Prologis, Inc. (PLD) Earnings Call Transcript & Summary

Session at Citi's Global Property CEO conference. I'm Michael Bilerman. I'm here with Manny Korchman. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are up here and available on the web. For those in the room or on the webcast, you can sign into liveqa.com and then use code citi2020 to submit any questions. I'm very pleased to have with us Prologis. Hamid Moghadam had a personal commitment. And after being at the conference for 24 out of 25 years, I felt that was a 1-year pass. So we're extraordinarily pleased to have with us Tom Olinger. Tracy Ward is here as well. Tom, a long-term CFO of the company. So Tom, why don't I turn it over to you to make some introductory comments? And within those, provide the audience 3 reasons why investors should buy Prologis stock today, and then we'll begin some Q&A.

Great, all right. Good afternoon. Thanks for being here. We're happy to be here. So a couple -- I'll just start with China, just to frame China, just so you understand what the -- our earnings exposure is to China. So we operate in China today through 2 joint ventures, one that does development, one that owns the long-term assets that's an open-end fund. We're 15% interest in both of those. So when you look at our NOI globally, China represents just under 60 basis points of NOI. So it's -- to put that in cents for you, that's about $0.02 of earnings on an earnings base of -- this year, midpoint of $3.71. And then there's about $0.02 of development fees that we could earn, right? From managing the funds that are doing the development, we could get about $0.02 of development fees. We have 42 operating -- well, 42 operating building complexes or parks in China. 40 of the 42 have been opened or are open. And of the 2 that aren't open, one's in Wuhan and one's in Chongqing just west of Wuhan.

Why are you here again? Joke.

Sorry. So those assets are -- have been operating. They've been deemed critical. They're delivering everyday consumables, so it's important. Now we do have about 50 buildings that are under construction in China. Those have not restarted construction since the end of the Chinese New Year, but I would expect in the next week or 2 that those would start to get back going up. So our exposure from China per se is quite small. Now the impact of what the virus does to the global economy, that's something, I think, we all need to watch, obviously, and see how it impacts us going forward. So we -- today, we have better systems and capabilities to track customer sentiment and customer demand better than we ever had, not just around systems and technology. We track all of our open spaces and availability and sales force. So we track opportunities. We track conversion rates, how opportunities convert into signed deals. And then we look at gestation, how long does it take for an opportunity to become a signed deal. It's too early to tell, but going into this, the metrics that we've seen with gestation and -- was quite similar to what we saw in 2019. So -- but again, too early to tell anything. What we would expect, we do have some dialogue with large customers. We're business as usual. We have examples of one customer in particular signing quite a lot over the last week, and a couple of instances of some smaller customers who've had some sourcing, some end product from China and just with uncertainty around that saying, I need to take a pause. So we would certainly think in the short term we will see customers take a pause potentially. It would not be surprising. But I think the key would be to think about once there's more clarity, I think there -- we would certainly expect a rebound. Because what we have seen with other supply chain shocks, of which I would put this in the category, would be, whether it was a Brexit, whether it's the NAFTA getting restructured, whether it was the Japan great flood and tsunami, when there's supply chain disruptions, what we see that follows those are resetting up supply chain where you cover redundancies, right? You're going to basically carry more stock. You're going to build more inventory somewhere in the system to avoid the future shock today. So we would certainly expect to see that on the rebound. So short term, well, we would expect some disruption. Medium term, we would certainly expect a pretty significant rebound, a recapture and a resurge. And then longer term, we would think this is a long-term, more positive impact for 2 reasons. One is the supply chain disruptions, people will build in more redundancy, and the supply chain will become more inefficient, which means they'll carry more inventory. And I think even more importantly is I think the -- a resurgence of online buying. I mean we're certainly seeing that in China, a surge of online buying. I would expect to see it elsewhere. So whatever your growth curve was on e-commerce growth, I think this notches it up.

Why?

Because I think people are going to want to buy more online and not want to go to certain places where there's crowds. I think there's a mental, long-term shift that's going to happen out of this, yes.

