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

Good morning. This is Jamie Feldman, the senior office and industrial analyst and Bank of America's U.S. REIT team. I'm joined today by Elvis Rodriguez and [ Nicole Fang ] on our team. And we want to welcome you to this Bank of America Global Real Estate Conference Virtual Roundtable Discussion with Senior Management from Prologis. Prologis is the largest global operator of industrial warehouse space with operations in the Americas, Europe and Asia. Joining us today from Prologis is Tom Olinger, Chief Financial Officer. We have a large global audience joining us today. So management will spend the first 5 to 10 minutes of our discussion providing an introduction of the company and update on operating conditions. We'll then move on to Q&A. We hope to make this an interactive discussion, so please add your questions on the Veracast platform so we can weave them into the conversation. I'll now turn the call over to Tom to get us started.

Thanks, Jamie. Hi, everybody. First off, I hope everyone is healthy and safe. I thought I'd start with just a few key differentiators versus the other logistics REITs and blue-chip peers. And it starts with our dividend growth and our earnings growth and what that has been over the last several years. If you look at our current year earnings growth projection based on our current guidance, 1, 3, 5 year CAGRs, we are leading the pack across the board and both from a core FFO and dividend standpoint. So we're really proud about the growth that we've delivered. It's quite differentiated, and we're excited and confident that, that differentiation can and will continue. And I think it starts with our in-place-to-market. Today, our in-place-to-market gap between in-place leases and current market rents is 13% roughly. And that's about $450 million of incremental NOI. So as those leases roll, that NOI drops to the bottom line. We've got a land bank that can build out over $13 billion of development. The land is located in critical way points of the supply chain. And we think that land and the underlying buildings that we can produce out of that land are going to be in high demand. From a balance sheet perspective, we continue to maintain significant liquidity. That's always been a goal of ours. We strive to have at least $4 billion of liquidity on hand every day between cash and line capacity. We are well above that. We closed the quarter at $4.6 billion at the end of Q2. We're well above $5 billion as we speak. From an investment and leverage capacity standpoint, all that growth that we've delivered, that sector-leading growth was all the while, we've continued to delever the balance sheet. So we have significant financial investment capacity at our current rating. And between Prologis at our current rating and our open-ended funds or 2 large open-ended funds in the U.S. and in Europe, there are also A minus rated entities. We have over $13 billion of investment in leverage capacity sitting on our balance sheet today. So quite a lot of firepower to support future growth and investment. And we continue to look for ways to capitalize on our scale. We've got a portfolio now that's approaching 1 billion square feet. And we're looking at ways to continue to capitalize and utilize that scale to, number one, help us make better decisions and also help our customers. So we're excited about that. Turning to an update of real-time metrics, what we're seeing on the ground today, I'd point out 2 things. The first would be leasing proposals. Quarter-to-date are just under 57 million square feet of proposals. That's about 13% below the quarter-to-date period last year, 2019 on a size-adjusted basis, but I would point out that September of 2019 was an exceptionally high proposal month for us last year. So this is more about a tough comp in September. In September last year, our proposals were running almost 2x our normal levels. So I think it's more about a comp than it is about underlying activity. So lease proposal activity, if you look at it from a normalized basis, what we saw over 2019, it's actually fairly comparable. From a leasing activity standpoint, we're up quite a bit, over 26% higher. So leasing volume has actually been exceptionally good. And we still see lease gestation period, which is -- how long it takes for us to close a lease, go from an opportunity to a lease is down significantly to 43 days, that's quite low. Retentions in the mid-70% range, around 76%, and it remains in line with historical levels. From a rent collection standpoint, our collection since COVID began are running ahead of 2019 pace. So starting in March through September, we are in all months running ahead of 2019 pace. So really happy to see that. And the trouble spots that we see collection wise globally would really be focused on the U.K. and in Southern Europe, really France. And I think that's more to do with the governmental policies around rent payment. And to a lesser extent, in California, we see it at spotty places in L.A. and the Bay Area a bit. From a rent deferral standpoint, rent deferrals remain quite low at about 55 basis points of AGR and deferral payments are becoming -- starting to become due and they're coming in, in line with our monthly rent collections. So we're quite pleased with that. And deferrals, just from a concentration standpoint, we see the deferrals concentrated in apparel, sporting goods and auto segments. And about 2/3 of the deferrals are in spaces under 250,000 feet. So that's where we're seeing it. And then lastly, I would just close by saying the supply chain post-COVID has gone, I would say, at another level of transition speed, and it's transitioning now from resilience -- to resilience from efficiency. So the old model was trying to drive efficiencies through the system. Now it's trying to produce resiliency. So think about it from moving from just-in-time to just-in-case. And the near-term effects are playing out differently across customer segments, as you might imagine. But we are certainly overweight -- our portfolio is overweight to the growing and essential beneficiaries of the COVID environment. And the big drivers that we see going forward are going to be twofold. One would be higher inventories as customers, again, try to drive for resiliency versus efficiency and then faster e-commerce adoption. We've all seen what's happened in the last 6 months relative to the acceleration that's happened with e-commerce. And those are going to -- those 2 factors are going to drive significant demand going forward for the next several years. And the supply chain going in to COVID was certainly not at a level adequate to serve the vast majority of our customers' needs relative to e-commerce. And there's just a lot of work to be done. And now with carrying higher inventories and further e-commerce adoption. That puts our customers and the supply chains further behind where they needed to be. And as all this unfolds, location and quality are going to matter more than ever because service times is what's critical, and that plays right into our portfolio being in and adjacent to the largest consumption zones in the world. So with that, Jamie, I will turn it over to you and your audience for any questions you might have.

