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

I'm Bill Crow, I'm one of the team of analysts that covers real estate, hotels, homebuilders for Raymond James. And I've been here for a long time. So I want to really thank you all for coming out and making the 44th Annual Raymond James Institutional Investor Conference a great success this year. All that success is due to you, but it's also due to people like Tim Arndt, the CFO of Prologis, who we brought here for the first time last year, and they were pretty excited about the format and the investor interaction, and we're eager to come back again this year. This is a stock that we are really enthusiastic about a year ago. Things changed. I'm even more enthusiastic now why because the earnings are higher, stock price is lower. So Tim, can you walk us through the story, and we'll get into a little Q&A at the end.

Well, that's a hell of an introduction because you're right. I -- if you were here last year, I was here with our outgoing CFO, Tom Olinger. We presented here together. He was exiting, I was coming in, and indeed, the stock price is off 30% or so. So it's been a great first year in the seat. But we had a very exciting year actually, despite the market volatility, had a huge acquisition. If some of you follow the story, I can try to touch on that briefly. But for those of you who don't know the company or the story, Prologis is probably one of the largest market cap companies that many investors have not heard of. We're probably S&P's [ 75, 80 ] or so. And we're the world's largest owner of logistics, warehousing facilities. On a global basis, our biggest footprint would be in the U.S., and I'll touch on some of that up here. But we own properties in 19 and probably soon to be 20 countries all around the globe. We have about $200 billion of assets under management. As I go through the story, we own about 60% of that on our own balance sheet, but about 40% of that in strategic capital or think of that as private equity, like vehicles, and that's a big part of how we founded the company and how we own assets today, and I'll walk through why that's strategic for us. We have 1.2 billion square feet is what's comprised in that $200 billion of assets under management, $39 billion of investment opportunity ahead of us in our land bank, and I will touch on why that's very important for growth from here. And just a very large, diverse base, 6,600 customers. We have a tremendous balance sheet on top of all of that, probably about the best rated amongst all the REITs, [ A-flat ] with S&P and a lot of investment capacity, which has been very helpful as we've gone through the last 6 to 9 months of market turbulence. You see that this is another snapshot here of what it means to have our scale. We have a metric of just how much global GDP passes through the Prologis' portfolio. You see it's nearly $3 trillion, more importantly, about 3% -- about 4% in the countries that we operate in, an expression of our breadth, but also we've seized on that and just seeing how much opportunity there is in the data and the amount of information flow we see as a result of that. So a little bit more on that to come. If you think of Prologis, what you have here, think of us in, I would have said 3 business lines, and I'll add a fourth here. Our primary business line is the rental business, the rental income of this operating portfolio. You see $5 billion of NOI. That's the rental income in effect. That's on our share basis. It's about $8 billion gross, but we use that figure to cut through our proportionate share of everything that we have across the joint ventures that we co-invest in. There's a tremendous amount of built-in growth ahead on this $5 billion. I'm going to show you how it's going to turn to $8 billion in the coming years by right of where market rents are. The second business to think about is the strategic capital business. We kind of renamed it from private equity. We used to call it that back in the day when we started introducing a couple of public vehicles. So in addition to 2 large flagship open-ended funds that we have in the U.S. and Europe that we use to co-invest in core operating assets, we also have 2 public vehicles, one focused on Japan, one focused on Mexico. Both of those are very interesting investments that you also look at as well. But strategic capital is not just an important component of the overall capital structure. When you have $200 billion of assets to capitalize, you've got to kind of tap all the quadrants and we've done that here. But it's a tremendous ROE accretive way to own the real estate by right of the same operating costs, but your proportionate share of the rents plus all the asset management fees as well as really interesting promote or incentive fee income that we've been receiving over the years that I'll highlight as well. Third business, I would say, is that we develop -- we're a very large developer. We build, I would call it, $3 billion to $5 billion of new logistics properties around the globe. Probably 30%, 40% of that's going to be in the U.S., 30%, 40% of that in Europe with the rest spread around China, Japan and LatAm. You see the $1.6 billion, that's referring to the recent run rate on value creation in that development activity. And again, I'll show you a bit later, the way you think about the development business for us is that we would expect to earn a margin above our cost of putting capital into developments. That margin has been about 25% or 30%. So you can think of, okay, if we're putting in $5 billion in new investments and there's a 30% margin, that's about this $1.5 billion of value creation. Now what we've done, we have a very unique model. Our model puts all these things together where we've developed the asset over here, create the value. So we take the development risk, the entitlement risk, the leasing risk, and when it's stabilized, we take a look at what that stabilized appraised value is, and we offer it to the strategic capital ventures, and that's how they grow. So they love it. They have built-in growth of new assets coming in every year. We recycle capital. We get capital back to go into next year's development pipeline and put a fee stream and additional fee stream on top that really has no incremental G&A because the cost of managing the assets is very low and only frankly decreases as we increase AUM. I referenced the