To address China, what were the 3 reasons to buy PLD stock today?

So I think one would start with our balance sheet. Our balance sheet today has significant liquidity today. We have significant investment capacity. We carry $4 billion-plus liquidity as a goal every day. We have significant borrowing capacity, I think, upwards of $5 billion or 500 basis points at our current rating of A3, A-. We have significant investment capacity that sits inside of our funds. Our funds probably have upwards of $8 billion to $10 billion of investment capacity sitting there today with equity draws and leverage. We also have sell-down capabilities in our funds to take our ownership today from 27% down to 15% to 20%. That's another $7 billion of liquidity. And we also have liquidity from the future sales of nonstrategic assets of $3 billion. So the balance sheet is -- has significant liquidity. So if opportunities present themselves, we are clearly prepared to act. The second thing would just be looking at the resiliency of our earnings, and it starts with NOI growth. And our mark-to-market today of our leases is about 15.5% underleased, which means our market rents need to grow about 18.5% to get to market. And that delta today on our NOI base is about $525 million. So if we could mark our leases to market today, we would drop another $525 million down to our bottom line. Today, 2020, our AFFO will be around $2.8 billion. Our dividend at our new run rate, we just -- the Board just approved is $1.8 billion. So there is about $1 billion of free cash flow. So there is significant pent-up NOI growth that's sitting in the portfolio, not to mention the other capabilities we have. And then the last thing I would say is our scale and our ability to drive value beyond the real estate. I think that the things we've talked about is driving value from the real estate. But we have a platform that has access to significant amounts of data. You heard us at our Investor Day talk about the opportunities that we've got. We think roughly 2% of the world GDP goes through our warehouses. There's a lot of data there that we can use to capture -- to help our -- help, number one, us make better decisions; and number two, help our customers make better decisions. So I think that's really -- can drive long-term value for our shareholders outside of just normal real estate returns.

I want to pick up on some of the comments on the supply chain disruption and tenants perhaps taking a pause. And I sort of understand the other side of it in terms of the bullishness that you are talking about in terms of carrying more inventory and more online. But at least in the near term, do you think that disruption -- do you think that there's 3PLs or other of your tenants that may not be able to survive that sort of shock within the system and there could be added credit issues, at least in the near term, not knowing how this plays out?

Yes. I -- I'll -- let me frame it first by talking about what our historical credit losses have been. So our historical credit losses historically have been between 25 and 35 basis points of revenue. So this is not a reserve. This is where we just say we can't collect the receivable, we write it off. If you look at the last 6 or 7 years, we've been averaging 18 basis points of bad debt write-offs. If you look at the worst it got in the last 20 years, it was '09 and '10, it got to 56 basis points. So that's the exposure. So again, today, we're running sub-20 basis points. So that hopefully puts it in context of where we are today. Our credit worthiness of our tenants has -- hasn't -- has never been better. Our diversification has never been better. Now that doesn't mean we can have somebody go dark tomorrow, but I would not expect to see any activity with our tenant base that would throw us out of our historical range of activity. So I feel very good about our credit exposure.

Do you feel like -- and clearly, we don't know how this will play out, right, in terms of the supply chain disruption. Do you think, as we get to the other side of this, that supply chains are going to become less global and effectively we're going to start creating more product in-country rather than shipped around?

I do think -- well, there was a shift towards less globalization anyway kind of going into this. I do think our customers will reevaluate supply chains and certainly look to build some redundancy in the system, which will make the system less efficient, but I do -- at the end, it's...

Could lead to more industrial demand?

It does because, yes, people are going to remember the shock, and they're going to prepare against it. Again, it's what we saw...

Somehow, every negative is a positive. I recognize that.

Well, no. I mean listen, in the short term, there -- we'll see some -- I'm sure we'll see some disruption. But yes, when the supply chain is inefficient, it causes people to carry more inventory.

