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

Great. Welcome, everyone, to Citi's 2021 Virtual Global Property Conference. I'm Michael Bilerman. I'm here with Manny Korchman from Citi Research. We're extraordinarily pleased to have with us Prologis and CEO, Hamid Moghadam. This session is for investment clients only. If media or other individuals are on the line, please disconnect now. Disclosures are up on the webcast. For those joining us live on the webcast, you can interact with us by typing in questions into the question box, and they're going to come directly to Manny and me, and we'll do our best to weave that into our conversation today. Hamid, I'm going to turn it over to you just to introduce Tom and if you can answer the following question. Coming out of the pandemic, if an investor were to choose only one real estate stock to own, what are the 3 reasons why they should invest in Prologis?

Okay. Great. Well, I think all of you know, Tom. He's been our able CFO for more than a decade. And I think, Michael, fundamentally, the reason people should be interested in us is that we have a really great business. And by that, I mean, we are in a sector that has very good supply and demand dynamics and some real tailwinds for its growth. We have a significant embedded growth in our rents. And we have customer relationships that enable us to do a lot more monetizing those relationships than just leasing them 4 walls and a roof.

I see you're wearing -- is that an AMB logo on your sleeve?

This is a 10-year merger sweatshirt that has the old AMB, the old Prologis and the new Prologis logos, all in one.

So if you look back, is this 10 years? Is that literally closed 10 years ago?

We closed -- we announced the deal in -- at the end of January of 2011 and closed it in June. So we're right in the middle of that window.

And so as you reflect on those 10 years, what you expected this combination to be versus what it's turned out to be, how would you sort of look back on that?

It's -- we had high expectations for it, but it's turned out better than my expectations. Frankly, I was nervous about delivering on the synergies on the cost and revenue side initially. The old AMB had not done a lot of M&A, have done no corporate M&A. So it was a new game for us. And we got a lot of confidence after delivering way more than we promised on that. But that was the easy work, really getting the 2 cultures to work was a challenge. I think, by and large, we're very successful in that. But our sector was just coming off a 10-year -- awful 10-year period where some really bad decisions by some really big companies had created a perception that industrial real estate would never perform. And of course, having spent the majority of my career in this, I knew that, that was an exception, not the rule. That was actually the only period where industrial real estate underperformed and we were shouting that from the rooftops. But of course, until you start putting up the numbers, people don't believe it. The e-commerce thing ended up being a huge tailwind, bigger than I thought. We were on to the e-commerce thing from the late '90s. You remember, the web band fiasco and all that, which drive us a very important lesson, but got us out of the retail business and solely focused on industrial. But the pace at which those opportunities emerged exceeded our expectations. But it wasn't all e-commerce. The rest of the business was very solid. Supply in the markets that matter were very disciplined because it's just tough to get land and entitlements and all that. And then we had these additional tailwinds that really helped the business. And I think the companies became more disciplined as a result of the near-death experience of the '08, '09 period. And then we get into the pandemic and a lot of the factors that were in place just got intensified and accelerated as a result of COVID. So that ticked it into a whole another level. So looking back at it, it's been a wonderful run. But I honestly, just like I tell people in the company, I think our best years are actually ahead of us, not behind us.

And as you think, you reported earnings is almost 2 months ago. It's hard to believe, even though we had some companies last week still reporting. Can you just give us an update on the demand side and what you're seeing from customers? And if there's been any change over the past 2 months since earnings that give you even more optimism or confidence on the demand side of the equation?

Yes. Our leasing volumes, proposals, visits, all those metrics are significantly higher than the first 2 months of last year, which were also prepandemic. And albeit last year was unusually low in the first 2 months of the year, I mean, the first 2 months are usually low, but last year was even lower than normal. This year, it's really off the chart. So we're very encouraged by the results. Both in terms of volume of industrial space absorption and also our ability to push rents. So we've been -- I would say that comment applies a lot to the U.S., but also to some extent, Europe. Japan is extremely strong, the strongest it's ever been. Latin America is on fire literally. I mean, it's just super strong. Don't ask me why. I mean I -- because they're so behind in e-commerce, I think, and that's really coming on strong. So I think in a few spots around the world, I mean, maybe Houston, maybe Madrid, maybe Western China, I mean, those are the only places that I would say, somewhat soft. Everywhere else, we're knocking to cover off the ball.

