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

Thank you, everyone, for joining our next panel at our Life After COVID conference here at Morgan Stanley. My name is Vikram Malhotra. I'm one of the REIT analysts in the U.S., and amongst other sectors, I cover industrial. We're very excited to have Prologis with us today to talk about life after COVID and what the industrial landscape may hold. And specifically, we have Gary Anderson, the COO of Prologis, who's been there many years and held many -- worn many different hats, a lot of experience in all parts of the business. And we're very excited to have you. Thank you so much, Gary, for joining us today.

Vikram, great to be here. Thanks for the invitation, and I'm looking forward to our conversation. I also look forward to the time that we can see each other live and in person, but we'll do that another day.

Definitely. Definitely. Before I begin, let me just read some quick disclosures. So please note that this webcast is for Morgan Stanley clients and appropriate Morgan Stanley employees only. The webcast is not for members of the press. And if you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website. And if you have any questions, please reach out to your Morgan Stanley sales rep. And I should mention at the start, we'd love to make this somewhat of a virtual dialogue with our clients and listeners on the webcast. So if you do have questions as you hear comments, feel free to type them in the browser or you can e-mail them to me at my first name dot last name @morganstanley.com. I like to always start out by introducing Prologis as the logistics firm -- or the largest logistics firm in the globe that has almost a 2.5% of global GDP flowing through its warehouses every year. And so it sees a lot of different data points. It has a lot of different perspectives and can certainly look at things from a forward perspective because it has a lot of leading indicators. So with that, as I mentioned, I'm very excited to have Gary on.

Let me start sort of at a very high level, something that Prologis has been talking about and maybe transforming itself, essentially making a big pivot to being more customer-centric. Can you talk to us about what that means?

Yes. It's a big topic for us, and it's a topic we've really spent the last couple of years on, customer centricity, and it's core and central, I think, to all that we do. And I think what it really means for us is showing up differently. I think it means being more than a great real estate company. You've sort of described us as a real estate company. I think we are a great real estate company, but I think that means creating value beyond the real estate, first, for our customers and ultimately and, ultimately, for shareholders. And if you think about the way that the landlord and tenant relationship works in our sector, it's pretty simple, I guess. It starts and ends with a lease negotiation typically, right? That lease negotiation typically ends up with a 5-year lease-up market. And then landlord and tenant forget about one another for about 4.5 years. And then near the -- near lease expiration, they start talking once again simply about that lease. And what we're trying to do is completely change that process. And we've spent really the last year reshaping our field organization to that end. So Vikram, we've gone from what I would describe as a sort of highly skilled but siloed group of professionals in our field organization focused individually on things like leasing and construction and property management and maintenance, and we have been working to convert them into an army of customer experience teams. And the job of those customer experience teams is really to intimately understand our customers' businesses, their pain points and then bring Prologis resources to bear on solving those pain points. And in the end, what we're trying to do really is create a significantly better customer experience, simplify their lives, solve their pain points and create stickiness with those customers so they come back to us over and over and over again, not only for great real estate but also for these incremental products and services that we're providing them.

And what's the opportunity in the sense of services and strategies? Can you describe that in a bit more detail? And has that shifted in a post-COVID world?

Yes. So look, the real opportunity, if you take it from the biggest -- from a big-picture standpoint is to build a moat. That's what we're trying to do. We're trying to build a very wide and very deep moat around the entirety of our business that, our competitive set, few you could replicate. You said it best. I mean we're already at scale today, and we're at critical mass. We've got $140 billion in assets, an A-rated balance sheet, 1 billion square foot in real estate now and, as you said, 2.5% of the world's GDP going through that platform. But for the first time, in my 26-year history at the company, we are actually starting to take advantage of that scale. And we're using it not only to our advantage but to the customer's advantage. So in its simplest terms, what we started to do is we started to think about why are we only thinking about the $6 per square foot that our customers spend on rent, right? That $6 per square foot represents about 4.5% of their total supply chain costs. So when you start thinking about that, why don't we think about helping them with the balance of their $126 per square foot spend. So -- and that's exactly what we started to do. So Vikram, we started with kind of those things that are closest to the real estate, right, closest to logistics real estate. So we started procuring racking and forklifts and material handling systems. We've got moving services, janitorial and pest control. All of those things are pretty simple to do. And now what we're doing is we are moving up the chain to sort of those more complex solutions that will greater resonate with our larger customers: automation, labor solutions, transportation solutions, data and IoT. And if you remember a year ago, we were at our Investor Forum in November. And we laid out a public statement that we're going to generate, call it, $150 million in procurement savings, $150 million in sort of essentials revenues over the next few years, so $300 million. And what I would tell you is that we are ahead on procurement, which makes sense. It's within our [ gift of control ]. We're a little bit behind on essentials. But I would tell you that everything is trending in the right direction. And I am more convicted now about this business than I ever have been. Because if we do this correctly, we can both delight our customers and squeeze more incremental revenue out of every square foot of logistics real estate than anybody on the planet and obviously can create competitive advantage -- sustainable competitive advantage. So that's what we're up to. That's what we're trying to do. And I don't think many will follow because it takes scale, for one, to do this. It takes a balance sheet to invest in innovation, and then it takes this -- the wherewithal to bring this innovation to life, and we're doing all those things. So I think we're on our way to building that moat.

That makes sense. And it's certainly interesting that you can so-called expand the pie by offering these services and become even more entrenched with your customers by offering these extra services. But you touched upon kind of a relevant factor: real estate is only 5% of the supply chain in terms of cost. There's a whole set of other costs on labor and logistics. Can you talk about maybe other parts the supply chain that you think will change in a post-COVID world? And how may it change?

