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

Welcome to Global Property CEO Conference. I'm Michael Bilerman. I'm here with Manny Korchman. We are very pleased to have with us, Hamid Moghadam, CEO of Prologis. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available here and on the webcast. [Operator Instructions] Hamid, I'm going to turn it over to you to introduce the management team that's with you and to introduce the company, and then we'll turn it over to some Q&A. Thank you.

Great. It's nice to see all of you in person. I can't tell you how much I was looking forward to this, and I mean that. I think you know everybody. Tom, our CFO for 15 years, who will be retiring shortly; and Tim Arndt, who is going to be our new CFO and Tracy Ward and Jill Sawyer are also over there. So we've got a full team, and I think you know about the company. So let's get into the Q&A.

All right. So the largest global industrial landlord with 3% of the world's GDP going through your portfolio. Do you want me to do the whole shtick or...

You seem to be on a roll. So, yes.

So I mean, what are the top 3 reasons an investor should buy Prologis stock instead of any other listed REIT?

Other than a fabulous management team, I think #1 reason is that we have a tremendous amount of embedded upside based on where rents are in relation to market. And that will ensure a long-term rental -- long-term same-store growth at the level that will propel earnings at an attractive rate. And the second reason is that we're building all these other businesses, including the strategic capital business. But in addition to that, an energy business, solar, our essentials activities that are going to add literally hundreds of millions of dollars of cash flow to the business on top of real estate. And that's something that we can do because by virtue of our scale and reach in terms of procuring those products and services for our customers or creating those revenue streams. And thirdly, I want to highlight our strategic capital business, which is approaching $1 billion of bottom line. And we throw these numbers around, but that's a pretty significant part of the business that I don't think is yet fully valued. And until recently, it wasn't valued at all. So I think there are lots of nuggets in there.

Hamid, maybe talk a little bit about sort of that valuation aspect, and you now are getting multiple components to the story, and they're all growing. Do you think about the structure to which it should be. And I think about how many listed managed entities you have and unlisted entities. Then, does that step back and say, well, the head stock, there's other pieces here that I can either monetize in the public or private worlds if the public market is not giving you the appropriate credit? Or is the standard answer that you've always said, you know what, the market will figure it out over time. And as long as I'm picking up growth, then there's no reason to alter the head stock?

Well, there is a lot of synergy between these different cash flow streams. And really, our ability to keep these customer relationships over long periods of time and supplying with other products and services is a pretty important part, which gets complicated if you end up separating the different pieces. But in terms of complexity of the business and a number of entities, when we completed the merger, AMB Prologis, which is now 11 years ago, we actually had 23 separate vehicles embedded in the company. And today, we have 10. So the business has gotten simpler in a way. And each 1 of those vehicles has become much more significant, like 5x what it used to be 10 years ago. With respect to our service businesses, let's take EV or solar, we are getting customers asking us to go to buildings that they lease from other landlords to provide those services. So long term, our portfolio as big as it is at the 1 billion feet and growing, won't be big enough for the aspirations of some of those businesses because they can be a lot bigger. And there may be a need to create some neutrality by spinning them out. But we don't want to lose the customer synergies in doing that. So we'll always own a big component of them in that sense. So we are planning for it. It's not a valuation question. It's more of a question of how big can those businesses get and how do we make sure we don't limit their business opportunity. But we're setting it up so we can do that. And frankly, at some point, given the scale of these businesses and the limitations of the REIT structure, we have to do it. It's not a matter of whether we want to do it or not.

We get that question a lot about how close are you to that limit today.

We're not close to that limit today because the base of the business is humongous.

Right. And as long as that's growing at the same sort of rate of growth you...

It won't. The other businesses are much faster growing.

When you think about the services business, is there a lot of capital or investments that you're making in types of technologies that -- to think about sort of the return on that? Or is this -- it's -- there is some capital investments involved. Obviously, if you're in the solar business, you have to by the panels. If you're in the EV business, you got to buy the charging stations and procure the power but it's a much higher ROI series of businesses than real estate, which is all about the capital investment and the return you get on that. So I think of the real estate as a core capital investment and then we build these things around it by the virtue of those customer relationships. So the ROI should go up over time with those additions.