fourth business line. I'll try to get to it back at the end. But we are going way beyond what we can do just renting and building these properties. This asset class has turned out to be much more strategic for our customers in the last 10 years. This was very much a commodity product, probably 20 years ago, I'll go back into the 2000s. Warehousing was probably the last thing on your list in setting up a business and what you wanted was probably the cheapest location to put your goods. But now that with the rise of e-commerce, and delivery and fulfillment expectations, everything is drawn closer into population centers. And that's where our portfolio is built and focused and we found that in that there's a much more strategic partnership with our customers as they don't think of us as just a cost center, but more as a top line revenue enabler, a strategic partner if they have the right location and supply chain footprint. So we have built a business that's founded on that. We call it Essentials that's meant to cater to working much more closely with the customer, and I'll touch on that shortly. Just a snapshot of -- so who do we lease to? You see a lot of the names here that would be obvious. Amazon is our largest customer. But at that, they make up -- I think it's still less than 5% or just about 5% of our annualized base rent. So it's a very diversified rent roll, 6,600 customers, as I mentioned, upfront. And this graphic also shows you kind of the segments of not only by name, but what types of tenants lease our facilities. And it's going to be 3PLs, the third-party logistics providers, the straight-up retailers, wholesalers, a little bit around manufacturing and then transportation. So I referenced this earlier that the $5 billion of NOI in our operating segment will become $8 billion. And we have very clear line of sight on that. In logistics, leases are typically 5 to 6 years in length. And so if you do the math, on average, you're about 3 years away from your last lease reset, right, on average? You just did some leases, you did some leases 6 years ago. And so to understand the potential rent that we have as we renew those leases, we very actively measure what are market rents compared to what rents are in place today. And that sits in this light green. That is 67% lease mark-to-market. So market rents are 67% higher than what is in place today. I'll explain why that is. If you're not familiar with the industry, that's kind of an astounding number. Bill can probably a test. Our sector has never really seen that kind of growth. And so it allows us to measure, well, how much NOI will that be even if market rents don't grow any further from today. If they stop today, which is not our forecast, that's $2.9 billion of incremental NOI, about $3 more per share on a roughly $5 per share of earnings. I guess that works out nicely, just ahead of us if we kind of go to sleep and let those leases roll up to market. Quick snapshot, if you do follow the company, some of the stats that we would look at to keep our closer investors current on where the portfolio sits. So 98% occupancy at the end of the month, it was a little bit above that at the end of last year. That is abnormal. Occupancies in the logistics sector have never been this high. We would typically think of them as stabilized. We underwrite new investments at 94%, 95% occupancy. Markets are exceedingly tight. No matter what you read in the paper, the supply chain is not fixed and our customers are not satisfied with what they've been able to do in procuring new space. And they just can't find new space and our occupancies have only been climbing kind of quarter-by-quarter over the last 3 years. Then on the bottom here, you have a couple of forward-looking or indicative metrics on, well, what do we expect? What is the sentiment and strength within the buildings from our customers. These numbers here come from customer surveys that we run every month. One is index we call the IBI, Industrial Business Indicator, you can read about it on our website and our research section if you're interested, but it's a diffusion index, where if we're sitting north of 50, it's going to kind of tell you there's a sentiment within our customer base for growth and need for additional space. And then utilization is an important metric of [ show you're occupied ], [ sure you're leased ]. But is the activity inside your buildings low? Is there some red herring in that metric? And not at all, utilizations have been very high. Another symptom of supply chain is continuing to be choked up. Moving past operations into a little more color on our strategic capital business. I'd probably focus on the top 2 charts here. The top left is just what is the growth in third-party AUM, assets under management in this business. It's been nearly 20% CAGR over the last 5 years. This has grown from asset values in and of themselves growing. And the fees in this business are based on fair market estimates of asset value. So that's been a large component of the growth. And then M&A, some private M&A in activity over the last 5 years as well as just our conventional building product, as I mentioned earlier, and contributing it into the vehicles. All those things go together to growing this asset base and growing the fee base, which you see to the right of that as well. And then a little more color on that development business. So this is -- we call this the development, our development track record. We established this about 10 years ago and have been sharing it since. It's a retrospective of about 20 years of development activity now. We've invested about $40 billion over those 20 years, building new logistics facilities all around the globe. You see the margin on that, making $11 billion on top of that $40 billion of investment, is a 27% margin. For some reason, the logistics industry quotes margins a little unconventionally than most businesses, but that's how we quote margins. But then interestingly, see the vast majority -- the majority of that value creation has been outside of the United States, which is sometimes surprising. In fact, if I tell you that most of the activity outside the United States is in Europe and Japan, that has sometimes surprised people because those are fairly low-growth economies over the last 2 decades, Japan in particular. But there are lots of drivers, secular drivers, a few that are still very much in