And that's just increased demand overall and just higher utilization as well in the existing assets?

I think it's 3 things at best that I can tell. I think a lot of customers have realized that this e-commerce bank is not going to go away. It's serious, and they need to play defense, and they're playing the catch-up game to the leaders in that business. And all of a sudden, we're getting a lot of requests for space from other retailers, e-commerce players, third-party logistics providers across the sector, pretty much in everything other than obviously the obvious travel, hospitality sectors and the like. So a lot of people are playing catch up. That's been really important. And then the entitlement picture is just becoming nearly impossible. I mean the ability to bring on product and develop land in markets that we want to be in, it's just super, super difficult. And I think all of us in the business have learned a lot from this and are bringing our businesses better. So I would say those were the main reasons.

As I look behind you in that virtual background, multi-storey, what city are we looking at?

Tokyo -- well, suburban Tokyo.

Just suburban Tokyo. How big of an opportunity is that in terms of multi-storey in meeting exactly what you're talking about, right? The entitlement for a single storey only gets you so far. But if you're able to build bigger, does that solve the equation?

The answer is it does, but it costs more to build vertically and land values have to be high enough to justify it. So I think it all depends on the rents. I mean, I think the rents in most markets in the U.S. don't justify it. We don't have a multi-storey strategy. We have a strategy, and sometimes the manifestation of that strategy is building multi-storey building and sometimes a single-story building. And sometimes, you start with the single-storey building and you tear it down and build a multi-storey building. We've done that, too, or you start with something else and you convert it to multi-storey. So I think it will be a while before multi-storey becomes the norm in the U.S. and maybe in Europe. But certainly, in Asia, that's the name of the game. And I expect it to spread more and more to places as land values become higher and higher.

As a global owner, you have tremendous perspectives, right, because you're able to glean trends that are happening in different parts of the world. What are you -- which I think informed last year early on, given Asia what was happening and probably gave you a lot more confidence early on in how you adjusted in the U.S. Flipping around now, what are you seeing in maybe certain regions that provides you either even more optimism? Or if there was any cautionary things that you're seeing?

Well, let me start with the cautionary thing. So I think everybody now wants to be in the industrial sector. And while the fundamentals of supply and demand are good, who am I to say, but I think people are doing some crazy things in terms of pricing this real estate. It's just the way that the money is frankly too much. And it's not going to produce really good returns if people just pile in regardless of the yields and all that. That's probably contrary to what a CEO should say, but I do see sort of some disciplined issues creeping in. Fortunately, it's not translating into new supply of product because usually in the old cycles, land would get developed, and we would have overbuilding. But now it's so hard to develop land in the right markets, that the money is just going into existing buildings and lower yields and all that. But on the positive side, the fundamentals are great. I mean the fundamentals of the business in terms of -- we had all the traditional drivers of demand. And on top of that, we have, obviously, e-commerce, where we picked up 6, 7 points of share over a period of a year. We picked up 5, 6 years of a share increase in one year. That's really been a big help, tailwinds. And also, I think this issue of resilience and supply chains. People across the system are finding that they need to carry more inventories. When they're all -- these ships backed up at [ L.A ]., that means somebody is not getting the product that they want. So the only way they can mitigate that in a world that's fully surprises is to carry more inventory. I think they just pushed it too much on the efficiency prime. And supply chains were sized to perfection, and the world is not perfect. So people are realizing that the incremental cost of carrying a little bit more inventory is nothing in comparison to the cost of losing those sales. So I think across the system, people are going to carry more inventory. And if they carry 5%, 10% more inventory across the system, that would be the equivalent of 5 or 6 years of incremental demand on the product. That's all going to happen soon. So I think demand is shifting to a higher level generally and is keeping pace, but it's not exceeding.

So Hamid, if I tie a couple of things together that we just talked about, one, the entitlement issues and how hard it is to create that supply, two, the need for that supply and that's typically been in new markets, so am I wrong to draw the conclusion that some of that supply is going to have to go to the secondary markets? And that it's actually going to be safer to build in some of these secondary markets because that's where this redundant or backup inventory is going to go?