Great. Thanks, Tom. And just a reminder, if people do have questions, please submit them through the Veracast website, and we will weave them into the discussions. So I guess just to take a step back, I mean, the top question I get on Prologis is stock has done well. Clearly, a strong outperformer through the pandemic. What's to come that will position the company to just continue to either have accelerating lease demand or market rents start to grow, resume their growth again. Just as you think about the next 6 months for this company, how do you think it's going to look versus the last 6 months?

I think what you're going to see is even further stabilization. I mean starting in the COVID, it was very clear that you had -- it was a barbell of the portfolio of customers who were thriving and the customers who were struggling to adjust. What we're seeing is, we've got very few customer segments that are on the downside of the COVID environment. So as we look at -- so you think about hospitality, those serving the airline industry, those serving the restaurants event planning. If you put all of those together for us, all of those different customer segments and that COVID watch list, that customer segment represents about 1.7% of our portfolio. So it's quite small. So we're seeing the -- the substantial majority of our portfolio adjusting to the COVID environment and really reinvesting in their supply chain. So I would suspect that what we're going to see over the next 6 months is a further layout of what we're seeing now, further development, and that is customers continuing to expand their warehouse footprint and get it closer to the end consumer to meet demand. And we put research out. I think everybody clearly understands e-commerce and that adoption and what that means. The other thing we're seeing this focus on resiliency, we your customers discuss that their inability to carry inventory through the COVID period in the supply chain disruptions, 2 things. One is they clearly missed. They didn't have that good in stock that we all wanted. They missed the sale. They missed the margin on that sale. And the other aspect is there's an acquisition cost of potentially having to reacquire you as a customer because if they don't have a good, you go to another website, procure the good. What is it going to take them? And what's it going to cost our customers to get you back to their website? And so as customers look at those economics, the economics clearly point to carrying more inventory. Number one, our warehouse rent is -- you've heard us say this is typically less than 5% of the total supply chain costs. And when you look at the rent, our rent as a percent of the total and product costs or the sales price, we think we're somewhere in the 0.25% to 0.5%, so 0.25% to 0.5%, 25 to 50 basis points of the underlying costs. So our costs are quite small. And you also think about the cheap cost of debt and capital today, the carrying cost of inventory is quite minimal. So our customers -- we're starting to see signs of them carrying more inventory. I can think of a handful of leases already that I've seen now, and I don't see a lot of leases necessarily that were specifically for customers carrying more inventory. So I think we're going to see the further build-out, the rapid build-out of the supply chain. And I think you're going to start to see rent growth. We're starting to see that in spots now, getting back on the resumption, resuming in the prior curve. And I think all that's going to take hold. Collections are certainly been a positive and better than, quite frankly, I would have expected. So I think that's going to continue. And when we emerge to the new normal. And I think that's going to be when we get a vaccine or therapeutics that -- that's when we ramp back up to our old rent growth curve and then some. I think our view is, today, that our rent growth pre-COVID versus post-COVID, our post-COVID view on rent growth is slightly higher longer than it is pre-COVID, and that gets back to the carrying more inventory in the e-commerce adoption.

