO guidance midpoint of $5.58.
Recent Developments & Outlook
In its 2Q23 earnings release/call, the company noted both headwinds and tailwinds.
In light of my earlier comments regarding the decline in economic growth, the company noted that Southern California's vacancy increased due to disruptions in port operations. Some customers are diversifying their operations away from the Inland Empire to other Southwest markets.
While the rent growth forecast for Southern California in 2023 has been lowered, the company remains optimistic about the market's potential due to low vacancy and underlying demand drivers.
Year-to-date, container volumes in the Los Angeles port (the largest in the U.S.) are down 24%, which has a major impact on real estate demand in the area.
Nonetheless, Prologis believes that its (diversified) global portfolio enables it to navigate market fluctuations, with various markets contributing to growth at different times.
For example, rent growth forecasts for several markets are increasing this quarter, including Las Vegas, Texas, Europe, and Mexico.
With over 5% rent growth achieved to date, the full-year rent growth forecast was adjusted to a range of 7% to 9% on a global basis.
The focus is on medium-term growth driven by replacement costs, barriers to new supply, and ongoing demand drivers.
We've indeed seen vacancy build and expected to reach the mid-4s in the U.S. by year-end but continue to believe that fundamentals will regain momentum in 2024 with the outlook for new supply declining as development starts continue to fall this year . In short, our outlook is completely unchanged and we feel great about our business. - Prologis 2Q23 Earnings Call
Essentially, weakness, so far, seems to be a normalization of aggressive post-pandemic growth, not a structural weakness that could hurt Prologis in a meaningful way. Additionally, increasing difficulties for companies to finance new construction are keeping a lid on supply growth in some areas, which is good news for established players like PLD.
However given what is still low vacancy together with structural headwinds to new supply and a huge consumption base, we believe strongly in this market . The global nature of our portfolio means that we will see markets contribute to growth in different periods evening out peaks and troughs. We see this playing out in a number of markets across the globe, where our rent growth forecast is increasing this quarter such as Las Vegas, Texas, Europe, and Mexico to name a few. - Prologis 2Q23 Earnings Call
These developments are also reflected in the company's guidance.
The company's outlook for the remainder of the year indicates an average occupancy range of 97.0% to 97.5% (unchanged). The company upgraded its same-store guidance, projecting 8.75% to 9.25% net effective rent growth and 9.5% to 10% cash rent growth.
As a result, the company increased its guidance for GAAP earnings. It is now projecting a range between $3.30 and $3.40 per share.
Core FFO, including promotes, is anticipated to be in the range of $5.56 to $5.60 per share. FFO executing promotes is forecasted to range from $5.06 to $5.10 per share. This reflects over 10% annual growth and marks the fourth consecutive year of double-digit earnings growth.
Valuation
Based on its guidance, PLD is trading at 22.1x FY2023 core FFO. That's roughly 9 points above the sector median.
However, a premium is warranted. Adjusted FFO has grown by 12.9% per year over the past five years. The sector median growth rate was just 1.9%.
This valuation is fair, which is also reflected in the company's consensus price target, which currently stands at $143. This is 16% above the current price.
FINVIZ
While I will rate PLD as a Buy , my personal opinion is that I'll play it safe. Given that I recently bought some industrial stocks quite aggressively, I'm accumulating cash again and waiting for a potentially better price down the road.
This is what I wrote in my REXR article (it applies here too):
While I am bullish on the company's long-term future, I hope to add this stock to my portfolio at a slightly better price.
Sticky inflation and an outlook of elevated central bank rates on a prolonged basis could cause more weakness in this industry.
All things considered, we're dealing with one of my favorite REITs. The company has a business benefiting from strong secular growth, an A-rated balance sheet, global diversification, and tailwinds that currently offset cyclical weakness.
I put PLD on my watchlist and may buy it in the not-too-distant future.
Takeaway
With a market cap exceeding $110 billion, a massive global portfolio, a sterling balance sheet, and strategic partnerships with giants like Amazon and Walmart, Prologis has carved out a unique niche.
Its proactive approach to sustainability, exemplified by high-ranking Dow Jones Sustainability Index performance and extensive onsite solar installations, adds another layer of appeal, as it helps customers reach their environmental goals and sets its assets apart.
While challenges like economic fluctuations and supply pressures loom, Prologis' diversified portfolio and emphasis on key growth areas like e-commerce put it in a great position.
On top of that, the company comes with a history of strong dividend growth, protected by steadily rising FFO.
I believe PLD is one of the best REITs on the market and a terrific buy on any weakness.
Reasons To Be Bullish
- Strong Secular Trends: Prologis benefits from the robust and growing trends in industrial real estate, including manufacturing spending, supply chain de-risking, and the expanding e-commerce market.
- Global Leader: As the world's largest industrial REIT, Prologis holds a substantial portfolio, spanning continents and showcasing an A-rated balance sheet, which instills confidence in its stability.
- E-commerce Growth: With a strategic focus on e-commerce, Prologis stands to capitalize on the increasing demand for logistics and distribution facilities driven by the ongoing rise of online shopping.
- Diverse Tenant Base: Prologis boasts a well-diversified tenant portfolio.
- Dividend Growth: Prologis offers a consistent and steadily growing dividend.
- Resilient Portfolio: Despite cyclical challenges, Prologis' diversified portfolio with exposure to secular growth sectors enhances its resilience against economic downturns.
- Optimistic Outlook: Prologis remains positive about its ability to navigate market fluctuations and achieve growth with a global portfolio that can leverage different markets at various times.
For further details see:
Prologis - One Of The Best REITs Money Can Buy