Yes. Let me first answer a question you didn't ask, which is related, which is that we don't have a dog in this fight, we're the largest owner of industrial real estate, whether it's the Eastern seaboard, the Western seaboard, the Middle seaboard, whatever. So we -- they're all our children, and we all love them, okay? So let's start with that. But having said that, inventory cannot just be at any place because there is industrial real estate. So one mitigating strategy would be to do what you're doing. So put the inventory 3 days away, that's not going to happen in this world where people wonder things the next day or immediately, and they wanted in 26 different colors and 5,000 different SKUs. So the fact that SKUs are going up, the fact that delivery time expectations are going down is bringing inventory actually closer to where the populations are not farther away. So the only thing that can adjust is rent, which means that industrial rents that were previously thought of as commodity, you can only charge as much as the person next to you is willing to give their space away at is all of a sudden turning to a point where price elasticity is great for the right real estate with the right delivery timetables and the right demographics around it. People are willing to pay a heck of a lot more than what they can lease space 3 miles down the street because what they're doing, you're competing with what was previously thought of as a retail location because you're looking for the same attributes. You're looking at the attributes, so how quickly can you get the product to the customers. And there is only so many of those locations to develop. So I think prices are going up. And what we're realizing is that the customers happily pay it if they don't have an alternative because the whole rental picture is only 3%, maybe 4% of total supply chain costs. So if they can save in transportation, if they can save in delivery time, paying double or triple rent is not an issue at all. Now they won't pay it if they have alternatives, but they'll pay it if they don't have alternatives. Otherwise, they're going to lose share. So that's a dynamic I'm seeing more than [indiscernible]. Good locations are becoming more and more valuable. And commodity locations are writing the normal inflationary trend.

So somebody in the in [ TV land ] here is asking, are you accelerating dispositions to take advantage of people doing crazy things?

We are not accelerating dispositions for this reason. First of all, I don't think this is a temporary phenomenon. I think the way that the money is so great, and we see it from all these directions that I think this will continue for a long time. Secondly, we're only 20% levered. So if we sell something and get liquid, and the money is sitting in the bank, not earning anything, instead of earning the 5%, 6%, we can earn on it doing something else. If 6 months or a year goes by, we've lost all that advantage. So really, what we're trying to do is match fund, the disposition proceeds with our needs to develop our land bank. And -- but I think the best thing to do is to look at the record that we've achieved in terms of selling assets from KTR, from DCT, from IPT, from LPT. I can tell you the stuff that we've sold on LPT to date, we've exceeded our underwriting by 18%. So we're doing just fine with the pace of dispositions and exceeding our objectives without really diluting ourselves, which is the strategy. And that's why we're not more levered. If you think about -- I remember, the asset sales from KTR were predominantly to delever, right? It was a choice of the cost of that capital, and you made the strategic decision. I'm not going to dilute shareholders by raising cheap equity. I'm going to -- I have confidence in the values, I'm going to sell assets. Now arguably selling anything over the last 10 years probably wasn't a good thing because the values are much higher today even if you sold something. But our [ stock ] is worth a lot more today, too, and we will issue more of that. Right. And -- but I don't want to go back to the KTR thing. It was more so -- post a deleveraging exercise, this is the normal trading of assets. How do you -- when you bring something to market as the largest owner, I would see my buyers like, they know much more than I do, right? It just creates a little bit of conflict of how do you maximize price in that scenario given how strategic and important you are within the industry. Yes, so let's -- first of all, let me just square at something on KTR. We did not sell a single asset that we didn't really thought was strategic to our business. It just happened that there were some nonstrategic assets that helped with the balance sheet, but we also did some private ventures that also help with the balance sheet and a bunch of other things. But to answer your question, look, I think we're pretty active, and we know a lot about what's going on, but we don't have exclusive license to all knowledge in the world. And the calculus is not, "Oh, my God, let me sell this to somebody else for 10% more because I can go invest it for 10% better over here. And I'm so smart, I can do that really quickly." It's $150-plus billion company. We can't do that. I mean that wouldn't do anything. You wouldn't even see the numbers. But that's kind of like -- that may work in a really small company, which is very opportunistically turning things over. But it doesn't work like this in our company. In our company, things that move the needle across the platform, really move the needle. And that's why we're focused on so many portfolio-wide initiatives, some of which that have to do with leveraging scale and technology and all that with the real estate, and some of it is to bring other products and services to the table that meets the needs of our customers, makes them stickier in terms of doing business with us. Those are the things that really, at the end of the day, are going to make money for [indiscernible]. I think we're pretty good real estate people, but I think our scale enables us to do other things on top of real estate that are really exciting too.