Hamid, at some point, you'd had a venture -- sorry, Michael.

No worries. Usually, he's tapping my legs. So that seems a little...

I'll stay away from that. You had a venture sort of piece of the business as well. How much of this is stuff that you're building and thinking about internally? I know you've allocated members of your team, both seasoned vets and also new people to sort of handle stuff like the Essentials business, for example, but how much of it are you buying either other companies or other technologies that help you get there faster?

Well, in the Prologis Ventures business, we are helping a lot of companies that are usually in the tech side of real estate grow by virtue of having access to our customer base. But we also are learning a lot about business opportunities that work within the framework of our customers and those that don't. So it's both an R&D function with some money invested. Now we've invested about $130 million in 35 ventures or so and very attractive valuations. I mean the portfolio is marked based on the next round that 2 plus x, but that doesn't mean anything. I mean frankly, if we make a couple of $100 million of venture investments, it's not nearly as important as if we can move the needle on our core business by 2%, 3%, 4%, 5%. That's literally tens of billions of dollars. So we really look at it at the place as a lab for learning things about our customers' needs and trying different things. I don't know if that answered your question or not.

Maybe spend some time, the global macro environment has become a little bit more challenging. Inflation is rising pretty dramatically. You have oil spiking. Can you step back and just given your globality, how is that affecting your business? What are the conversations you're having with corporates? And is there any pause in overall take-up and rent growth?

We haven't seen any pause since we last reported. And if anything, we're seeing business at a higher level of energy and activity than the end of last year. So the business has just -- even with everything going on -- well, in the last 2 weeks, I can't really tell you there aren't enough data points, but prior to the last 2 weeks, for sure, and it was significant. So I don't I don't think on the margin -- I don't see any deceleration anywhere. We'll see. If this thing goes on or expands and involves other countries or gets really nasty, obviously, it's going to have an impact on the rest of the world. But I would think of that impact in 2 different ways. There is the direct impact. What does it do to demand for space? And the answer is simple. It's going to increase demand for space because any kind of uncertainty, whether it's COVID, whether it's an earthquake somewhere, whether it's fires in California, whether it's weather in Texas. I mean you go around and look at all the disruptions, all it means is that the supply chain is going to get more challenged and more buffer inventory needs to be carried around in different places to meet demand. So in a sort of a sick way, the effect on demand is actually good for us. I don't want to get our demand that way, but it is good for us.

I mean as long as we don't go into a recession.

Okay. So that's the second piece is what's the impact on the macro economy. I'm not an economist, but the -- but we had an economy that was rebounding from COVID that had a lot of momentum, and we poured -- obviously, a lot of monetary policy went into that. Now we've poured a lot of fiscal stimulus on top of that. So the economy was just going full blast and a lot of it was leading to capacity issues that were causing this inflation, including labor and the like. So this thing will for sure take something off of that. But this thing has so much momentum that I don't think this thing is going to stop it unless it ends up being full-blown war in Europe or some kind of a nuclear disaster. I don't know. But unless I'm missing something, I think the economy has a lot of momentum.

What are you seeing in Europe following the start of the war that's happening?

Everybody is really nervous. But I can't tell you -- it hasn't had an effect that we can see in leasing decisions or anything like that because people are just got their head down and they're thinking about where are they going to put the next piece of inventory that's coming around because everywhere is out of space.

Do you have anything in Russia?

No. Prologis did, but we cleaned it up when we did the merger. That was not a fun experience.

Maybe, Michael, I'll just jump in on that on a similar topic, Hamid. Just how are exchange rates impacting -- how may they impact you that they've been swinging wildly as well?

They are not because our 90%, what's the number today?

95%.

95% Of our exposure is in U.S. dollars because we mitigate our currency exposure through the use of funds, mostly funds in non-U.S. dollar-denominated markets and the leverage that is associated with our equity. So our overall leverage is very low, but most of it is actually -- disproportionately, is outside the country for that very reason. We're a U.S. dollar dividend payer, so we need to have everything in U.S. dollars.

And our cash flows are hedged over 3 years out.

