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

Welcome to Citi's 2024 Global Property CEO Conference. I'm Nick Joseph here with Craig Mailman with Citi Research, and we're pleased to have with us Prologis and CEO, Hamid Moghadam. The session is for Citi clients only. If media or other individuals are online, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions. Hamid, we'll turn it over to you to introduce the company and team, providing the opening remarks, tell the audience the top reasons that investors should buy your stock today, and then we'll get into Q&A.

Good morning. I picked up a little bug a couple of days ago. So I'm going to turn it over to Dan and Tim to talk about it. I'll try to jump in, in Q&A. But Dan is now our Global President. He's responsible for all real estate operations. And I think, Tim, you know pretty well. So let's turn it over to him.

Sure. So I'll jump in here. So Prologis, we own 1.2 billion square feet of the highest quality logistics buildings in the best markets around the globe in 20 countries. We also have a robust development business, $7 billion development portfolio right now with $40 billion of opportunity with embedded in our land bank. We also make money through a strategic capital vehicle with about $60-plus billion of third-party capital that generates AUM fees as well as promotes. And lastly, we have a growing Essentials business that you'll hear about in our Q&A here. We have very strong fundamentals right now in our space, largely driven by e-commerce. We have very visible organic earnings growth that we plan to capture through our 57% mark-to-market. This will ultimately generate $2.4 billion of additional NOI on top of today's numbers. And then the last point I'll make is this growing Essentials business at Investor Day in mid-December, we quoted a number of -- of numbers related to what we see that business doing over the next 5 to 7 years. And we're very excited about that as it relates to growth prospects.

Perfect. One of the questions I'm sure you guys have gotten a few times this conference is, your thoughts on kind of the inflection around development, delivery, kind of peaking and when that absorption can exceed new deliveries and what that means after season and rents. So maybe some updated thoughts there around the timing of that kind of trajectory.

I'll start there, and maybe Tim has something to pile on here. But right now, we see the supply picture getting better. At the end of last quarter, we talked about a slowdown in new starts to the tune of 65% from the peak. We actually see that trending now to about 75% down from the peak. So the supply story is working in our favor as we projected. Demand-wise, 2023 was a pretty slow demand year, about 25%, 30% below a normalized demand expectation. We see that normalization happening this year. So as the completions from starts in '23 and late '22 come on board, you see that now -- we see the completions to diminish throughout the year, and we expect demand to normalize. So we see that inflection point sometime in the second half of the year, which bodes really well for the story in '24 and certainly '25.

And obviously, that's on a macro level. But if you start to think about some of your larger, more important markets, where are you for some of those as you start to see a reacceleration in market rent growth?

I think the story for the last few quarters has been Southern California. There's certainly a supply story that has been of concern to most in the Inland Empire. I say that, and we have the highest quality portfolio there. That is 97-plus percent leased. So in any of these markets, we're typically outperforming the market fundamentals by 150 to 250 basis points, depending on how you look at it. So we think we will see that market start recovering this year. Let me give you a little backdrop though. It's important to know this. The Inland Empire rents today are still 70% to 90% above where those rents were going into COVID. There was just hyperbolic growth throughout COVID and into '22. And as that market settles, we're still very pleased with our portfolio and what we expect to see from a rent growth perspective. Supply will be constrained just by virtue of the regulatory environment in California. So we see decent things happening there in the coming quarters.

And Dan, you know the demand trends are normalizing. I think some of the commentary suggest some larger tenants who have maybe been a little bit less active in '22 and '23 are looking at those 3- to 5-year growth plans and trying to figure out when they need to start to take space to make sure they can get the facilities that they need. What are the conversations there on the larger side? And is the smaller tenant side, which has still been pretty robust here, is that still hanging in? Maybe give us a sense of where first quarter leasing is trending to kind of put it in context?