play, but the 1 throughout this 20-year period was just supply chain reconfiguration meaning a modernization of logistics networks and supply chain in Japan and in Europe over the last few decades that agnostic to core economic growth has really fueled the need for new development and giving us a pathway for all that value creation. So what's ahead on value creation, you want to know about our land bank. And we own -- we have a relatively small amount of capital invested in our land bank today, that -- meaning that it's a low basis. We have about $3 billion invested in land. But then we also have a lot of optioned land in what we call covered land plays, which is just there's something on top of the land, a truck terminal or something that's generating some rent, but we know that facility or site in the future will be a logistics building or potentially higher, better use down the road. But in any event, all of that control gives us access to what we think is down at the bottom here, $39 billion of total expected investment in all these markets around the globe. Again, if we're developing $3 billion to $5 billion per year, that's 10 years of development activity on land we control. That's really remarkable and gives us a lot of optionality as we go into each year. We kind of only need to build if we want to stay on that run rate, 1 out of every 10 choices that we have. And in this market, we'd probably like to build on 1 out every 3 of them. The market conditions are so strong. Securing land you can -- I love our CEO says we're not making any more land, right? And that's in play here, particularly logistics is somewhat unfavored by municipalities, that's a good thing in the end. It's not great for our development guys. It makes their lives very difficult to get land in and get it entitled for logistics, but it makes the $200 billion that we have under control and in operations today that much more vehicle and we're valuable rather. And we see that in play in places like Southern California. You may have heard there's almost outright moratoriums on development of new logistics facilities in Inland Empire, for example, and that's really going to serve market rent growth and asset values going forward. So this is in diminishing supply and makes growth challenging, but makes the ownership of the portfolio very accretive. The balance sheet. So I don't know if I mentioned, I've been with the company about 20 years. I spent about the last 10 as Treasurer. So this is kind of near and dear to my heart. We significantly upgraded the balance sheet post GFC. Again, I mentioned we have probably the best credit rating amongst REITs. If you measure that by credit spreads, credit spreads would tell you, we do have the best. We carry the lowest credit spreads in REIT land. It gives us a tremendous amount of debt capacity on our metrics if we want to stay within our rating, which, of course, we do. So as we look at the environment we're in today and whether investment opportunities arise, as there's tremendous capacity within the balance sheet. There's a little bit of focus here on USD exposure as well, which just to spend 1 moment on. In the past, about 10 years ago, in this global footprint, we had a lot of non-dollar exposure. We had a lot of exposure to yen, to euro, even renminbi, other currencies. And that was a bit out of favor with many investors who appreciate owning a global platform, particularly for logistics. It makes a lot of sense in our sector, but don't really love the FX volatility in a large capital-intensive business. So we have completely eliminated it, I would say, where our equity base is now 97% exposed to dollars. And you see the earnings exposure is essentially all in dollars. And we do this all through our debt financing strategies, a lot of natural currency hedging in -- by placing debt in nondollar currencies. And then on the earnings side, the use of forwards and derivatives as well. So if you've -- I'm sure you followed a lot of names in the last year in particular, where not only rates, interest rates, but also FX rates have thrashed company earnings around, you haven't heard that out of Prologis and you won't. Another thing that's sort of related to our scale and earnings power is just our G&A, our overhead low. This is something as you're following real estate companies, to understand, what is that company taking to operate that asset base. And if you look at the right side here, Prologis and this is to be expected, shame on us if we don't achieve this on our scale, but we have the lowest operating structure per AUM than any of the other logistics REITs and then really any of the other blue-chip REITs in the other sectors, malls, apartments, et cetera. And I would highlight that, that is absorbing the investment into a lot of nonoperational G&A, meaning we have an internal corporate ventures team. We have a research team. We have this emerging energy business. And we make all of those investments. Those investments in the future of the business are embedded in this 20 basis points on AUM. So it's a really great achievement. So moving quickly to the market here. Hopefully, you know the logistics market has been on fire. It has had a tremendous run, probably the last 10 or 12 years by right of e-commerce really taking hold over that period. If you don't know the e-commerce story, quickly, this would be the CliffsNotes that the logistics use, the intensity of warehouse use in e-commerce is about 3x what it is in logistics use for a brick-and-mortar store. And it's kind of easy to understand that briefly. If you think about a warehouse of goods that are destined to go to a store, if it's a bunch of shirts or bottles of water, they're all going to be in a big box, hundreds of them, never unwrapped, they're going to stay on a pallet, go to a store, they get unpacked and fulfilled in the store. The store is almost a use of warehouse space, right, the back of the store. That's vanishing as e-commerce arises because now that box is opened underneath the warehouse roof, it's packaged up. There's an entire floor area dedicated to packing all of those parcels onto trucks. The warehouses now take returns. You used to take your returns to the store. Now you send them back to the warehouse. So now there's so much more warehouse use. We've calculated it that it's about 3x more square footage need for that e-commerce channel. So as you look at