Maybe we can spend some time just talking about the overall inflationary environment on construction costs as well as labor costs. I think industrial benefits from being a little simpler construction relative to other property types for some cement and built up 4 walls, put on a roof and you're done, is very quick, but can you talk about how much you're seeing that inflationary pressure and how much you're getting it on the rental side to keep your yields and margins intact?

Okay. So the way I think about it, and it's a data point. So it's not the overall picture, but I think it's a good data point. We have 3 projects, 3 buildings in Oakland at the foot of the Bay Bridge that we built. The first one, 5 years ago; the second one, like 2.5 years ago; and the third one just completed. And I would say -- and they're identical buildings pretty much. The first one, if it costs $100 million, the second one was $120 million and the last one is $160 million. So there's been significant inflation. And that's, by the way, not counting land because the land...

Do you think land had market basically? That was a cost.

And that -- this is just on the construction part of it, not on the whole project.

So 60% over...

5 years.

5 years.

Now that's the Bay Area. There are places that are lower. There are places -- there are not too many places that are higher, but they are places that are lower. So it's been significant. And so what's my takeaway from that? My takeaway is that our 1 billion square feet that we already have is just had somebody put a much higher pricing umbrella on it that we can crank rents because the next piece of space is going to come on at a much higher price. Land has appreciated even more than that because in markets that you want to be, I'm not talking about the markets that are wide open, like, I don't know, Columbus or something. But in L.A. or San Francisco or New Jersey or any of these markets, land has doubled or tripled as well, and it's very hard to get entitlements. So I think there's been a tremendous amount of pressure. The good news is that all of that has led to higher rents. And then together with cap rates dropping, our margins have actually gone up in light of those increases, which is kind of a good situation to be in. So my takeaway with that is big pricing umbrella under which we can crank rents, and we've been able to expand margins. But the most important thing is this, we are now committing to steel and concrete capacity for hundreds of millions of dollars, which are fungible. We don't have to exactly have -- okay, we're buying this side beam. They're fungible capacity. We can go out and do this. We've got the balance sheet to do this, and we can do it not only at substantially lower cost, but we can do it by having certainty of delivery of that material so we can meet customer requirements on new build-to-suits and spec developments. That gives you a huge advantage on your win rate because if you can go to somebody and say, we can deliver the building in 9 months versus somebody that says, "Well, I'm not going to get my steel for 12 months." That's a different ball game. So that's another example on how scale and reach helps us serve our customers and shareholders.

Can you talk about the labor side of inflation, both from the perspective of your tenants which you're battling. And I know you have the workforce training and you're trying to do a lot of programs to help them but also from the employees at Prologis. And overall, how you're dealing with that inflationary cost and return to work and things like that.

Well, return to work, I mean, our policy is pretty simple. You can do -- if your job is one that can be done remotely and not the receptionist can't be remote, but a lot of jobs can be. As long as you have an agreement in place with your boss as to what your deliverables are, you can work from anywhere you want, how many different days you want but you've got to come in for culture meetings and staff meetings, basically, the things that bind the organization together. So we're about the most flexible real estate company that you can have. And by the way, we have to be. We're in the Bay Area, and that's the epicenter of flexibility.

Are you coming to the office every day?

I was coming to the office from June to like a couple of weeks ago, every day and then not many people were. So I went to Kabul for 2 weeks and worked from there, and I've been back to the office since then. So yes.

Got to love that. Just going to take the jet over to Kabul, will be...

No, no. But I was -- I mean if you're going to zoom you might as well zoom from some place nice.

Be somewhere nice.

So no, I've been coming mostly, Tom and Tim are usually there. Tracy's there. Jill is definitely there all the time. So a lot of us are there but a lot of people aren't there. I would say we're 20% in San Francisco. We are the lowest in San Francisco than anywhere in the world pretty much. Japan is almost back. China is back, all that. So flexibility is our policy. We are getting, obviously, wage inflation and by and large, we are on top of it. One area that we have not been on top of it or we were not on top of it until a couple of months ago, was on deployment talent, particularly 4-, 5-year-old deployment talent out of college because people love our deployment people who have been trained well. And they get 3 levels of promotion and a big pay increase and all that. And some of it, we just can't match or don't want to match because we also have other people coming through the pipeline that we can develop. But by and large, we have the ability to pay whatever we want to our people, and we do. Our total -- our total regrettable turnover in the company is 3% a year. Our total turnover is 7% or 8% a year. It's -- it's good and bad. But -- so that -- those are the numbers. With respect to our customers, it's the biggest problem they have. Labor is the biggest problem they have, and that's why we're doing our community workforce initiative. But that's not even going to scratch the surface. I think automation is going to affect it. I think they're stealing with one another -- from one another all the time. I mean there's 40%, 50% turnover in warehouse labor every year.