Sure. So I would say the conversations are similar to what we saw over the last few quarters, which is the demand is there, it's getting pent up. Decision-making has slowed. Certainly, these decisions have a lot more implications coming from issues in the Panama Canal and the Suez Canal and other costs that these shippers ultimately have to cover. So we think that is definitely slowed decision-making. But we are hearing from our customers that, that demand is there. They have to optimize their networks. They have to find a way to basically modernize their network actually is a better way to put it. So we feel pretty good about some news that we'll see from our bigger customers throughout this year. There are pockets of some small -- of the smaller users, the 3PL Networks and otherwise, that are just a little more apprehensive about taking space until they have a customer on the other end of that lease. So I think it's certainly pretty good, Tim. As I look for the first quarter leasing...

Well, we have an update on our book. We're sitting just below 97% on our occupancy. We'll probably end the quarter somewhere around there in keeping completely with our forecast. We had a midpoint on our guidance range of about 97% for average for the year, which is a reflection of precisely the pattern. Dan just went through where the first half is going to be maybe a little softer on that occupancy trend as we end the market, both are building occupancies, again, we believe, by the back half of the year.

Yes, there is one thing that Dan said that I don't want you guys to lose sight of. The dialogue with the big customers that was so concerning to some of you, not to us 2 years ago has totally reversed. So don't be surprised to see them out there looking for big chunks of space...

And we've seen Amazon get more active in the market. Are you seeing some of these newer competitors from Asia whether it's TikTok driven or Tmall or how does some of these alternative retailers that haven't really had a footprint going to potentially impact this demand as Amazon is already getting back in and other people are still playing catch up as everyone is still moving to faster delivery times.

I don't have anything specific on the names that you mentioned, but the more the merrier right?

Tmall and Shein need to build a network in the U.S. and either they're going to do it directly or through relationships initially with 3PLs and then eventually on their own. But those are 2 names that are going to go for market share. And the importance of that is that it sort of forces the other 2 big e-comm players to also up their game, Walmart and Amazon because they're going to have competition. So they need to match service levels and the like. So I think you're going to see more players and you're going to see a widening of the opportunity set.

And Dan, just circle back, we got a question coming in. Just specifically about IE rents and the stabilization there. Maybe from peak to trough. And maybe as I ask this question to try to strip out some of the outlier rents or maybe it was at a point where there's literally no supply in people just throw out numbers and got it versus where you really thought that air was more crowded, I guess, around where rents are. And from there, kind of that peak to trough for the IE if that makes sense?

Yes. I think I'm not going to have the number for you off the top of my head here, but what I'd say is that hyperbolic growth where we saw 150% plus rent growth in a matter of 2 years, it's really hard to -- it's a very emotional market, right? And there was such a land grab going on that high watermark rent was made and extrapolated across the whole market, literally on a daily basis. And so as we see the market now normalize, it's also emotional. And with the glut of 100,000 to 200,000 square foot spaces, that's a pretty dangerous place to be right now. You're going to have much more of margin of error, I guess, in that size range and you are in the 500, 600 plus range. So if I was going to venture a guess, I would say there was, I don't know, 25% of that was air in the -- I guess, between peak to trough, that 125% to 150% rent growth, there's probably, I don't know, 20%, 25%. It's a total guess though, we have no idea. I think you should always think about replacement cost rents and where those leave us at the end of the day. It's hard to do a residual analysis right now -- or sorry, it's not hard to do residual analysis. It's hard to find land comps right now. If you did a residual analysis, you would still get to a number where the rents are well into the mid-dollar range on a monthly basis.

And we've talked a little bit about demand here. But one of the other kind of nascent tailwinds is nearshoring and onshoring. And also some of the manufacturing demand because manufacturing facilities are in the construction number. And so as you guys think about the tailwind in your portfolio, how you're thinking about that -- the magnitude of that relative maybe juxtapose against like the e-commerce tailwind we've seen -- and just talk also about how markets generally will play out in terms of that big manufacturing demand driver and then the tail around the vendor that's not necessarily part of just our overall GDPs type inputs into general demand.

Sure. So from the nearshoring perspective, I look over at our Mexico team here, we're absolutely seeing the benefits of onshoring nearshoring on the border markets, and our Mexico portfolio is on fire. We don't really see it in the U.S. We are in 31 markets in the U.S. We're focused on high barrier to supply markets. These aren't the markets that are getting this new manufacturing that you're seeing, whether it be EVs or chips, those are happening in outskirt markets that just are not in our wheelhouse. Sure, we'll do some merchant build potentially from there, but we don't see that as a big demand driver, and we certainly wouldn't put it in the same conversation as e-commerce.