We skipped over the first question that we've been asking, which is about ESG when sustainability of Prologis clearly has been a core competency forever. But it is, ESG overall is important for all company stakeholders. What do you think is the one thing that Prologis is doing to improve the company's overall ESG score over the next 12 months?

Well, I'm very proud of our score, number one. Well, the area I'm really proud of where we're focusing is our Community Workforce Initiative. It's something -- I think it's unique. It's a problem we're trying to solve just around helping our customers find qualified labor pools. And it's a way that we can help our customers buy and also really invest in our communities and have a real impact. So we've rolled it out. And I think in 7 -- 6 or 7 global markets is something we endeavor to roll out and, I mean, at some point, hopefully, train up to 25,000 future employees for our customers. So it's something -- I think it's having an immediate impact both to our community and for our customers. So I think it's a win-win.

So I think ignoring sort of the stock market disruption over the last week and potential stresses to the global environment, we've spoken about whether this time is different from just sort of the highs and lows industrial has experienced. Can you give us your updated viewpoints on sort of why it's different this time? And what about your portfolio insulates you from sort of the highs of occupancy dipping to the lows?

So sure. I think a number of the -- first, it starts with -- if you want to compare this to The Great Financial Crisis, I'll just give you an AMB sort of numbers to frame this. From going into the crisis to its low point, we lost about 11% of EBITDA just through -- the first hit is occupancy and then it's lower rents. Today -- what's different about today would be going into the crisis, I think at best, rents -- our in-place rents were at market if not slightly -- probably realistically slightly above market. Today, our rents are 15.5% of market, which means they need to grow 18.5% to get to current market rates. So there's a massive cushion that sits in there just with the -- of the mark-to-market difference, that $525 million delta that's sitting there today between market rents and our current installed rents. So that's a massive buffer. So if you ran any reasonable scenario today against our portfolio today versus The Great Financial Crisis, you would see EBITDA, quite frankly in most scenarios, stay relatively flat even if you assume the worst, if The GFC happened all over again. So I think the resiliency today is sitting in our mark-to-market. Our asset portfolio quality has never been better. Our balance sheet has never been better. So I think what's different is the asset quality focus, the mark-to-market focus. And our sheer scale helps us from a standpoint, and I think that's underappreciated. There's scale that drives efficiency and there's scale that drives customer dialogue. And I think it's the scale that drives customer dialogue that's underappreciated and then also connecting the data dots around that because what we're finding is some markets across the world are starting to act similarly, right? You might have south-based market in SoCal, might act like Southwest London, might act like East Bay, San Francisco. So our ability to look at customers transacting in all of these markets across the world and start to look at activity, I think, helps us when the markets go up and helps us when the market go down to stay in front as best we can of activity.

Just going back to your earlier comment on the EBITDA cushion. That's assuming no change in occupancy, right? That's just assuming that rents...

Oh, no.

Don't come down. Are we misunderstanding that?

No. Yes. No. Yes, you could -- I mean, in the financial crisis, right, we saw occupancy levels go down 400 basis points, 500 basis points. So yes, you could -- listen, with rolling 15% to 18% of your rents a year, you could absorb a massive shock both from occupancy as well as rents.

How do you feel about the supply picture today heading into a softer economic environment relative to where we were in The GFC?

It's definitely better particularly in the infill markets. It's high-barrier markets. It's definitely better. And you can see that in the numbers. And now you might look at -- absolute numbers might look similar. But absolute numbers, you need to look against the base. I think the most meaningful numbers are to look at supply as a percent of stock and look at net absorption as a percent of stock. Those are the most meaningful numbers. And if you look in the vast majority of our markets, the supply that's being delivered as a percent of stock is at pretty healthy levels. I mean the markets where -- as you would guess, that are delivering the supply are in your less -- lower barrier, less infill markets. So I feel much better about the supply. This will be -- to -- the real impact today is going to be on the demand side, not the supply side.