What -- do you find that that's affecting their take-up of space at all, the fact that they can't find enough people or they have to pay more? Is it impacting at all their ability to pay or their pace of take-up.

Yes, they have to carry more space because they don't know.

They don't know, that answer is always better, right?

No, I'm not saying it's better. It's ultimately anything that reduces profitability of companies and all that is not good. But remember, the recipient of that -- of those dollars are people that are going to be consuming. So it's 1 big happy circle ultimately. But people have to carry more inventory when they don't have reliable labor source that you don't know will show up or not show up.

I think we're going to make a very short list of people in the room that are happy about inflation. We'll put you at the top.

I'm not happy about inflation.

On that topic, we have a question in the live Q&A. What percentage of tenants cost does rent represent? And I remember we talked about this probably 3 or 4 years ago, and that was probably closer to 5% and now you're showing me 3%.

3% to 5% is the number, depending on....

So how has that changed? And I guess is there the ability for it to change. We've always talked about better locations or closer in locations, helping to save on other costs. Is that just a linear function of the 2 or a correlated function of the 2? Or can you actually now squeeze for more of that because transportation is going up so much, can you present a better cost saving scenario?

For sure, one thing that we've discovered that surprised us is that really prime locations that save time the customer is almost insensitive to the price because it affects so many other parameters. But those are really sort of special locations. In a commodity location, you can't do that. So in San Francisco, you can do that in L.A., you can do that. New Jersey, you can do that. Dallas maybe not so much. Houston maybe not so much. So it depends on where you are and within that market, which submarket you're talking about. But on some of the submarkets that you have this kind of pricing power because of proximity to the customer like South San Francisco, take San Francisco, we've tripled rents and people still haven't said ouch, makes us wonder how much money we left on the table over the years. But anyway, we'll find that.

And I guess just thinking to other points of this conversation, inventory levels have been somewhat low because it's been hard to either make source or deliver that inventory rather than a lower desirability for having the inventory. We're not having a consumption issue we're having a production issue. How has that environment or scenario impacted the tenants' either demand for space, planning for space or take-up of space and how does all that look together? Yes, rents have been great. Because the people that want it, want it now and they want to -- they don't care what they pay for it. But if I sit here and say, okay, I've got 1,000 computers in inventory now, I know I want 1,500, but the next container ship only has 700 on it. Why would I lease it, if I can fit 2,000, right? Like they're all sort of moving in different directions.

So a couple of reasons. First of all, you may not have a whole computer. You might have a computer without a keyboard and the keyboard is stuck somewhere. So you've got to store the rest of the computer before you get the keyboard. So part of it is that. But if you look at a macro level, inventory to sales ratios and inventory levels in relation to economy are very low. There is about 10%, 15% below trend line inventories today where we sit. And everybody wants to build inventories to be 10%, 15% more than normal because of resilience that they need to build in the supply chain for future shocks. They've learned that this business of squeezing inventories to the last nickel may be smart in the short term, it kills you in the long term. So I think there's a 25% spread between where inventories are today and where they're going to be. And on top of that, you've got e-commerce that continues to push forward and e-commerce is 3x as much in inventory-intensive as bricks and mortar. So I think inventory levels have to go up. The reason they haven't gone up is because of this part issue that we talked about and lack of space being out there. So I think what's going to happen is that, over time, some of these good locations that are occupied by marginal tenants, that are running marginal businesses, they're going to get priced out of the market and those buildings are going to get occupied by people who have really viable high-growth businesses because you can't bring on more space. I mean they don't make more land in places you want.

And then sticking to e-commerce. Certainly, there's been some pushback from investors that I speak to that worry about the largest user of e-commerce pulling back or seemingly pulling back space. Talk about what's actually going on?

