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

I am Jeremy Metz, Managing Director and Senior REIT Analyst at BMO Capital Markets. I'm very pleased to kick off NAREIT 2020 Conference here with Prologis company presentation. With us from Prologis, we have Tom Olinger, Chief Financial Officer. Tom, it's great to see you virtually here. So thank you.

Good to see you as well, Jeremy. Good morning, everybody.

So Tom, as I think about Prologis, it's evolved on many fronts over the last few years. So maybe perhaps to start, you can give us a quick review of the evolution that's going on to really position this company as the battleship it is today.

Well, first off, I want to make sure -- I want to thank everybody again for joining, and hope everybody is healthy and safe. And it is interesting, as you said, doing this all virtually. So we've been -- since the GFC, we've been focused on making sure we had the right portfolio for the long haul. And that's been a foundation of what we've been building is to be in the right location and then have the right quality buildings in those locations. That's been key for us. And the supply chains certainly have been moving our way relative to the time element of the supply chain, right? Consumer expectations for convenience, which means delivery time has been critical. And everything that's happened with the COVID-19 situation has really elevated those aspects around time and convenience, the work and live, the work-from-home, shelter-in-place economy. So it's been really insightful over the last 2 months to see all of that play out per se with just the acceleration -- the rapid acceleration of e-commerce and the activity that we've seen in that aspect of our business with our customers. So I feel really good about how we've positioned the portfolio. And for the longer term, as you've seen in our research, we think there's 2 key elements that are going to further drive demand going forward. The first is the supply chain is going to carry more inventory, just this whole concept of being resilient versus efficient. And that's going to have a meaningful impact on incremental demand. We think that could -- customers could carry 5% to 10% more inventory that would lead to significant more warehouse demand. And then second would be the acceleration of e-commerce, and that -- just the steepening of the curve with e-commerce. So we're excited about both of those aspects. I think we've positioned ourselves extremely well to capture that incremental demand.

Yes. Appreciate the intro. Maybe we start high level, and you can just talk about real-time industrial market condition today since your last earnings call. What incrementally has changed? What are you seeing out there today? Are things getting -- are you seeing -- you feel a little more optimistic?

Yes. Overall, we feel things are playing out as we've roughly expected. I'll just give you a couple of stats, and these are in our presentation on Page 12, and this is real time through the end of the day on -- well, really on -- through May 31. So this is the first 2 months of the quarter. We've seen leasing proposals are up 5.4% year-over-year. That's -- again, I'll give you all these stats on a size-adjusted basis. So again, proposals are up 5.4%. Leasing activity is at a little over 28 million square feet. That's actually down 16 -- a little over 16% on a year-over-year basis, again, size-adjusted. Not surprising when we've thought about how this would all take shape. We talked about an initial surge in activity as customers were scrambling to catch up with the COVID and needing more -- for those customers who needed more space, we saw that surge in March into April. And then things have leveled off. And then now we're seeing the impacts of the shelter-in-place activities. So that's sort of the second phase. And then as we get back to the new normal, we'll see, obviously, activity pick back up. But it's really happening in line with the phases. The timing is the wildcard here. Lease gestation is down significantly. We're at 45 days. That's down from over about 80 days. Retention remains high, 79-plus percent. So that from an operating standpoint, that's what we're seeing. So great activity around proposals. E-comm activity has been significant. In April, it was almost up 40%. It settled down a bit in -- I'm sorry, yes, April was, gosh, almost 40%, and May, it settled down a little bit, but our leasing pipeline has a significant amount of e-commerce activity. So that whole segment continues to be extremely good. On a rent collection standpoint, if you want to go there, rent collections for April, and this will include amounts deferred, is 97.6%. May, we're at 95%. So across the board, when we look at our collections relative to 2019, we are -- in the U.S. and across the globe, we are right on top of 2019 percentage. Collection levels with the exception of Southern Europe, primarily France and the U.K., those economies have been in shelter-in-place longer and have governmental actions that support tenant payment delays. So that's -- collections, I feel good about collections, what we're seeing consistent with last year with the exception of those 2 geographies.

And how are you dealing with the deferral picture amongst that from what you've seen?

It's -- right now, we've given deferrals of around 40 bps of our gross annual revenue. We've talked about deferrals for the year being no more than about 90 bps. So I think deferrals are playing out roughly as we've expected. Again, we're focused on customers who need the help and not customers who are trying to be opportunistic here. And so deferral requests have certainly leveled off. And we're still working through a modest amount of customers in process just to understand what they might need. But I would say, deferrals are playing out again relatively in line with what we expected.

Yes. Combined with the strong collections activity, it sounds like a pretty healthy backdrop here today.