e-commerce penetration, how much of retail sales is occurring in the e-commerce channel versus traditional brick-and-mortar and that uphill slope. Every time that moves up and this 3x multiplier effect occurs, there's much more demand for logistics space. And then there's kind of been a knock-on effect, which is the brick-and-mortar stores that are now competing with e-commerce where in my shopping habits, if I want to buy something, I'd probably go e-commerce because I'm certain they're going to have the variety I might need or just have it in stock versus am I going to venture out and hope the store has it. So the stores are challenged with that. And they -- similarly, even if they're not e-commerce, need to get closer in, have more variety, have a turn of their inventory and replenishment. So all of this has driven the need for inventory to be resilient and closer into the consumer. So that has fed a lot of secular demand for our product. And then on the side here is some discussion. You can look at it on our website just on our case for resiliency, which is really that COVID has brought on a just-in-case mentality for our customers instead of the adjust in time. They just need more inventory to not miss sales. I will skip that in the interest of time, just staying on e-commerce because Amazon's headlines scared a lot of people last year. We could talk about that maybe later. It turned out to be a nonevent is how I would summarize it in the end. But what you have here is a snapshot of how much of our leasing was dedicated to e-commerce. And then we also know how much was Amazon. And despite whatever volatility has occurred and then some declines as you've seen in 2022, occupancies have not just kept up but grown. Just to say this is not an e-commerce story solely. And as e-commerce players, in particular, Amazon kind of stepped back, there are many other names in industries that are stepping in and requiring the space. And so the demand has been very broad-based. I will skip that in the interest of time and focus on supply then. So if you like all this and you get the case for demand, traditionally, again, I'll go back kind of 20 years when things were very different. Supply was the thing that always came in and ruling the party. You see a market where rent growth is picking up. There's good demand. These are not 20 or 40-story office buildings. They are relatively simple structures to build, at least back then, particularly on a greenfield basis. So supply could come in and in a year's time, really head off all that surge in demand and just kept rents and pricing power low and depressed. And so there was a period of time really through the early 2000s where market rent growth in our space was not as good as it is today. It's completely different today. Now entitlements, as I mentioned, are much more challenging. Our SoCal team would say, if we need to put a new building up in SoCal, we need to be thinking about 3 to 4 years of lead time to bring down the land, get the zoning, go through the entitlements, deliver the building. The buildings are getting more sophisticated to build. Financing has kind of gone for them right now. And then as I said, if you want the close-in locations, they're not making any more of those. So it's very challenging to get a site that's going to be strategic in our infill markets and submarkets. So supply, there are some big numbers on new supply out there. We try to put them in context here in this line. I probably am going to run out of time to explain it, but the downward slope of this line is saying that there's really not enough supply out there on the pace and need of demand to give us any concern or to really serve the market. So supply, despite the big numbers, has been very well contained. This is a picture of new development starts, just to highlight the drop off and starts at the end of last year. So as we look out to 2024, when we would see new development starts begin to get delivered, we're going to see a dearth of new deliveries in 2024, giving another leg for occupancies and rent growth thereafter. So in 2 minutes, I'll try to tell you quickly like all the other stuff we're doing. Being close to the customer, as I said, with this being much more strategic kind of transaction for our customers, we're developing a new relationship with them and not just being a landlord who comes to see them every 5 years to jack up the rent. We try to be there now when they're moving in to see how we can help facilitate all the things they need when they move in. They invest multiples of capital when they move into 1 of our facilities to set up their structure on racking and forklifts and material handling equipment, automation. We can participate in all of that. And we're standing up a business to do just that. It's called our Essentials business. Also, you see energy and sustainability. Again, I could spend an hour on this, but we have 1.2 billion square feet of floor space to rent. So we have 1.2 billion square feet of roofs around the globe, and our roofs are a great place to put solar panels. Today, we are the second largest producer of solar power in the U.S., on-site solar power on 4% of our roofs. We haven't even begun to really tap the opportunity. And I would say in the last 10 years, we kind of did that off the side of our desk, our developers might put solar on. It was sort of a part-time activity. We have completely flipped that on its head. We have an energy team in now, dozens of people strong, really going fast at this energy business, which is going to be complemented with the next pillar you see here, mobility, EV charging is essentially here. It's going to come in a big way in the next 5 years not in just all of our vehicles, but delivery vehicles as well. No logistics facilities are really set up for that. We have a team that's standing up that business and way down the road on it. And ultimately, workforce labor is a big challenge for our customers. You can build the building and everything. But if you can't get 2,000 people in there at the Amazon facility to run it, it doesn't do you much good. And as a facilitator of making these parks and investments work, we're trying to find ways to aid on the workforce issue and also make some margin there as well. There's so much more I could probably tell you, but I think I'll pause there in the interest of time and just see if there's a few questions.