I remember when the PLD-AMB merger occurred you were in charge of integration. And you've now done multiple deals since then. Two of the most recent: big public to public; obviously, another private REIT put in there. I mean what are you able to drive more out of these mergers today given the history that you've had from an M&A perspective? Like, how much juice above and beyond just the exchange ratio is there as you put companies into the PLD platform?

Yes. Clearly, with every transaction, we get more and more confident about our ability to drive just basic operational efficiency, whether it's running the assets more efficiently, leasing the assets more efficiently. I -- we have high confidence we can do that, and we've got systems and capabilities built that I think will allow us to do more of that. Where I think we've made further strides is our ability to integrate portfolios and start to pull data from those portfolios and to add to our information analytics that allow us to drive more value because we know, through looking at our own portfolios, where we have concentrations of assets in submarkets. Typically, if we have 20 or more assets in a submarket within a 5-mile radius of each other, we outperform those submarkets between 100 to 200 basis points of rent change a year. So we know we drive real value there, and that's where our focus is.

Was it right?

Oh, sorry. I can ask him to do his best to make an impression.

I don't think we need that.

Just...

There's no upside in doing that.

No, I know that.

There is for all for us.

That's a part of the longevity, Michael. You don't answer questions like that.

Let's just talk about the real estate itself, the sort of changes there. You talk about moving closer to population centers. Certainly, that's been a trend. There's been some chatter about sort of small box being the new big box and big boxes are no longer sort of in vogue. What are you seeing today? What should we be looking for, thinking about as -- over the next couple of years as you guys grow that's going to be different than the past 2 years?

Well, I think, again, when you look at the performance of the different size categories, I think it really -- you need to look at the location. I know that sounds obvious, but that's the case. I mean big box sits on the edge of major consumption centers. If you're in -- talking about big box in Tracy, California or Inland Empire, that's a different story than big box that's in our less infill markets. So I think infill big box or an approximate infill big box is doing quite well across the board. Small spaces, I think, are doing quite well. Actually, we would see all the space sizes operating pretty consistently right now, but those are in infill areas. I think trends to watch going forward, I do think that the momentum for more product -- faster product movement through the system is clearly happening. And like I mentioned, I think this coronavirus issue, in my view, is going to accelerate that to some degree. We'll have to wait and see how it plays out. But I do think there will be an acceleration there. And I think our bigger customers will clearly position themselves to take advantage of it. I do think there is a belief that we can all get things in 2 days or a day and that the supply chain is set up to efficiently do that. I think, by and large, most customers would tell us that they can't efficiently deliver product in 2 days. They can get it done, but it's not very efficient. It's not where they want to be, and there's plenty of examples out there where our customers are trying to just get to 2-day delivery in an efficient way. And as we all know, the bar keeps getting moved as to what the -- how quickly we all want things delivered. So I think the overarching thing is to get as close to the endpoint of consumption as possible. We're watching, I think, technology and how technology is going to impact productivity inside the warehouse. It's something -- automation is something we watch very, very closely. Just like inventory-to-sales ratios came down over time as the supply chain got more efficient, we certainly expect technology to drive utilization inside the warehouse higher and make productivity per foot of warehouse space, whether that's on a vertical basis or not, more effective. So it's something we're watching closely. But at the end of the day, we think you got to get as close to the endpoint of consumption as possible because that's what accelerates time and delivery.

So the comments you made at the beginning of the session on higher redundancy and more inefficient inventory sort of go counter to what you just said about more efficient inventories, higher returns, quicker deliveries. So is that to say that that's just a geographic difference or that we don't really know what's going to...

No. I think you've got 2 things going on there, right? I think you've got the push to have more product, the desire of our consumers to have more product being consumed. And -- but you're also going to have productivity gains, technology gains that will make the warehouses more efficient. So our -- my own view, again, is that, that technology will become more efficient over time, it's going to take time, but of -- the amount of product that's going to be coming into the system would, in my own view, more than offset that technological advancement. And you could argue, too, you're going to see technology drive more consumption online, whether it's virtual reality, the like. You're already seeing it today in apparel in certain categories where it's just easier to buy your size online as well. So I think technology is going to help drive more volume, but it's also going to make the supply chain more efficient.

