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

Hi, everyone. Thanks for joining us. I'm Caitlin Burrows, and I cover REITs at Goldman. I'm happy to introduce Tom Olinger from Prologis. He's the CFO. I have a list of questions for Tom. But I think for you in the audience, you do have the ability to submit questions of your own. So to the extent that you have any, feel free to do that, and I'll see if I can work them in. But thanks, again, Tom, for joining us.

And if we want to just jump right in, I guess, at your Investor Day, almost exactly a year ago, you discussed transforming Prologis from a traditional landlord model to a customer-centric business. Can you just talk about what that transformation looks like and the progress so far?

Yes. Good afternoon, Caitlin. Good afternoon, everybody. Thanks for giving us your time today. Yes. We've spent a lot of time, I would simply put, trying to digitize our customer experience. And while the COVID environment has accelerated that digitization, and it's everything from how our customers can search for availability in our portfolio, digital tours, a resource center -- a digital resource center for our customers, digital leasing and even we're working on what we're calling smart building technologies so to fully enable all the technological firepower that our customers need when they come into one of our buildings. So we're spending a lot of time and effort around that today. Our IT spend the last year or 2 has been averaging in the $85 million to $90 million range. So we're putting a lot of effort and resources behind this, and we think it's going to clearly pay off. And it's ultimately, I think, being able to digitize our customers' experiences, coupled with our scale, we think that gives us a really unique opportunity to create a moat around our business with our customers. And I think it ultimately gets back to really utilizing our scale. So if we can digitize our experience and then help them unlock the advantages of our scale. And from a perspective, we've got almost 1 billion square feet today. And our data opportunity is really what happens in that almost 1 billion square feet every day. So we think we did a study with Oxford Economics at 2.5% of the world's GDP happens in our warehouses every day. And there is a clear amount of -- that's a massive amount of economic activity that's happening. So how can we create value from that? The first one is just driving better decision-making for ourselves and with our customers. So using our volume, our data sets, our analytics, our customer interactions to make better revenue decision, how to optimize the revenue better, and we're spending -- we're probably in year 3 now of our revenue optimization efforts and then also using that data to create ways to help our customers. I'll give you an example. We were quoting sensors on dock doors, for example. And it was initially just done so we can better understand maintenance requirements and get in front of that and save on the CapEx running dock doors. We happen to be the largest dock door buyer, end user in the world, just given our footprint. And we have a large -- one of the world's largest trucking companies as a customer of ours. They are -- they told us they spend more money in dwell time than they do in paying us rent every year. And dwell time is one of their driver sitting in a vehicle. It's idling. They're not moving, but it counts against their drive time. And because a lot of times they come up to warehouse and they have to wait to -- for their beta open up. They have to wait for the goods that they're -- on their trucks. They might be in the right bay, but the goods aren't ready. So we started working with them as a way to use these sensors, as a way to begin to optimize, tie into the inventory management system of the customer inside the warehouse, tie into traffic data. So we're in the very infancies of doing that. But we think with our footprint, we can really create opportunities to help our customers solve problems. And then the other way would just be around procurement -- procuring better. We have a goal of saving $150 million annually in procurement costs between construction costs, CapEx costs. We're in year 2 of a 3-year initiative to drive $250 million. We're going to get close to $150 million this year. I think we're going to be just short, but we're ahead of schedule. And we'll be at $150 million or north of $150 million next year. And then the other thing would be how can we capitalize on the scale and open up the scale of our portfolio to our customers and then share in those savings. And we believe our $1 billion square foot portfolio is the largest forklift buyer in the world, the largest racking buyer in the world. We know we're the largest LED buyer in the world. And we are working with the largest vendors, the leading providers in all of these different verticals and negotiating what we think are our most favored nation purchase agreements. So these are the lowest prices that these vendors offer, and we'll share those savings with our customers. So our goal there is to also generate $150 million of revenue annually over the next 3 years. We are behind that plan. COVID set us back a little bit because our initial plan was to a lot of in-person meetings around that, which obviously couldn't happen. However, the blessing in disguise is the digitization efforts that we're doing. To offer these services and setup a digitized way to do that, I think, is going to be really beneficial going forward. So I feel better about the opportunity to hit that $150 million. We're a bit behind, but I think we're going to make up some ground.