Okay. So I mean, we did see kind of a spike in leasing volumes, surprisingly, saw a spike in leasing volumes when COVID began. You think leasing over the next 6 months or so could actually be better than that?

Well, I would look at our leasing right now. Our leasing is running, as I mentioned in my opening remarks, about 26% above. If we looked at just quarter-to-date for Q3, we're running 26% above on a size adjusted basis, so adjusted for Liberty and IPT acquisition. So leasing has been quite strong. And so the spike we saw in March and early April, that was a spike and then it died down in late in April and May and then picked back up again in June. I think leasing is going to continue to be pretty good, continue to be good because, again, our customers need to react to continuing to further accelerate the build-out of the supply chain. So I think that's what's taking hold, and that's going to drive more leasing activity, and I think you'll continue to see development activity pick up as well to help meet that demand. So, yes, I would expect -- the spike again, we had a massive spike in March and April. I don't expect to see that level in that 6-week time frame. But I certainly think the leasing volumes we're seeing now, I don't think those are -- I think those are pretty sustainable.

Okay. And then in terms of market rents, you'd mentioned you're starting to see a pickup in some markets. Can you talk about which markets? And do you think that's going to spread to more over time? What magnitude are we talking about of growth?

Well, yes. I think on -- if we looked at, call it -- I think it's better to go back and talk about when we said we -- at the end of Q2 that we're going to see rents be flat in the second half of the year. I think that's playing out, although I think there's a slight arrow up from that perspective. Because I think what you -- I would guess we're seeing rents holding or increasing in 2/3 to 3/4 of our markets. And then there's a small -- 1/3 to 1/4 of the markets where rents are slipping a bit. And then the slipping is really coming in the form of concessions, more free rent versus headline rents are holding. It's just someone might need another month of free rent on a 5-year lease to get something done. And so I think where we're seeing rents slip a bit in that 1/3 to 1/4 of the markets. I think it's to the tune of, call it, 1% to 1.5-ish percent in that range. And then we're starting to see markets that are -- that held up extremely well through COVID, where we're seeing rents up in the low to mid-single digits. And markets like Houston, yes, we're definitely seeing lower rents in Houston because they're getting the triple whammy of COVID. They went into COVID with high levels of supply and then you have the oil complex price drop, which obviously significantly impacts that market. So I think we're going to see rents hold in the vast majority of our markets and start to approach their prior curve, but I think approaching the prior curve is going to be dependent on getting to the new normal. And I think that, again, gets back to whenever we see therapeutics or vaccines take hold and people can resume more normalcy, I would say.

Okay. We've got -- there are some questions that have come in. I guess sticking with rents, given your retention rate of 76%, how aggressive do you think Prologis can be pushing rents right now?

Well, it depends by market, and it depends on what we see in our proprietary data. So I think we're going into this quarter, we were, I would say, very balanced on balancing occupancy and rent growth, probably with a tilt towards a bias or a slant towards occupancy. I think that's starting to change in certain markets. And without getting into specifics, I think, again, it's market by market, where we see our proprietary data, where we see our leasing pipelines and our proposals and stack that up with what's in the market. And with our data analytics, we can make a decision about pushing rents versus holding for occupancy. So it's a market-by-market decision. I would say right now, there's -- we continue to probably tilt a bit towards occupancy overall, but that is -- I think it's starting to change.