So when you say other parts of the supply chain, you mean locationally? So for example, e-commerce penetration has accelerated. It's driven this accelerated demand, certainly pre COVID, and that demand is continuing post COVID. But if you're really talking about change, where that change is going to happen, where that innovation is going to happen, I think it's going to happen in the urban core. That's where it's happening today. Companies are experimenting with primarily last-mile and Last Touch delivery models that are trying to figure out how to meet that new demand. And there are hundreds of these models that are being tested right now. So for me, with respect to that Last Touch and that last mile, it's hard to say which of those models are going to ultimately be successful. What is clear to me and what's clear to us is that we need to continue to focus on the consumption end of the supply chain, right? The consumption end of the supply chain doesn't move, and we're focused on sort of those high population density centers with high disposable income. And we've been doing that for a decade now, as you know, so it sort of reshaped our platform, and we continue to focus there. So no meaningful strategic change from that standpoint, but maybe some change around the margins in terms of where we're making our investments and how we're making those.

Yes. And just to -- maybe just to be clear and expand. We -- obviously, you focus on real estate. You've now started getting more in entrenched with the customer. But I guess what I was also trying to get a sense of is, how could -- maybe the labor side or the transportation side, other parts of the supply chain, how could they change in a way that maybe creates more room for you to charge rent, for example?

Yes. So again, at 4.5% of the total supply chain cost, $6 is nothing, right? So as you move closer to the customer, the interplay is always on sort of those 3 categories that you mentioned. It's labor transportation. It's inventory cost and inventory carry, and then it's the $6 in rent. And those dynamics are always in place. So look, I think that there's a whole host of things longer term in the transportation sector that will come to bear on this industry. And again, transportation is probably 45% of total supply chain costs. So we're working on things around how do you move things in drop lots. How do you move things within the bounds of our own facilities? The other thing that's obviously happening is EV and automation, right? With EV, you can move things quietly. So you can move them at night, right, even in densely populated locations. With automation, you can move things further. So there are definitely going to be some locational impacts with respect to those changes with transportation. But the net of it is, and we're already seeing it today, the growth in rents in urban core, right, our Last Touch or our last-mile facilities, is growing at a much faster rate than anywhere else. And that's because the trade-off is happening in our favor with respect to rent taking a higher percentage of total logistics costs in the urban core. The labor -- look, labor is a huge problem. I mean -- so we have customer advisory board meetings every year and most quarters -- twice a year, actually, with the largest customers on the planet. And their first, second and third priority is labor. So if you're not familiar with what we're doing, we have put together something called the Community Workforce Initiative. And the realization that we had is that when we make an investment -- a building investment, in any community, we're making a 50-year commitment. We're going to own that building for 50 years. We're a long-term holder. And that's a much longer commitment than a customer makes for a 5-year lease arrangement, right? So we've realized that it's incumbent upon us to begin to solve this labor problem. Otherwise, the building will certainly lose value. So we've set up this Community Workforce Initiative. We're working with communities and nonprofits. And our intent is to train 20,000 people in those markets to be a qualified logistics workforce, 25,000 by 2025. So that's one thing that we're doing. I guess the other thing that we're doing is we've created a partnership with a group called WorkStep, and this is one of our venture company investments. And that company basically matches qualified long-term talent -- logistics talent to our customers. And the reality is there's a lot of work to be done here because the ecosystem that has to be built for talent includes sort of full-time staffing, which is what WorkStep does. It also has to include part-time and seasonal staffing, which WorkStep doesn't do today. So all of that needs to be -- it's sort of that we're working on. It's a huge opportunity because, again, labor represents about 35% of total supply chain costs. So if you converted it to dollars per square foot relative to our fixed [ spots ], it's $42 a foot. So there's a huge opportunity there for us to help customers solve those pain points. So that's where we're headed.

That definitely makes sense. And I remember reading, I think, it was XPO or one of the other 3PLs talking about it wasn't necessarily the supply of real estate that caused them to expand or not expand in a market. Sometimes, it's just difficulty in finding labor and their view on finding labor in the next 12 months. So labor is definitely a key issue like you hit upon. Maybe just to expand a little bit on these additional services that go around the lease and the asset itself, can you maybe quantify a little bit about the revenue opportunity? But can you talk more specifically about how you measure the return of these investments and how you may measure them over time in terms of either IRRs or return on investment? How do you see kind of the revenue impact and eventually that translating into returns?

Well, again, I mean, we view -- as we've said, over a 3-year period or so, we expect to generate this $300 million that we talked about. So today, I would tell you that we're not kind of underwriting real estate any differently than we did before. And I don't think that will change. I think we'll always have sort of that fundamental, basic, standard and stringent underwriting for the real estate component. But what we are doing now, and I think this is what you were getting at, is we're beginning to collect data where we can actually forecast incremental revenues based on that next square foot of real estate leased, right? So we've just completed an exercise with our field teams and our core sort of centralized essentials teams in building a business plan for 2021 for essentials, and it was a ground-up plan. And it's kind of as you were describing. We based it on vacancies, on lease expirations, schedules, on our customer segmentation data. And we've kind of started to build a forecast just like we do our real estate forecast in conjunction with our forecast -- in conjunction with our real estate teams. So look, it's still early days there. The data is still coming in. We're still building that business and getting smart about it. We've got a 25-year history in forecasting -- or a 30-year history in forecasting real estate. We've got a 24-month history in forecasting this other stuff, so it's going to take us a little bit of time. But I do think, ultimately, we'll be thinking about it as you were describing. We'll clearly be able to project incremental revenues on a per square foot basis. We will clearly look at building-level or unit-level IRRs, incremental IRRs or incremental margin, however you want to think about it, but we're not there yet. But we will get...

That's good then. That makes sense.

I'm highly convinced that we will get there. We're already starting to budget and forecast that way.