If you think about just taking the technology front, right, we have a SPAC boom where there's 8,000 SPACs announced today, exaggeration. But is there an opportunity for you, just given the platform that you have, to make some strategic maybe ideas on that front? And is that being evaluated at all?

Well, we're looking at strategic ideas all the time. And -- but really, the ideas are what scarce. Capital is not what's scarce. And how to best capitalize those ideas, which we're doing every day, is a choice between balance sheet or doing a SPAC or doing a private vehicle or whatever. But -- so that's more of a corporate finance issue as opposed to a business issue. So our attitude is pretty simple. I think we are only interested in things that help our customers or help us run our business. We're not going to go into the biotech business or something like that. By the way, we may redevelop some of our buildings into biotech buildings and pick up a big margin. But we're not going to stay in that business. And by the way, we've done that before. So we're sticking to logistics real estate, but there are a whole lot of products and services around this. Whether it's labor, whether it's energy, whether it's products and services that are used in the warehouse, that over time, we can grow those businesses. And if they become material, we can always spin them out to the shareholders or do something different with us. But I think a lot of people start with the corporate finance thing is -- with the money part as opposed to building the business for it, and we start with building the business part. And if it's successful, there will be a zillion different ways to capitalize it and maybe SPACs are the strategy [ du jour ]. And maybe 3 years from now, when we're ready to do that, there's some other better strategy. So I don't know but there is not a day that goes on, that I don't get a call from one of your colleagues trying to get me to do multiple SPACs actually. So it's not because we [indiscernible], it's just that we rather build a business and then figure out how to finance.

Hamid, if we take the other side of that disposition question, and I appreciate your commentary on the company's size and sort of impact to those deals. If you think about the customer element and sort of the market share element and all those other positives you just spoke about, wouldn't then that sort of pretend not doing any dispositions because losing that customer relationship is probably a lot more expensive than whatever benefit you gain from selling the asset, notwithstanding how frothy the market is?

So the customer relationships are actually one of the input parameters to the decision of what we consider nonstrategic, okay? So customer relationships are really important, but there are some customer relationships that are a lot more important because of their scale and scope and all that. So it's a factor in our consideration. It's not the only factor in our consideration. Look, if it's in a market or in a product variety that we are not particularly good at running, we're not doing that customer any service in that building by holding on to that real estate because it's not our thing. So it's either in the wrong market or it's not the right kind of product for our holdings. It's not bad real estate. I mean a lot of this stuff, people put on their brochures after they buy it from us because it's good real estate. It's just not our kind of real estate.

Hamid, maybe you can go through the whole -- the third point you brought up, the relationships and the clients and driving additional income above and beyond just the lease that you have with the customers. Where are you now with the net evolution? And how should we think about the benefits that may provide over the next 12 to 24 months?

Great question. So there are 2 aspects to this. One is they're actually all bundled under one effort. And the unifying theme is leveraging scale to do things better, okay? The 2 big components are customers -- excuse me, procurement and what we call Prologis Essentials. So procurement is how we develop buildings, how we buy components, how we do all that kind of stuff, including stuff that goes to the Essentials business. That business, we're done. We've achieved the original objectives that we laid out, which is about $150 million a year of savings. That's already done. It's not a revenue line. It's a cost saving line. So it shows up in development margins and all kinds of other things over time. But we have a way of capturing it and a way of measuring it, and we've done that. And we're 99% of the way through our objectives on that, the incremental opportunities will be introducing more product categories through our procurement function, okay? So that one's done. The Essentials business is a business of selling products and services to our customers that they need to operate in our warehouses, okay? Let's -- we started with the stuff that was really adjacent to our business. For example, installation of LEDs. We are installing LED lighting in our buildings during the term of the lease. And the customers are happy to pay additional rent for it, and we procured that LED lighting at 1/3 of what we used to before, 1/3. Because we -- instead of bidding them market by market, we brought the entire scale to it. By the way, we are doing -- we've been asked to do this. We haven't done it yet, to do it in our competitors' buildings by the same clients that that lease rates from us and them because we can do it so much cheaper. So that's a really basic idea, and then it goes to racking systems and forklifts and maintenance services and all that cleaning services, post-COVID cleaning services and leveraging that scale to buy that. And it goes all the way to labor solutions. You know about our Community Workforce Initiative, energy solutions, things of that nature. So it's a wide swath that will never end. The product list will continue to expand, and I think we are at the $40 million, $50 million level this year on that. Our original objective was another $150 million coming from that. But I think the current vision is much, much, much bigger than that because as we're scratching the surface, we're getting more and more excited about it.