Got it. And maybe talking about some other themes of the Investor Day that was a year ago. You also established a core FFO growth target of 8% to 9% annually. Can you just go through some of the components of that growth outlook? And how you were just mentioning how the pandemic impacted some of your other goals. How the pandemic might have impacted that growth outlook?

Yes. So I feel -- the punchline is, I feel better about that. I felt good about it a year ago. I feel better about the 8% or 9% growth today. And it largely gets back to the structural drivers we're seeing in our -- in the supply chain. And it's around the fact that the continued growth of e-commerce and our customers carrying more inventory. We think rent growth -- our rent growth outlook today is higher today than it was last November because of those fundamental drivers. If you look at our growth, we think we can generate consistent same-store growth of, call it, 3.5% to 4.5% over this 3-year period. That took a step back in 2020 because of occupancy and a little bit of bad debt. I think that reaccelerates into 2021 going forward. So while that's been a little -- same store, it's been a little slower in 2020, we were able to make up though -- that shortfall in earnings with higher strategic capital fees and lower interest expense. So we're going to see core earnings growth this year in the 13% to 14% range for 2020. And then as I look out for the next several years, I feel very good about being able to hit that 8% or 9%. So there -- the core driver of our earnings is going to be that same-store growth. Today, the -- our leases on average today are over 12% under rented. And that 12% delta between market rents today and our in-place rents is over $450 million of incremental NOI that we will capture just based on where rents are today. And as I mentioned earlier, we feel really good about rent growth reaccelerating. And I think it's going to run -- the growth rate will be higher going forward than it was pre-COVID. We obviously have our Strategic Capital business that is a high ROE, high-return business. We can scale that business up significantly. And the incremental revenues dropped to the bottom line. We've got a land bank that can build over $13 billion of development. And that land bank is, I would say, materially -- the value of that's materially below market. So I think we're going to continue to see elevated development margins going forward that contribute to our growth. So the bottom line is, I think, while same-store took a step back in 2020, it's going to reaccelerate going forward. And essentials creating value beyond the real estate is going to start to kick in, in the outer years. And so I feel very good about that 8% to 9% growth.

Maybe just a question from the audience -- the virtual audience here that I had that's a follow-up to that growth rate. So I'm going to look over here as I kind of read the question. But -- so as, Tom, the growth rate in the business has been nothing short of extraordinary and it sounds like it's set to continue. Yet, at some point, in theory, we'll hit a point where e-commerce driven space demand in the U.S. has been met with enough supply. Have you and your team quantified how much space is needed to meet e-commerce demand today? And maybe I'll add on. I know people talk about supply as a risk, but how do you, as a follow-up to that, think of supply as a risk to meeting those growth drivers?