Okay. And then another question and key topic. Prologis released a report on retail conversions last night. Can you just talk about the firm's view on the risk from that? And what you think it means the supply picture?

Yes. Good question. So yes, I would encourage you all to take a look at that, if you can. It's, I think, another excellent piece out of our research team. The bottom line is, when we -- the way we cut it and when you look at the retail that sits in our markets across the globe, so whether that's malls, power centers, stand-alone retail, we think about -- there's 4 things you got to think about, economics. There's political, there's physical and legal. And from an economic standpoint, how does the pricing work? And typically, in our infill markets for these larger sites, there's certainly an economic valuation towards residential, for sure, today or office with a biotech slant to it. So we continue to see where the economics typically don't work for these larger parcels and looking at our history, we've certainly seen that. And then there's just the legal aspects of what do the leases allow you to do. But I think the biggest ones are economical and political. And from a political standpoint, in these more infill markets, do the municipalities want the transition? Do they -- are they willing to accept the new economics? You've got all the nimbi activity that can happen. So the bottom line is, we think that the -- when we -- and you could see the math that our research team does, but we think that the inventory that can happen that can come from redeveloping retail in all the various formats, could be about 3% of annual completions over the next decade. So just not a meaningful amount. We think it could average around 8 million square feet a year, when we look at all the different conversion possibilities. So it's certainly taking hold. It's going to happen. It's probably -- it will take time, but it is a rather de minimis amount of activity now. You could also cut that and look at where it's going to happen in our markets. It's going to be certainly more infill. It's going to be more last touch. And if you look at the stock as a percent of just the last tuck -- the last touch category, it's probably more like 5% of that supply for that category. So again, it's going to happen. We see it starting to take hold and certainly accelerate in the COVID environment. But again, any way we cut it, it's a rather de minimis amount of further supply.

And how active do you think Prologis will be in some of these conversions?

I think we're going to be very active. I mean, we've certainly been watching the space and working in this space. We've done a handful of, I would say, single site, single-tenant type of sites. That's where we've seen the most success sites that might have ideally 8 to 10 acres. You've got -- excuse me, a single building on-site where you don't have all the issues around co-tenancy clauses and the like, and you're able to go in there and work for the municipality and get the right zoning on it. So we've seen that. It's not easy, but we've seen that. I think we'll be very active, and we'll be in the middle of this, where it makes economic sense. We've certainly got a deep footprint in these markets, and we've got scale, and we'll look to leverage that scale in this environment as well.

Have you -- do you have direct relationships with mall owners that might bring you in across markets?

Yes. I mean, we certainly have -- we know these folks, they know us, just given our position and our size and our scale in these markets. If something is going on, we get the phone call. So yes, we're in the middle of it. And I would suspect, again, the economics have to work. And I am confident that we see -- people are calling us if there's anything going on. I think people would be -- they certainly want us involved, again, just given our expertise and our size and our capabilities.

And have you seen any tenants desire the closed anchor, kind of the one-off closed anchor in an existing mall that's actually -- the rest of it's alive, prefer that to a stand-alone?

We haven't seen that yet. I think, again, it's going to get back to what the tenant -- what our customers are going to try to do with the space. Typically, where we've been successful, even with these the stand-alone retail sites, the keys are getting -- you have ingress egress to the site, right? Can you get -- because these sites need high-band counts, high truck counts. So you need excellent ingress egress. You need ample dock doors to get loading and unloading happening. And you typically need a lot of surface area for a van parking and truck parking and staging. I think those are the critical aspects now. If somebody is trying to use a site for more click and pick up sites, that gets a little different. But no, we haven't seen customers try to go after a traditional anchor space and convert that to at least the type of uses they're trying to use our buildings for.