There's a question here on the liveqa. "What do you think about the growth in the cold storage market? Are there opportunities there for Prologis?"

From a traditional cold storage building, where it's freezer, cooler, that sort of a building is not what we want to hold long term. We would like a building that has high levels of flexibility over time. We're investing in assets for 50 years-plus, so we want a building that is flexible to meet multiple needs over time. If you think about a cold storage facility, we like a building that has a lot of ingress, egress, lots of dock doors coming in on both sides of that building. That's not what you get with cold storage. You want to limit the amount of entry points because of utility costs and you don't want to lose cold air. There's a significant investment in equipment in those buildings, freezer/cooler equipment, and there's a large labor component. So we want to focus on what we think we do best, is to own that highly flexible warehouse. That's what we want to focus on, not the other piece. We do have some cool and cold storage in our portfolio. The vast majority of that would be cooler or freezer in a box. And that's where you bring in modular freezer/cooler equipment and looks like you're assembling kind of large containers, shipping containers, and you lay the freezer/cooler on top of the existing foundation. So if -- at the end of the day, if that tenant leaves, you can yank that out. No damage to your floor. Your warehouse is right back to where it was, and we're good to go.

Tom, can you talk a little bit about the acquisition environment, the investment market? It's been pretty much a pie eating contest, rat race, globally, I mean, in a positive way. I mean that's pushed up values, and the fundamentals have supported it, right? So it's been both an insatiable desire to put capital to work in the space, and there's been a good return on that capital. You've been active, clearly. So you're not shying away, you're using both your equity as well as your private funds to participate in that. But I guess how do you sort of underwrite today larger transactions on a global basis? And how do you sort of see the competitive environment for those companies and portfolios?

Yes. So some, I guess, stakes in the sand of how we look at things. First would be we have a very specific view on where we want to be from a location standpoint and what the quality of the asset we want to have in those locations. So we are holding steadfast to where we want to be. We want to be in these high-barrier, high-population, high-consumption markets. That has not changed. We will not waiver. We're not looking to expand our investment viewpoint just to amass more AUM. And number one, so it's got to be the right location and quality; and number two, equally important, it has to drive the right long-term returns. We have no interest in getting bigger. We do have an interest in getting better. And if better means getting bigger, driving a higher value and we can create value for our investors, we will do that. From a -- so that's our underwriting approach. We approach from an unlevered standpoint. We don't look at levered returns per se. We want to look at where we can drive unlevered returns over time and create value over time. So we're willing to look past short- to medium-term periods to drive long-term value if we get the right return long term. So I think we do take a very long -- we do take a very long-term view on those. From a competitive landscape, for sure there is more and more interest than ever in exposure to our asset class. And it is becoming more difficult to find assets in scale that meet our location and asset quality, that's for sure.

Okay. Does that present you an opportunity to shave off a bigger piece of sort of your portfolio to rightsize given all the large acquisitions you've done and be in a position where you can do the same amount of development or other growth and realize more sort of relative growth from it?

Well, absent our $3 billion of asset sales between IPT -- our share between IPT and Liberty, I -- we believe right now we've found the right balance of our asset mix, that we've got the right balance between global markets at almost 90% and regional markets at 10%. We think there's advantages for us to have that presence in all markets to serve our customers in the most economically accretive way. But yes, we're always evaluating what's -- what assets we want to hold long term and make sure it lines up -- our portfolio lines up with the direction the supply chain is heading. So we're certainly not -- you know our history, right? If -- we are not adverse to selling assets. Now your point on being able to fund development, 2 things on development. One is we have significant capacity internally to self-fund for an incredibly long period of time. And then second would be from a development standpoint, that our focus is really driving value out of our operating portfolio and not to drive developments to a certain level. And the reason there is we know we will make a lot more money pushing rents in our operating portfolio than trying to push out more development -- spec development into a market. It's easy math. We almost have 1 billion square feet now, and we're going to push the value of that real estate and maintain maximum pricing power versus putting more spec development out.