There's a question, Hamid, that came through on the webcast. Have you seen a significant change in the competitive dynamic for the assets that Blackstone has accumulated? In other words, are you seeing them have a platform/network benefit?

I honestly don't know and rather would not talk about that and talk about our own business. I mean it's -- I don't -- I really don't know.

I guess if we don't want to talk about Blackstone, is the competitive landscape out there for industrial, just given all of that interest, are you seeing that -- like you talked about the crazy prices that people are paying. And so whether they're going to be right or wrong is going to be a few years out, right, in terms of whether they get their money back or where they get the growth, are you seeing anything on the operational side as people are aggregating up more industrial assets from say, a competitive standpoint?

Well, you've got to have the scale and of all the players that I see out there that has a scale if they can leverage it is Blackstone. And they certainly have an operating company and all that kind of stuff. So you would think that they would be best positioned to do this. Whether they're doing it or not, I haven't heard anything from customers, but you should ask them. They would be able to tell you. It's not easy to do. I can tell you that. It is very difficult to do it even in an operating company environment where you have a balance sheet. It's much more difficult to do it in a fund management balance sheet where you actually have to invest balance sheet dollars to benefit third-party investors. So how does the calculus of that work? How do you charge those customers for those services? We don't have to worry about that because we invest the money. Our investors benefit from that, whether they're private or public, even in the private ones, we own the majority or a pretty big stake in those things. So we don't have to worry about that. And you're going to have to ask them how they do it over there. It's tougher to do.

Okay. Sorry, Manny, do you have one?

I do. There's one in the queue here, actually. Just can you provide an update on fundamentals and outlook in Central and Eastern Europe, such as Czech Republic, Romania? And then is that an area of interest for you?

Oh, absolutely. Czech Republic is a great market. Prague is a great market. It's very hard to find land. We have a market-leading position there. We love the Czech Republic. Slovakia, its smaller sister, is not quite as good during the cycle, but it's a good market. It's very auto dependent. So it's been a little hit, but it's coming back very strong. We have a very strong business there. Hungary is usually the stepchild of the 3 big economies in Central and Eastern Europe, but it's been a very robust market. The economy is not as great, but the industrial market has been actually really good. Poland is the one I worry about. Poland is the largest market in Central and Eastern Europe. It has the most demand, but it's like Dallas in the 80s, literally. I mean there's way too many developers, way too many games, free rents, side letters that you don't show to investors, all kinds of games that people play. So it's a it's a tricky market to get an adequate return on capital because there are lots of crazy development that's going on.

Hamid, you have a history of bringing your top customers together. I would assume over the last year, that's been a little bit more challenging to do in fiscal. I guess what -- how have you maintained that leadership role from an industry perspective in a remote environment? And how do you sort of see that evolving?

That's interesting. We're doing it the same way you're doing this conference, and participation has gone up because these are busy people that we bring. And to get on the plane and come to San Francisco and do all that kind of stuff or do it in Europe or do it somewhere else, it's tough for them. But they've been -- the participation rate was good, but it's great now. It's almost perfect because we can do it in 2 or 3 hours. It's not as much fun, and you don't get to spend as my social time getting to know people, but these are people that we know pretty well already. Obviously, we don't want to do it that way forever. But I think we can do it more frequently this way and have more frequent touch points make it easier on these guys. So we're getting a lot of value out of that.

And when -- how is your travel, you were historically on the road a lot?

My travel has -- I've been on one plane, right, since a year ago. Back and forth to Cabo, by the way, where I...

Because you're digging the industrial facility in Cabo?