Yes. Great question. There's a lot there. So I'll try to remember all of it. One thing I should say is that, that 8% to 9% growth, I think that also translates into cash flow growth at an equal level and also in the dividend growth from the same level. We're going to generate free cash flow in 2020 of over $1.1 billion of free cash flow after dividends. And I think that base is going to grow consistently with our underlying core revenue growth. As it gets to forward and really supply, it's timely. We came out with our second automation report -- research report today. And it gets into the heart of the question. I think part of it is with all the e-commerce acceleration that we saw in COVID, how much of that future demand was brought forward into 2020. And while certainly, we saw a significant -- I mean, obvious significant growth in e-commerce levels, the supply chain hasn't grown nearly in lockstep with what the e-commerce sales have grown, meaning that our customers are struggling to keep up with current demand levels. So supply chain is way behind. The supply chain was behind where it needed to be from being optimized going into COVID. It's meaningfully behind. The vast majority of our customers would describe their supply chains as under stress. And it's about to get worse in the next 1.5 weeks to see the ultimate peak. So the bottom line is we think that we'll continue to see incremental demand from e-commerce. In the U.S., we think that could be another 100 million square feet of demand a year going forward for the next 5 years. We think our customers are going to carry 5% to 10% more inventory to be more resilient and to protect against stock-outs like they saw on COVID. That's what they're telling us. That could be another roughly 60 million to 100 million square feet of annual growth over each of the next 5 years. And then just simple core consumption growth, if you think about the GDP growth in the U.S. growing 1.5% to 2% a year, that's another roughly 100 million to 150 million square feet of space. So we think that we could be in a position where we could see 125 million to 150 million square foot shortfall of space over the next 5 years. So I think it's actually going to get tighter going forward than we've seen already today. And I know that surprises a lot of people because as the person asking the question pointed out, our growth has been exceptionally strong. We've been resilient. But this -- I think you got to follow the supply chain here and the supply chain is way behind. And our customers need to make investments to catch up and to optimize where it is today, and then we're going to grow from here. So I feel -- I don't worry about supply in our markets long term. I just -- yes, could we see a hiccup here or there? For sure. But we're in these markets because land is scarce. That's why we've been here for 30 years because we're in these heavy population centers. And if land becomes available, it's most likely going to go to a higher and better use like residential versus logistics. And that's great for us because, yes, it's harder to get that next piece of land. But we've got 1 billion square feet of this stuff where you're going to be able to push rents and really grow your cash flows.

Got it. In the research report that you published earlier this year and you also kind of mentioned it before, but Prologis has mentioned that 2.5% of the world's GDP flows through Prologis properties. So you also have the largest portfolio compared to industrial REIT peers. Could you just go through some of the ways that you think Prologis' scale differentiates you from your peers?

Yes. I think one starts from -- from a customer standpoint, we are -- with a few exceptions, if you look at our top 25 or our top 50 customers, we're the largest landlord for the vast majority of those customers. So we've got mind share with those customers. We're able to peer in them, work with them, look at what their plans are for the next 1, 3, 5 years. And one advantages of having a portfolio of our size that our customers really like is they get their estimates wrong sometimes on what they need in each market size wise. And when you have a portfolio of our size and the customer wants to take more space in L.A. and take less space in D.C., right, we've got a big enough portfolio. We've got enough puzzle pieces where we can help move things around and make it an economic win-win for us and those other customers. The smaller portfolios, you just can't do that because you don't have the pieces to move around. So that's something that's really valued by our customers. So I think there's one just from a customer relationship standpoint in being a preferred provider and being able to serve them across 19 countries in the world. We cover -- our country set covers -- our markets cover roughly 70% of the world's GDP. So we can be in the vast majority of the places where our customers need us to be to serve them, and that's a real advantage. I think having all of that data and our scale allows us to optimize revenues. We just have a bigger footprint, and we have a bigger data set of what's going on. And we lease, on average, 650,000 square feet a day, just given our size. And that's a lot of data. And we can connect a lot of dots because our portfolios -- it's not just what happens in L.A. It's also what's happening in Cologne, Germany because these markets start to act like -- DHL is going to be in both of those markets, and they're going to make decisions similarly. So we're able to really see how the supply chain is moving, how our customers are thinking and build that knowledge into what we buy and what we build as well. And then the other thing is just creating value beyond the real estate using that scale, that moat that we have around our portfolio that we think we can create revenues and cost savings because an asset's in our portfolio. So you might have an asset that's owned right next door and obviously, it's going to generate similar cash flows to ours. We think we'll outperform it because of our scale. We know that in our markets where we have concentrations of 20 assets or more within a 5-mile radius, we outperform the submarket by 100 to 200 basis points a year on rent change on rollover. We see that. So we know we outperformed that asset. And now if that asset's in our portfolio as well, not only do we outperform, can we crank up its revenue optimization? We can also start to sell services to these customers. And you have to have scale to do that. So if you own 50 million square feet or 100 million square feet, yes, that's a lot of space, but that's not enough space to give you a scale advantage. So we think the scale advantage with creating value beyond the real estate is another moat that we can build and defend and really create meaningful revenues going forward and a real differentiator. So when that real estates in our ecosystem, it has a much higher value and generates higher cash flows.