Yes. Yes. We're -- I'm pleased, particularly that May collections, again, May collections, with the exception of U.K. and France, are in line with May of last year. And May of 2020 collections are ahead of May of -- April collections -- sorry, May 2020 collections pace is ahead of April 2020 pace. So it was good to see that level of activity as well.

Based on those gestation stats, you mentioned, I mean, obviously, the tenants who are out there are ready to make a decision and ready to act quickly, which would seem like, again, a pretty good sign here of who is out there.

Yes, I think that's right. It's also a function of I think tenants are waiting -- if you're in the space, they're probably waiting longer. I think they're waiting longer to make a decision, right? And quite frankly, the longer they wait until the end of the -- when the lease is going to terminate, the longer they have -- the less time they have to actually do anything. So I think the lower gestation periods are real positive, right? As you said, customers are making decisions faster, and I also think they're waiting to extend, in some cases, to the very end to make a decision when they, quite frankly, don't have any real decision to make other than to renew, which is why we think retentions could stay elevated.

Yes. No, I think that's fair. And one of the differences we've talked about many times, I think it's important, is the mark-to-market in the portfolio. And what sort of runway that gives you here, even in an environment where maybe there's a little bit of a pause on the overall market pushing on. So could you just maybe comment on that? And how do you see the run rate? And how does that position you a little better than it would have in the last cycle or so?

Well, yes. So we are in-place. The market today continues to be right around 15%. So our in-place leases are globally approximately 15% below market rents. And that's a huge buffer for us because our average lease term is about 5 years. And when you look at that 15% mark-to-market, clearly, what's going to leases that are expiring this year and next year are significantly further below market. That's why you're seeing rent change on roll that's been in the mid- to high 20% range. And our expectation is for rents to stay flat the rest of this year. So I would expect to see rent change on roll, continue to stay in that mid-20% range this year and in the next year, even with no rent growth. And once we get back on that path of rent growth, and I think that mark-to-market could stay -- we should continue to stay elevated. So it gives us a lot of organic growth going forward for the next 4 to 5 years.

Yes. I think that's important and unique, especially as we look across other sectors as well. Just...

And I'm sorry, Jeremy, just to put that in nominal terms, that 15% today is over $0.5 billion of incremental NOI. Once -- if we could wave a magic wand and mark all of our leases to market today, that would generate an incremental $0.5 billion of NOI annually.

If we switch gears a little bit and we go -- the development program, it's been a strength of this company. Maybe just an update on where it stands today in terms of the process, capital to be spent, and then just what kind of actions, just as a reminder for folks dialed in here, what kind of actions you took as the pandemic played out a little bit to reduce some of the risk in...

Yes, I'll start there. We -- in mid-February, really, we dialed back all speculative development at that point just given what was transpiring. And the last thing we want to do is put incremental space on the market. What drives our earnings and what will drive our earnings going forward will be the growth of our operating NOI going forward. That's by far -- that's 90 -- 80%, 90% of our NOI growth is coming from that, just enhancing the growth of our existing operating portfolio. So the last -- so we want to maximize the pricing power that we have in our markets. And so the last thing we want to do is put more development or spec development into that market. So we've backed off on spec development. However, we have, I would say, a very active build-to-suit pipeline, and it's -- right now, our build-to-suit activity is -- it's certainly exceeding my expectations. It's been -- continues to be good. In most of our markets, there -- we're still at record low vacancy levels. So the demand -- the supply/demand balance is still quite good and customers needing space. In a lot of cases, we don't have space to provide to them. So that's where build-to-suits are coming into play. So I expect build-to-suits to be -- activity to be better than we expected. We were quite conservative in what we forecast for the balance of the year. So I think there's clearly upside on the development side.

And a hallmark of this cycle has been the discipline developers have shown broadly, not just within the REIT. So as we think about some of the pulling back on the spec that you mentioned, are you seeing a similar level of discipline across peers and institutions in the industry, which gives you some confidence that, that discipline is maintained as of today? Obviously, they're still in process that will be delivered, and the industry will lease up. But as it pertains to just what you're hearing and anecdotally and seeing, are you seeing that similar level of approach and discipline today?

Yes. I'd say broadly, yes, we are seeing that across the board. There's always pockets of, I'd say, bad developer behavior. Whether it's Poland or a submarket here or there, you'll get pockets of that. But I'd say broadly, across the board, we're seeing development scale back.

Yes. I think that's good. And then as you -- once it's time and you feel comfortable with the market, obviously, go and step and start adding more development to the pipeline. But just how much of a pipeline between what's on balance sheet, what do you have options for? Just as we think about the growth when it's time again, how big of the pipeline are you sitting on today that you can start to activate in years to come? How much of a runway do you have just as you currently sit?