No, which I can do Zoom calls from there just easily as I can from anywhere else. So I have done 0 business travel over that period of time. And once this thing is over, I really think that my business travel, I'm going to try to cut to maybe 1/3 of what it was before because I think you can get a lot done remotely. Like, if you're meeting somebody or you have an important customer relationship or a new investor or something, obviously, you need to build a relationship. Same with your team. I mean we've hired 300, 400 people during the pandemic over time. So those people have never met any of -- in person. So you need to do some traveling. But I think we were doing an -- we, all of us, including you, doing an insane amount of traveling, and I think there are better ways to leverage technology. And I think this technology is going to get better and better and better. So it's not a total solution, but it's a big quality of life improvement.

Does that you mean your...

Tracy loves hearing that.

I said me, I didn't say about Tracy. I don't know what her answer is actually.

You know what, you can't -- nothing will be property tours when we're tracking around Europe or Asia or the U.S.

You just wait. You just wait to see our new virtual tours. I think you're right, it won't be as much fun, but it will be very productive.

Productive, right, but you need -- it has to find the right balance. I mean look, I love when Manny was out in New Jersey with your team, I thought it was great, right? And it was a way to bring the assets to life without being physically there.

Actually, [indiscernible] through the biggest liquor distribution facility he's ever seen in his life.

There was careful planning on both companies and to decide what we're doing. It worked out well.

Yes. With just a little bit of time left, just we have our rapid-fire and just ESG. And I know ESG has been an important part of the company's history. What are your top 3 priorities over the next year to continue to improve your overall ESG score?

I think our initiatives on energy, which include further expansion of LED and also maintaining or enhancing our position as one of the top 3 producers of rooftop solar in America, not real estate companies. Top 3, Walmart target and us sort of go back and forth in position. So continuing to enhance that. So energy would be one. Labor solutions, our Community Workforce Initiative and doing that because that really, not only serves the needs of our customers, but it also really does something great for our communities, which is that it takes a lot of kids that would otherwise be up to know good and gives them some real-life skills that they can find employment. And the third thing would be our employee initiatives, our own people, enhancing the quality of their lives and how they conduct their work and all that with flexible arrangements. And generally, the employee experience. So those are the 3 priorities. And particularly, the third one after COVID is going to be really in [indiscernible].

Yes. Does the increasing labor costs impact your business? And as part of that community, that training, providing you a labor source that is attractive from a cost perspective?

I don't think we can do it on a big enough scale that it affects the cost of our customers doing business because the need is insatiable. I mean just one customer had to hire 400,000 people this year. So I mean, we can make a big dent, but we can make that big event. We'll sure try. So I don't think we're going to affect the pricing, but I think it's a really good thing because it meets the need. It shows customers that we care. And frankly, it really helps a bunch of young people, which is a good thing to do. So -- and people know we're not carpetbaggers. We're not coming into their community to build a building and give entitlement. Some flip it to somebody and go somewhere else. They know that we're there to invest in the community.

So when we are sitting physically together in Florida a year from today, what will be the one thing that will have surprised people the most about your business over the prior 12 months?

It will be stronger and with a longer tail -- not tail, whatever you call it, future. And there'll be more belief in the strength of the business for longer next year than this year. But if I can get a second one in, I think it will be -- we'll be in a unique situation where interest rates will be higher and cap rates in industrial will be even lower, but I don't say that with pleasure or glee or anything like that, but...

Got it. So what do you think your corporate travel budget overall for the company will be in 2022 as a rough percentage of 2019? I know you said what yours was, but if you thought about the entire organization.

Less than 50%.

Less than -- in '22 versus 2019? Wow. Okay. The hotel companies are not going to like that.

I think we'll have more parties locally.

Yes. Same-store NOI growth for the industrial sector overall in 2022?

With us in it or not in it?

Everything. The whole kit and caboodle. Yes, the entire industry.

[ 3.5 ].

And then the 10-year treasury a year from today, it's $153 million right now.

$250 million to $275 million.

All right. And cap rates for industrial lease that were going lower. So if the average cap rate today, what is a 4%, do you think, 4.25%?

Depends on the market. Not so great markets are 4s, and the really good markets are in the low to mid-3s.

Great. And well, I really appreciate taking the time. It's great to see you.

Nice to see you.

And I can't wait to see you physically in person.

Looking forward to it. Thank you, everybody. Take care.

Thank you, again.

Thank you.