Got it. And so there's obviously a lot of pieces to the Prologis story. Which pieces of the Prologis story do you feel like are underappreciated by the market?

I think the question from the audience, I think, kind of hits to the point where it really gets the maturation of the supply chain and the assumption that the supply chain that -- it can handle what's in front of it today. And we've had all this demand that was pulled forward. And I would just -- I think what's refreshing about this -- your investors that are at this conference this week is, it's more diversified. It's not just real estate specific. It's looking across sectors. And I would just encourage folks to talk to their -- the analysts that cover consumer products or 3PLs of transportation and really understand where the supply chain is from their customers -- the 3PLs and the consumer company's perspective because I think you're going to find that the supply chain is really behind. And there is significant runway on supply chain optimization. And then you throw on top of that, carrying more inventories. So I feel better about our long-term growth prospects today than I did pre-COVID because of what we're seeing in the supply chain and what our customers need to do going forward. So I think that's #1. I think #2 is, I think it's more difficult for investors to understand quality differences of logistics real estate, and it really comes down to location and functionality. I mean you can all go out and find the best -- you know the best office in each city, office buildings. You probably know the best hotels. It's harder to do with logistics. I think logistics gets painted with a pretty broad brush. But I would tell you the bottom line. It all comes down to how much revenue those buildings -- those logistics buildings can generate. And that will tell you what's the rent growth, what's the mark-to-market on those leases inside those buildings, and that's what really is the differentiator. And I would tell you to look at our core earnings growth over the last 1, 2, 3, 5 years. Our CAGR growth is going to be north of 500 basis points or higher a year than our competitive set. And the base reason for that is the underlying quality and location of our portfolio. We're located in and around major consumption zones where the supply chain is trying to go. It's all about speed. The only way to speed up goods to get to your doorstep is to move those goods closer to where they're being consumed. They're closer to your doorstep, and we're in that path. And that we've got a portfolio that -- I know people -- it's hard to believe with logistics that can't be replicated, but we've got a portfolio that just cannot be replicated. It's taken us 30 years to build this. And the proofs in the pudding. It's all about cash flow.

I guess, when we're talking about the growth rate of Prologis, one of the important components of that is on the development side. And it seems like developers caused speculative development earlier in 2020 due to economic uncertainty. But like you've gone through, demand is really strong. So would you say that this development pause is now over? And how you -- how is Prologis thinking about your development as you go into 2021?

Yes. I think in Q4, it does feel like demand and development activity is, sort of, I would say, pretty close to pre-COVID levels, at least what it feels like in Q4. And I'll point to data for that as well. So we track all of our proposal activity in Salesforce. And our proposal activity -- this was through the first half of Q4, through November 15 of Q4, our proposal activity was running about 8% -- a little over 8% ahead of 2019 levels. And our leasing activity was -- signings was 18% ahead of 2019 levels. 2019 is a tough comp, right. Very good demand year. So looking at proposals being 8% higher, that tells you that there's a pipeline of demand that's out there. And that's what gave us confidence to take up our starts guidance meaningfully in Q4. And the proposals are one of our best forward indicators of demand. So it feels like that level is -- our proposals is sustainable, and I think that's going to take us into '21. And I think we're going to see good levels of development activity. Our land bank today can build about $13 billion of development. And that land bank really reflects -- it's extremely well located. It's in these core markets, these infill markets, where our customers need to be. And I think we're going to see elevated levels of margins going forward because of what I think are going to happen with rents -- rent growth. And what's going to happen with the land values are going up, and our land bank is extremely well positioned. The other thing I would say is we spent a lot of time, over the last 5 years, finding infill sites in these markets. And the vast majority of the time, that's not land. It's some sort of a site that's got an existing building on it. It might be a truck terminal. It might be a surface lot. And we've acquired a lot of those assets over the years, and that's -- those assets are not sitting in our land bank because there's some sort of a fee stream being driven off of them. And I think there's another $3 billion-plus of redevelopment opportunities taking those sites and modernizing them and densifying them into modern logistics. So I feel really good about our development capabilities on our land bank.