As far as just what build-out potential we have from our existing land bank today?

Yes.

Yes, it's $11 billion. When you look at our land bank and land we control under option, it's $11 billion. That would not include what we would call covered land plays, and that would be parcels, land that's sitting in other assets because right now, it might -- it's leased to surface parking, container parking as well. So it doesn't sit in our land bank, but it sits in other real estate. That -- the build-out of the covered land plays is well in excess of $2 billion, which would be incremental to the $11 billion. So we've got quite a pipeline capacity to meet incremental demand and it's sitting in the markets that we want, right? It's sitting in these global markets and its facilities that can help serve that last portion of at-home consumption.

And I respect that it's still early in this, but are you starting to see opportunities certainly where you might be sitting in a position to take advantage of others who might need to start, whether it's [ grabbing ] certain land opportunities that are -- given your scale and you touch all the key markets? Is that starting to happen yet, or just a little too early for some of that too?

No, it actually is starting. We've got -- I can think of 2 examples in the last 2 to 3 weeks where we're acquiring land parcels in 2 markets in the U.S., one, via municipality, another from a buyer that needed to act. And we've got what we believe is very attractive pricing, particularly relative if you think about pre-COVID, what we think the pricing would have been. So I'm not sure that's going to be broad-based with large portfolios. But certainly, if you think about certain sellers or certain owners that, for whatever reason, need liquidity, municipalities certainly are going to be under financial duress given the financial requirements and the needs from the COVID-19 situation. So I think we're going to find opportunities like that. We are certainly a trusted buyer. We can act quickly. We've got the financial wherewithal to act quickly. So we give a lot of confidence to sellers that we stand behind what we say, and we can move quickly. So I think that's a real advantage for us. And hopefully, we'll continue to mine these opportunities. But I'm very encouraged by -- again, like you said, it's early, but I'm very encouraged by what we're seeing.

Yes. And sticking with some of the opportunities. You mentioned, obviously, as we think about your size and scale, there's an argument of how you can control your markets from a revenue optimization standpoint, whether that be rent or occupancy. Over the recent years, you've talked about the benefits of clustering assets. So what kind of advantage do you think that gives you here in the current environment? What kind of opportunities does that present that others may not have?

Yes. I think the opportunity sits around our ability to mine the data that's coming from our portfolio. And yes, there's clearly a clustering effect. And when we look at our portfolio and we see submarkets where we have greater than 20 assets in a 5-mile radius, we see clustering benefits where we outperform that submarket on rent change on roll by 100 to 200 basis points annually. We see that across our portfolio. So we have significant scale, and we can certainly use that data to help us make more informed leasing decisions. I think what's even more impactful is when you start to see submarkets and markets across the globe act the same way. A Northern New Jersey acting similar to Inland Empire West, for example, or South East London acting like the boroughs of New York, right? So we start to see those similarities. And then when you layer on top of that, how our customers are acting globally, you start to see some pretty powerful trends. So the advantage is when you've got today, we've got north of 960 million square feet. You couple that with our customer base, what they're doing and our dialogue with that base, it gives us some very powerful information. And that information is clearly valuable when markets are in an upcycle, so you can optimize and push rents. But it's equally, if not even more important, on the other side when we're in a COVID-19 situation, and things are less uncertain, demand is less certain. So it gives us an advantage, just as, I think, a bigger advantage on the downswing to that we're pricing appropriately and then being able to see that inflection point in submarkets when we see the markets turn. And we can capture that via development, and we can capture that by trying to seek optimized rents. So I'm really excited about our data capabilities and what we've developed, and I think they're going to be more just as advantageous to us in a downmarket and as we come out of this downmarket as it was in the upswing.

Yes. Actually, sometimes, these are the more challenging times where it becomes even more evident versus some of the good markets where all boats are getting lifted in some capacity. I do think the data is very important. One other direction you've taken that is global procurement, ability to drive some additional revenue synergies. Maybe you can just take a quick minute and touch on some of those other tangential opportunities that the data and your scale will give you there.

Yes. So from a scale perspective, on the procurement side, we've set targets to generate over -- well, to generate $150 million of annual savings through development spend, through CapEx spend, also some operating, G&A expenses. We're well on target, I think, this year to get very close. So our long-term goal was $150 million. Now clearly, development volumes could be down this year relative to what we thought. But I think we've got a really good shot at getting close to the $150 million in annual savings this year. So I think we could -- we've got a shot at hitting that target. It's gone extremely well. When you just look at the size and scale of our portfolio, when you think about LED lights inside a warehouse, dock door levelers, all these different things, we're probably, if not, we're probably the largest purchaser of those items globally. Then you start to think about other things that we're not buying but our customers are buying inside the warehouses, forklifts, racking. Our installed base, our customer base would clearly be the largest buyer of the world of some of these other types of items. So we're looking to help our customers optimize their operations and through utilizing our scale and ultimately helping to benefit us. So that would be more on the essential side of the business. Clearly, with the COVID-19 situation and limiting direct face-to-face contact, around those types of needs, it's been tougher to, I would say, continue that momentum. But -- so I do think the essential stuff will take a pause a little bit as we try to get back to whatever the new normal will be. But we are no less encouraged today about the opportunity of that essential side of the business where we can drive value for our customers.