Okay. Another question coming in. Can you just talk about -- or can you quantify how either Prologis' global scale with 1 billion square feet of space and even the technology that you guys have implemented in recent years. Are you able to talk at all about the latest impact on same-store growth or just on how that flows through to the bottom line in terms of margins?

Yes. One thing that we track closely, and I think we do this first by market or submarket, where we have concentrations of assets in a particular market, and we look at where we have 20 or more assets in a 5-mile radius. That scale is a threshold that we measure and we look at. Our history tells us when we have that level of scale, so 20 or more properties in the 5-mile radius, then we generate from a rent change on roll perspective, we outperformed that submarket by 100 to 200 basis points of rent change on rollover. So we outperform on higher rents in that particular submarket. That's something we track. And we've consistently been able to achieve. We saw that with DCT. I think we're going to see -- I think we're seeing the same thing with the Liberty and the IPT portfolios as well that, that concentration and that reach allows us to drive outperformance just with that data. And I think -- I actually think that, that level of outperformance is going to accelerate, just given the incremental analytics that we now have and the -- also the ability that it's not -- it's the linking submarkets around the world that act the same -- have the same attributes. And you've got global customers who are active in those markets. So I think that's a little tough to quantify across markets, but it's definitely a benefit. But again, I'd go back to saying we outperformed by 100 to 200 basis points on rent change on roll in those submarkets, and we're continuing to add scale in these markets. So when you look at where we're developing, where we're acquiring, we're going deeper and deeper in these markets. So there's very few markets where we do not have that concentration today.

Okay.

I'm sorry, Jamie, I'll give you one quick example going back to DCT, although that seems like a while ago now, but DCT, even given their size, they had no markets or submarkets where they had more than 20 assets in a 5-mile radius. But we brought every one of their assets that we kept came into a cluster into one of those concentrations. So it tells you what we're able to do just with the scale and concentration to drive outperformance.

Okay. Great color. Another top question we get is just you have this very attractive cost of capital. You have a lot of capital. But how can you really put it to work in scale? And you had mentioned in the last question, DCT, Liberty, IPT, I mean some big portfolio deals you guys got done. How should people think about the ability to continue to use that cost of capital to really drive growth and scale?

Well, number one, would be looking at our land bank. Our land bank can develop over $13 billion of new development. And I think that also -- that's just our land bank today, but that doesn't pick up would be our redevelopment opportunities in what we would call our covered land plays that we have out there. That's -- that opportunity is another incremental, well north of $2 billion of that development. So we've got significant development capacity that sits on our balance sheet today, and we have the ability to self-fund that and we continue to self-fund that. And this leverage capacity that we have this investment capacity have, I am confident over time that we'll have the opportunity to deploy that. I think I'll go back to my beginning comments and saying, we've delivered, by far the best core earnings and dividend growth across our sector and across the blue chips, no matter how you want to slice it over the last 5 years, and we did that while building up a significant liquidity and investment capacity and deleveraging. So when are we going to use it? Well, we'll use it when we find opportunities that can create and enhance our long-term value. Our job is to create long-term value and wealth for our investors. And we will -- if we see opportunities to enhance our growth long term, we'll do it. Portfolios happen, number one, meet our location and quality slice, number one, we're not going to bend our long-term view because we know these locations are what's going to drive outperformance over the long-term and long-term growth that we want to achieve. And the second thing would be, it's got to be at a price that makes sense for us long term, again, that we're creating value. So hard to say when opportunities arise. But again, I know we get the question and I think embedded in your question is, well, yes, we're big. We're 1 billion square feet. How do we continue to grow? Well, we've grown significantly over the last 5 years. And if you go back to our Investor Day of last November, we talked about being able to drive core earnings growth between 8% and 9% a year. And I think our portfolio is set up to do that. And so I think just with our core portfolio in our core businesses that we can drive significant growth. And then if we see opportunities to deploy capital, incremental to our normal deployment activities, then we have all the firepower we need to take care of that. So I am confident we're going to continue to outperform and our competitive set with growth and then to extent opportunities present themselves that click the quality and the growth objectives, we're ready to roll.