Got it. Maybe moving on to one of the other differentiators of you versus other industrial peers is on the Strategic Capital side. Can you just discuss the strategic capital program and how it differentiates you versus peers? And how you're thinking about this business line as we go into 2021?

Yes. So one of the real benefits of the Strategic Capital business is it allows us to operate globally in a very effective way from an FX management standpoint. So we're a U.S. REIT. And obviously, we've got to send out our taxable cash flows out the door in the forms of dividends. So regardless of where we're earning those cash flows, we're in 14 different currencies today. We've got to bring it all back to dollars and get it out the door via a dividend. So Strategic Capital allows us a format to raise capital outside the U.S. to help us match our non-dollar assets with non-dollar liabilities. So what we try to do is hold most of our assets outside the U.S. in ventures or funds. So we're bringing in that third-party equity that's in euro, sterling, yen and being able to match it up because the other way we could do it, we could raise U.S. dollar equity or debt and repatriate it into those countries, but we're taking FX risk, right? You're taking a spot risk at the time you do it. We don't want to expose ourselves to that -- those FX movements. So there's a real structural advantage to -- of the Strategic Capital business from an FX management standpoint. However, putting that aside, it's an extremely profitable business. It's an extremely scalable business. We've been able to add AUM into that business. And with very little incremental G&A over the last 5 years, I think we have substantial room to add more AUM with minimal, if any, incremental G&As. So I think all of those incremental fees are going to drop to the bottom line. So that's obviously a massive ROE return on that business, and it just gives us another avenue to raise capital, right? There's the public markets that we, Prologis, can access and then we have this whole network of third-party equity. So we're able to have a lot of different arrows to shoot when it comes to raising capital for expansion or acquisition opportunities today, between our balance sheet on Prologis and our 2 open-ended funds, both 1 in the U.S. and 1 in Europe. We have $13 billion of debt capacity between ourselves and those 2 entities. So we've got -- it gives us a lot of firepower, a lot of maneuverability for -- to see opportunities and to follow-up on opportunity. So it's a win-win. It gives us a structural advantage to mitigate risk around FX. It gives us a hugely profitable business that's immensely scalable and it gives us access to capital to grow our business when we see opportunities.

I guess thinking about that capital that you have raised, I guess, to what extent do you have the capacity to put that money to work or does it feel like you're being limited by the speed at which you can develop?

Yes, it's a good question. I do -- right now, we've got -- we have investment queues. So our -- we have 2 big open-ended funds. One is in the U.S. One is in Europe. Both of them are about $15 billion of assets. Both of them are A- rated entities. Both of them have leverage of, call it, 20%. And they both have equity queues of about $1 billion. So we try to manage the queues to where we can put that money out within 12 to 18 months. That's what we tell investors. And if we can't put that money to work in 6 quarters, they're allowed to exit the line. No questions asked, if they want to. So we don't try to have an overhang out there. We're going to be patient. We know the types of assets we want to buy. They need to be in the right location. More importantly, they have to generate the right long-term growth. We're not interested in just going out and acquiring AUM. We're only going to do it if it improves the bottom line, right? We're plenty big for scale, which we talked about, to do everything we want around the customer, around operating efficiently and about having the lowest cost of capital of any REIT out there. But we're only going to grow, if it drives value to the bottom line. So we're forthright with our investors in the private capital side, and we'll put the money to work as soon as we see the right opportunities to do it. And if we can't do it, you can take your money back or stay in line. It's your choice.

Maybe switching topics a little. One topic for 2020 has been the idea of de-urbanization. So I guess do you have a view on whether this is happening? And in any case, if there was some de-urbanization, what impact do you think there would be to Prologis?