Absolutely. And we're getting near our time. We have a couple of minutes left. I did want to touch on 2 other aspects I think that we get asked about often. But perhaps first, you closed on 2 large entity-level deals earlier this year with Liberty and IPT. Maybe just a quick update on how the integration has gone with those and how the portfolios have reacted relative to your expectations. So for understanding that we're in a little bit of a unique world, but just how those are going.

Yes. Both transactions, the integrations went quite well and they're completed. The advantage of those transactions was that we had, in the case of really 4 to 6 months, between signing the transactions and closings, and we endeavor to get effectively all of the transition, all of the integration done. So on day 1, when those assets come into our portfolio, all those assets are in system, and we can operate and transact within system. That is always our goal, and that was the case in both when we closed IPT and the LPT portfolios. We were transacting business in systems day 1. So we don't want to bring other systems over. We don't want to run dual systems. We want to run our way of doing business, utilize all of our capabilities, all of our analytics. So those assets come in and are operating as we would operate them day 1. So I think that's been critical to our success in this process. And then how are the assets performing, both of those portfolios are doing better, are coming in and performing better than we had underwritten. We had high expectations for them. But clearly, they're doing better, particularly on the occupancy side as well as -- even the rent side are both doing better than we expected. So very, very happy with how all that's transpired.

Yes. And there was a lot of operational and financial synergies you had available as well. So obviously, a time to enact some of that, some of that was going to be future. But it's great to hear those are still...

Yes. And I should mention that, Jeremy, and we hit our day 1 synergy targets on both portfolios from an operating standpoint as well as a financing standpoint. We did a significant amount of refinancing in late January, in early February, and realized those interest savings as well. So we hit our targets across the board on both portfolios.

Great. And then when I started this, I referenced the company as a battleship here today. And I mean there's a lot of different aspects. You've on a lot of them. An important one from our view is the balance sheet which you played a big role in shaping here, and I think it's an important advantage. It gives you advantages, gives you security. I'd love to just kind of hear you give just an update on it and just leverage kind of the comfortability you have with everything to that.

Yes. Our -- stepping back and just history-wise and coming from the AMB side of the house is when we went through the GFC, the one thing our lesson learned on the AMB side is that we didn't have as much financial capacity or liquidity that we would have wanted going into that, the GFC. We told ourselves that was never going to happen again, and we positioned our balance sheet accordingly. We will always run our company to be an A-, A3-level entity. And with that, we will always carry significant liquidity as well as financial capacity. So our goal is to have a minimum every day of no less than $4 billion of liquidity between cash and line capacity. We've been running near $5 billion here over the last -- really since quarter end. That's where we stand. And so we'll continue to keep that financial flexibility. So we're always on our front foot. If opportunity knocks, we can answer that. The other aspect would be from -- we have significant financial borrowing capacity at our current rating. And if you look at our current rating and our 2 open-ended funds, our large open-ended funds in the U.S. and Europe, both of those entities are A- rated entities as well. So borrowing capacity between ourselves, Prologis, and those 2 entities at their current ratings is over $11 billion today. And then we would have capacity -- we, Prologis, would have capacity to sell-down in our funds as well. Our longer-term targets are to own somewhere between 15% and 20% of our open-ended funds. So you throw that into the next, we would have financial capacity today of over $13 billion. So we've got real significant liquidity north of $4 billion target every day. We've got significant financial capacity, call it, $13 billion. And we also keep the runway clear on maturities. We've got no consolidated maturities until 2022, and that's a very attractive euro bond that's sitting out there. So we've got a clear runway. And the financings that I see down the road in the next 2 to 3 years based on our current environment, we've got refinancing opportunity to lock in lower rates longer based on what I see over the next 2 to 3 years. So I feel great about how we're positioned for the balance sheet, and we're prepared for opportunity should we see it.

Excellent. Balance sheet in good shape, company in good shape. So with that, we have hit our time limit here. I appreciate you coming on. And I think we've covered a lot of great topical items here. So I hope you have a great day. We appreciate the time, Tom. It's good seeing you.

All right. Thanks, Jeremy. Thanks, everybody, for your time, and stay safe.