Tom, you talk -- there's a question that came in here, and then I'll give to you just the -- it says, "You talk about having 2% to 3% of global GDP under your roofs, right? When will you see the data? Is it immediate? So how much damage the coronavirus situation has on the global economy," right? I guess what is that feedback loop?

Yes. So to be clear, so today, I think the feedback loop we're going to get the fastest is going to be from our customers. We don't have systems today to track data flows inside of our warehouse.

You don't have cameras everywhere that's tracking...

We don't have -- yes, we don't have that today. Someday, hopefully, we'll be able to assess movements. We're certainly doing some...

Thermal in terms of what's going on inside?

Yes. We'll see. But...

In China, they can tell when you leave your apartment. You guys can do that, track the box.

Yes, we could. But I -- we'll see it from our customers. So I think real-time leasing flows. Again, if I -- I didn't mention that we average about 600,000 square feet of leasing a business day. That's sort of our run rate right now.

A day?

A day. A business day.

Some of your competitors do that in a quarter.

Well, listen, we've got -- we lease 40-ish million square feet a quarter. So we've got real volume coming in real time. We've got real -- enough data to be meaningful, and we're seeing it across the globe, which is important. And it's a real advantage for us. We -- again, too early to call, too early to tell, but we'll -- I think we're going to be able to see real time with the data as best we can, better than ever what the sentiment is. If we see that tailing off a bit, we'll certainly let you know.

But there's been no impact as of yet?

It's too early, no, other than some anecdotal, some big customers who have stepped up and probably accelerated a bit and some smaller customers who have said, hey, I got a -- I need to take a minute here or a pause and figure out what's going on. But we -- again, we would expect to see some short-term disruption here. I think it's only normal. But long -- medium term, we would see a rebound and probably a catch-up surge. And then longer term, I think net more positive just given the structural changes we think something like this puts in place. Just like we've seen with other supply chain disruptions, there's a permanent change in how the supply chain works going forward.

Jeff?

[indiscernible]. How do you deal with a potential customer that wants to be in a [indiscernible] and a customer [indiscernible] plus older [indiscernible] sitting on [indiscernible] a customer who wants [indiscernible]?

Yes. That's great. So it's a good question. So we didn't hear it. So how do you balance a customer who wants to be in a high-barrier like a target market for us and also a low-barrier market? Number one is we generally don't do work with them in the low-barrier markets. And if they ask us to help them, I mean, Amazon is a great example, we probably work in maybe half -- maybe we'd partner in half of the markets that they work in that fit our criteria. Sometimes a customer will ask us to be in a market or develop a building for them in a market where we don't want to be long term. For the right relationship, we will do that. But very up front, we will say we are selling this asset. So we have numerous examples across our top customers of doing that. So I think our benefit, to your point, of how to kind of avoid that is we are -- generally, our top 140 customers drive about 40% of our business. We are generally their largest landlord. So we do enough business with them, and we can partner with them and say -- look them in the eye and say, we can try to help you here, this is not a long-term market. We can't -- we don't have product there or we'll do something for you there, but we're going to need to sell it right away. And our economics need to be right for us for that.

All right. Rapid fire. And even though you did an amazing job, Hamid's coming back next year.

[ Virtual ].

So will the industrial sector have more or less public companies a year from now?

It's not more.

So it would be less?

Less, yes.

Same-store NOI growth for the industrial sector, not Prologis, in '21 and, as an anchor, 2020 is about 4.5%?

Are are you talking cash or GAAP?

You mean cash.

Cash.

You said 4.5% for '20?

Yes.

And what's '21 for everybody but us?

Everyone, the entire sector.

Including you. but then seriously.

4%.

10-year treasury a year from now? It's 1.06% today.

That's a fool's errand.

You're still the CFO.

1.50%.

When will the U.S. enter a recession? What year?

This session has ended.

Thank you all.

Which year?

'23.

'23. Thank you very much.