It's a good question. The bottom line is, it's clearly happening. I think most of what we see is, at least, in our markets, it's people living that were in the city center who are now going to the burbs or cheaper local within the metroplex. Now there are certainly people who are going to lower cost areas, in more remote areas. But the bottom line, we're not changing our investment thesis. We think we want to get as close to the endpoint of consumption as possible. So we still believe in developing and serving these metroplexes. And while we don't expect to see a major migration out of these areas, yes, we might see out of the city center into the burbs. We think the vast majority of people will stay in there. And net-net, any decline in consumption that we might see from an exit is we think is going to be more than made up by the cyclical and structural changes -- I should say, the structural changes that are happening around the supply chain and the need for speed as all of our customers try to optimize their space. And the reality is the mindset -- if you think about us, as consumers, we like things next day is how we've kind of been conditioned. The vast majority of our customers' network cannot consistently or efficiently do next-day delivery. They just can't. So the whole network needs to optimize to get to that. And then Amazon or someone else is going to set a new bar whether it's same-day for certain things. And I think that kind of gets back to the heart of the initial question around where the supply chain is. The supply chain is far from where it wants to consistently operate.

Maybe in terms of some industrial real estate demand drivers, do you think that the increased activity from e-commerce that we've seen in 2020 was a pull forward of demand or incremental demand? And maybe said differently, do you think the strength of 2020 could actually be a headwind for 2021 or not?

Clearly, there is some demand was brought forward, no doubt about it, in 2020. But I don't think we're going to see, I guess, the echo of that or a slowdown in '21 as a result because it goes back to -- we certainly saw increased requirements, but the supply chain is so far behind where it needs to be to handle the existing load that I don't see any hiccups going forward in where that demand slows down next year. I would expect occupancy to improve next year. I expect rent growth to improve next year. I expect development activity to improve next year just based on what we're seeing. So I do think you could see, as Hamid mentioned on our third quarter earnings call, we could certainly see e-commerce sales as a percent of overall consumption drop a bit as folks get out and spend money on experiences versus things. But I think the long-term structural growth -- slope of that growth is going to continue. So I don't expect there to be any noticeable slowdown in demand going forward. And again, I'll go back to what we think from about a rent growth perspective. We feel better about our long-term rent growth today than we did last November at our Investor Day. I feel better about our earnings. I feel better about rent growth, if all gets back to these structural drivers of what's happening to the supply chain.

Got it. Another 2020 theme for industrial REITs has been about the potential conversion of retail space to industrial space. How widespread do you think this trend will be? And how would it impact you guys?

The bottom line is, I mean, there's certainly -- it's getting, I think, a disproportionate amount of press and articles. But we don't see it as a significant driver of supply. It's not a lot of shadow supply that's sitting there in our markets. We did a research piece on this probably 2 months ago, 2.5 months ago that if folks are interested, we can certainly get it in your hands. It's on our website under our Research tab. But the bottom line is we think retail conversions in our markets could add 1% incremental supply annually over the next 10 years. And again, in our markets where if these sites do become available, typically, they're going to have a higher and better use around residential. That is typically what we see in our markets. Just given their geographic makeup, you don't have these big sprawling regional malls, right, that you have in less land constrained areas because in these high metroplexes you just don't have that type of retail. You have more multistory retail. It's going to happen. We're certainly participating in it. We're seeing more opportunities around single retail tenant sites. Think about the big box type of user that might have an 8-acre site and the buildings jammed on one end. It kind of looks like a warehouse, lot of surface parking, good ingress, egress. That's the type of thing we're chasing where it makes sense. But there's 2 things. One is just the economics is there are a high and better use of that space in our markets. And typically, it's going to go to residential because residential land values are 2, 3, 4x higher in value than logistics land. And then you have the overlay of the municipalities of what do they want? Generally, logistics is going to have the lowest tax base against residential, office, retail, hospitality. And we bring the most traffic. So there are 2 strikes against us relative to municipalities, right. Particularly with COVID, municipalities are under financial strain. They're going to look for the highest and best use of these sites. And the economics point you in a different direction.

Got it. Well, we've hit our 35-minute time mark already. So Tom, I want to say thanks to you keep us on schedule, and thanks to our virtual audience for joining us. Thanks, everyone. Have a good rest of the day. Bye.

Yes. Thank you. Happy Holidays.