There is one second order effect that you should keep in mind is that $60 billion of fabs and all that other stuff that's being now built is drawing on the same labor pool. And given what's going on with immigration and limitations on labor, cost of construction, obviously, in the last couple of years have gone up a lot. So some of that rent that we were talking about earlier, the air and the rent and the Inland Empire and elsewhere is actually real. It's there to justify replacement costs. Another segment of it is higher yield requirements. So it's not just air. There are different types of air if you'd like. And some of that [indiscernible] will come out of the rents for sure because when you have 2 bidders, 4 pieces of space instead of 10, the frenzy is less and people can be more patient. But don't assume for a second that most of that is -- a lot of it is real. And California has put together all kinds of exactions on development that are affecting costs in a major way. So there's some real things going on there.

And there's a follow-up to the nearshoring question here. really just getting at how you guys think about incremental investment to play this theme, the markets clearly of Mexico, but are there any others? I would throw a Phoenix in there, given Taiwan Semiconductor and others. But is there any kind of shifting strategy internally to try to capture some of this that you may not have exposure to today? Or is it just you're happy to let others kind of capture that upside and you guys are sticking to the strategy?

I'd say 2 things on that. I think, one, if you just think about our strategy now for 40 years, it's been pivotal to the consumption end of the supply chain. So everything we're talking about in these last couple of questions is where goods are produced. And it's just not a central part of our thesis ever really. And so maybe some manufacturing is going to come to the U.S., maybe some of it will stay, but that's not our bet. It's ultimately where everything gets consumed. We know that's where the demand will be constant. The one exception, I think, to that rule in the world is going back to Mexico, again, we just see -- we have a great team and portfolio there. We've recently seen and our FIBRA team has seen an opportunity there to strengthen that and making a proposal of Terrafina as some of you may have seen. So that's something outstanding. We don't have any update for you on, but that would be just one place that I would say we see a very constant long-term demand driver that we would like to participate more in.

And we did touched on a little bit on the regulatory side. Clearly, California has things around you supply. Other markets are doing that as well, even parts of Dallas, right, which you don't normally think about. But then there's other ongoing issues to throw an example out in New York with congestion pricing, right, and how that could potentially change the flow of goods in and around the metro area. Like how does that affect where you want your buildings where the next incremental development comes and maybe tenant behavior to be able to just navigate around that higher cost that they would have going through the city if they needed.

So that's a good question. Ultimately, the consumers determine where demand is. They don't relocate as frequently as manufacturing can move around or other things that move around. Yes, there are population changes, but they usually take decades and decades, and they're pretty slow. Now within the metro area, sometimes a given location becomes too expensive or too congested or too tightly regulated, and that demand leaks out to another part of the metro area. But you're not going to go supply New York from Pittsburgh. It's got to be somewhere in the region and up and down 95 in the case in New York or up and donw 95 in the case of California or 4 or 5 down south. So I think that is more of a -- within the region where the demand takes place, then is the demand going to be in some other region completely. Rents as high as they might be today and escalating are still 2% to 3% of total supply chain costs. And at the end of the day, these companies compete for their customers by providing 2 things: choice and speed of delivery. Actually not price because the computer has sort of democratized price. You can look across and shop across. So they're competing on service levels. And if they got into [ toward ] the location, they're going to lose business, particularly with these new players coming into the market and buying for their share. So I think they're going to fight hard to keep their service level and their choices.

You had mentioned, obviously, the Essentials and the solar opportunity in your opening remarks. So I think it probably makes sense to move that direction. As you think about the opportunity currently, and I know this was a focus of the Investor Day, but where do we stand there? And kind of what's at least the near and medium-term opportunity for both of those?