Yes. If you look at Amazon's numbers, pre-COVID today, they're running about the same as pre-COVID. During COVID, they really stepped on the gas because everybody else was panicked and they went out and did 75 million feet of leasing, I think, in 2020, extraordinary amount. So they're at their trend rate, but they really front-end loaded everything when they could then everybody else had pulled away. Eventually, they will slow down for sure because they've pretty much built out -- their huge network in the U.S. is pretty well built out. But the rest of the world, they're still building out and they're still running to catch up. So if you look at it over time, they're doing just fine.

How do you think about their desire to own more, and they typically had that ownership model in -- outside of the U.S., and it feels as though they want to own more here. Are you seeing other corporates do that given the rapid rise in rents and also that critical nature, right? I think you go back 30 years when you started this business, I don't think industrial sheds were the prime. You clearly had foresight 30 years later that it became that way. But are tenants thinking about that critical space of owning it rather than leasing it.

First of all, it was 40 years ago. I had to tell you this. But the answer is they should not just because of the rent factor, but also interest rates are pretty low. So presumably, they can buy the buildings and do okay. But -- and you would have thought with the new leasing accounting rules and all that buying and renting are pretty much the same thing. So there are all kinds of logical reasons why your thesis is a good one. We haven't seen it. And Amazon's ownership is 8%, and it's been stuck at 8% forever. So people talk about it, but we watch that really carefully, but it's still 8%. Now going forward, maybe it's different, but we haven't seen any evidence of that.

If they move, is there an opportunity for you to go more managing, right? So if you can still you can do these build-to-suits, flip it to them, they're owning it and you're managing them, you're giving all these benefits of the services business. Does that help offset potentially if it goes that way?

It's not on my worry list because, frankly, as Amazon has a more mature footprint, Target and Walmart and Home Depot and Best Buy and every other successful retailer and the ones that are left are really successful because the competition has gone. Lowe's, they're stepping on the gas to do the same thing and build out the networks. So Amazon is continuing at the same rate, but I think a lot of other people are finally taking their head out of the sand and saying, we need to play this game and we need to play it well.

So a lot of the retailers you just talked about are trying to leverage their store networks much, much more for that last mile delivery taking up space. Are you finding that in addition to the supply of new industrial product, which is being picked up, but it's obviously rising, that, that supply from the tenants is acting at all as a limit.

It is. So think about the inventory chain. It's production, it's delivery, it's bulk storage and then its delivery on pallets to stores. All of that happens, instead of the same way as before. So instead of the goods coming out of the checkout, they're going out the back door. But it's the same thing. So yes, there is more warehouse space, but because of the 3x factor that may erode to 3x a little bit, but still there's a lot more warehouse demand.

[Operator Instructions]

I think what -- Hamid, I think what Michael was trying to get to, and I think a couple of questions here in the queue are trying to get to the same thing is, I think people are just trying to connect how much stuff is in warehouses now? How much empty space is there in warehouses now? And then how do you make up for the difference? And how much are you willing to pay for? And when I say warehouses maybe part of it is to Michael's point, like that back room at Walmart is now a warehouse rather than a store shelf. And so we'll talk about warehouse and warehouse-like areas. And so the specific question here is if inventory levels are 25% below where they're heading, where does the customers face for that incremental extra inventory stand? So essentially, is there shadow space, is there just underutilized space that's going to absorb that? How much of that is going to come from new supply, which, to your point, is harder to build, how much of it goes to the back room to Michael's point. And just I think that's really where people are -- I think people understand that the trends are good in the space and that it's a rising tide. But specifically, that next pallet that gets produced, can it just be absorbed in the current system? Or is that actually going to be an incremental square footage driver?

Okay. So we survey customers every month as to their utilization rate. We literally walk a statistically significant percentage of customer spaces, and we measure their utilization on a score of 1 to 5. That number, and Chris puts it out, that's on our website, you can look at it. That number peaked at 87% utilization, and it's now at 85%. And normally, it's at 80%. So it's still very tight but not as tight as it was a little while ago. Because remember, everybody stopped buying stuff and manufacturing was still -- that's when it got really tight. So it's still very tight from a utilization point of view. So I don't worry about shadow space quite that much. With respect to your math of the back-of-the-store space, which is competitive, it is, and it will come out of warehouse demand. But remember, that's e-commerce. E-commerce takes on that 1 unit of warehouse space makes it 3 and that back-of-the-store takes away from some of that 3. Maybe it comes down to 2.5. I don't have the answer to that, but it's still a multiple of what it would have been in the retail channel.