So we've got time for a couple of questions.

[indiscernible].

Let me just so everyone can hear. The question about was the continuing negative headlines surrounding Amazon, whether that presents opportunities?

Yes. The -- so I don't know that 100 number, and we can take a look at it. It surprises me and I've seen those headlines be fairly distorted on kind of the real facts. When they came out last spring, and they had a tough Q1 earnings, they came out and pointed to -- they had heavily invested. They admitted it in 2020 and '21 kind of took forward demand of anything they needed in their business. Workforce included is the other 1 that was highlighted to meet the surge in e-commerce that they were seeing through COVID. And it's seemingly included a lot of excess space as well. So the market got puckered up. We got puckered up. What is this about? We have about 160 leases with Amazon today. And the net of all of that talk was that they gave 0 of them back in any way. Now it's also important to know what does giveback mean. They are in a lease for 5 years. They can't just say never mind. There will be some way they would need to exit it. Typically, what we have seen them do outside of our portfolio in pretty limited numbers is sublease. And I think it's just smart. They are saying that they have facilities that they will use eventually. I think you're kind of going there, but don't need it today. So if they can carry it for 2 years, in some more economic way through a sublease, they are engaging in that activity. The other thing they were doing was not taking occupancy of a new facility, why move in. But if they are moved in with all of their automation and the workforce, and it's in 1 of our top markets, submarkets, they are not moving out of those kinds of facilities. I see their activity is probably neutral right now in our markets and portfolio. We're doing some leasing, some renewals. They're not in a growth mode today, but we expect that they would be again. And I think they've said as such. They've talked about how they believe they'll need to expand in the coming few years in the U.S. again. So I think that was pretty overblown. And look, if you don't believe me, look at market occupancies and ours or anything else, the market is on fire, and it's not as though they -- that note a year ago with some leading indicator on what demand was going to become.

You have time for 1 quick one.

[indiscernible].

The question was about the growth of the solar rooftop business.

To put a number on, I think it's going to be about 10% ballpark by 2025. We're generating 400 megawatts of power today. We updated a goal we had through 2025 to have a gigawatt by then. So that's pretty simple math, the 4% to 10%. We think the penetration in the portfolio is ultimately about 60. And I would say that number keeps getting upgraded as our leader of that business continues to kind of mine it and understand what the potential is. But there's, I suppose, a decade or more of growth in that.

We are out of time. Tim, thank you very much for coming here again this year.

Yes, yes. Thank you.