Hamid, we've been asking every company what is their biggest growth opportunity that you believe the market is not giving you credit for?

Essentials, energy and all the related businesses that we can bolt on to the basic real estate business.

And what value differential do you believe it's worth relative to what you think the market is giving you credit for? What's that delta?

I think if we do that well, it can be bigger than Prologis. Bigger than Prologis. In time, not -- probably not in my -- but in time. If we do it well, yes.

Which would mean a lot of third party, right? That would mean the business has grown to where you're -- it could be third-party or not third body, I don't know.

Number one...

Are you willing to sell those services to non-tenants?

Oh, yes.

I love Prologis people with their uniforms crawling all over other people's buildings.

Our customers are doing it. We're already doing this. I mean this is not new. We're installing LED and other people's buildings. Right. Because the customers want it.

ESG has always been very critical to the enterprise. And I know this is going to be hard, but what is the #1 ESG priority for you for the next 12 months that when we look back, you'll be upset you weren't able to accomplish?

So the governance part, we got nailed. I mean we shouldn't talk about that. Number one, and my belief in ESG is that we shouldn't do it because it's good or because the investors are demanding it. We should do it because the customers value it. So I would say our energy production business and our community workforce initiative are the community and sustainability investments that we're making that I'm most excited about.

There's a question that came in here on self, autonomous driving and how that will impact the space. You talked about that 3% to 5% just in terms of their cost of operations. What does that self-driving potentially impact them in their ability to pay rent to?

It creates more margin for us to capture through increases in rent because the labor and the fuel prices that account for a big chunk of that supply chain cost will shrink because EV is cheaper and autonomous is less labor. So that will let you be able to charge more of that margin as economic rents.

I know you're not in this but obviously -- your tenants are using trucks and gas a lot. So do you not -- is that a worry that, that -- the tipping point to cause a lot of these companies in terms of that rising cost and their ability to pass that through to their customers.

It does. And I think there are other reasons why that concerns me, for example, in Southern California, in this indirect source rule, they're taxing landlords for emissions from trucks of their customers. I could have 2 identical buildings. One of them is running EVs. One of them is running a gas truck. And I would have to pay more taxes on the one that's running a gas truck. So there are lots of reasons why that concerns me. And I think the answer to it is to electrify the fleet and the sooner that happens, the greater. But the capacity of all these manufacturers of trucks and all that is booked many years into the future. That's the bottleneck.

Just before we get to rapid far on the flip side as an autonomous question. Is that what's going to help to -- you mentioned Columbus earlier in the session. Is that what helps revive some of those further out or noncentral non-coastal economies. You put in a truck, you don't need a driver?

No, those economies are going to survive, and they have their role. But at the end of the day, the parameter that drives location quality is time. Amazon's trained everybody to do 2-day delivery, than 1-day delivery now in certain countries, you order in the morning and the afternoon -- do you really need that box of golf balls, no. But because you can, that's upped the game with everybody. And when you do that, and that becomes the desired service standard, you have to get close to the customer and there isn't enough space.

All right. We're going to go to rapid fire. But first, I want to raise a toast. I know we don't have any alcohol. But Tom has announced his retirement. And we've given him a hard time over the years. Pretty sure we said, he'd never get the balance sheet to where it is. Oh, no, but he has been an absolute pleasure to work with and the financial side of where the company was upon merger to where it is today in terms of net U.S. equity exposure, lower leverage and simplicity deserves a lot of credit, and they've managed the transition very well. So I congratulate you. I'm envious of your retirement, so congratulations. Okay. And we're going to go over Harry Styles. All right. You guys think about same-store NOI growth for the industrial sector in '23?

4.5%, 5%.

10-year treasury a year from now, it's 1.8?

1.7?

Will the industrial sector have more or fewer companies a year from now?

More.

More. All right. Thank you very much.