Every day that passes, we think the overall opportunity is actually bigger in aggregate. So marginally bigger than when the Investor Day took place, by the way, that was December -- second week of December. So we're not talking about a lot of change. Energy, I am super bullish about. And I think that's limited by our ability to execute, and we are building a lot of ability to execute. We have over 100 dedicated people in our energy team. And with the planned hires, we're going to be about 130 by year-end. And you guys know how much I hate overhead. So we're putting it on because we can make money doing it. And so really, that business has got nothing other than clear runway for growth. The operations business is a little trickier because it's not one thing. It's 30 different things and how you sell each one of those 30 things to your customer and how quickly you can convince the customer that you're not only a good provider of that at a good price, but you can actually follow through, provide the service, et cetera, that's trickier. So that's more pick and shovel work, but it's getting traction. The new area that we're spending more time on this year is labor and automation because they are 2 sides of the same coin. Labor continues to be a real constraint for our customers. Originally, we took a pro bono approach to this by training these people -- training high school kids for these jobs, et cetera, et cetera. More recently, we've been partnering with people who have an effect uberized or whatever you want to call it, DoorDash is the temporary labor for warehouses and have now solutions -- branded solutions that provide just-in-time labor for some of our customers. And that business, I suspect, would grow just like the automation advisory business will grow, and that will become an important part of the Essentials platform.

One of the big themes was having other industry analysts at the event. And so you guys at the core is still a real estate company. There's -- it will be nice to have that -- when you think about these bolt-ons, this latest one with basically, maybe, call it, outsourcing model for labor. What's the capacity to continue to bolt on these businesses from just an opportunity set, but also how do you manage the complexity around valuation, right? You want to get credit for having these businesses. And if I have to have 15 different comps for 15 different areas plus the real estate, you're probably just not going to get value for those and investors will just want them for free. So as your point, these are higher ROI businesses, lower should be pretty high margin. So how do you balance that? And then I guess long term, it's probably not an issue now, but just with REIT rules, how you structure some of this to not get over the dirty income test?

Yes. Let me just add to some of the concerns that you raised by throwing in the data center business, too, people ask us, "How come you're not doing more data centers" and our company don't go into the operating business of data centers and all that. Anyway, it all comes down to one belief, which is that the more disparate cash flows you have in different businesses, the market is going to value it at the lowest multiple of any of those cash flows. So we're maniacally focused on staying and remaining as a pure-play logistics player. No question about it. Does it mean that we shouldn't take advantage of opportunities that are in adjacent spaces. The answer, in most cases, is no, we shouldn't. But if there is a case that our customers need it, and that product or service is consumed along with the real estate that goes along with it, and we can deliver it faster, cheaper, more efficiently than others. Yes, we should do it, but we should put it in a format that at the right time, we can spin it off and making a pure-play business. Is that time now? No, it's not significant enough. Right now, I think we've got a real estate multiple, and these businesses are relatively small. They're in the hundreds of millions of dollars range. I know that sounds a lot, but it's a $5.5 billion EBITDA company. So once they sort of approach $1 billion of EBITDA and all that -- we are -- have already structured them in a way that we can position them. There's another reason to do it, too, which is that if we can build these capabilities the way we are, it's going to be attractive to other real estate companies that are in our space, but don't have the scale and the ability to do this. And in order for us to take advantage of that or this new company to take advantage of that, it probably needs to have its own identity because I'm sure our competitors don't want people with Prologis logos crawling all over their roofs. Although one of the companies that we have since bought had that situation happen a couple of years ago, which was pretty funny. But -- so bottom line, these companies need to have their own identity and their own structure, and they need to be really good at what they do. Otherwise, they're not going to get the right kind of business.

One of the questions coming in, just on the transaction markets you haven't touched on, are you seeing any difference from 3 or 6 months ago, some people are hearing from peers about increased competition. Can you talk about what you're seeing in spreads and pricing tail and how does that impact your thoughts on pace and timing?

I would have guessed that the market would have normalized by now more than it has. I think when the trend of interest rates was down and down and down, it was looking like the market could come back early this year. I think while volumes are a little bit higher than they were last year, I wouldn't say it's come back in a meaningfully strong way. So I think people are feeling their way around. Now having done this for 40-plus years. I can also tell you that there are closed-end funds that eventually will have the money taken away if they don't spend it and human nature is that they will end up spending it. So I've become a little cynical in my old age, but I think that is likely to contribute to some high volume of transactions, notwithstanding what I said earlier.

And there's a question as, I guess, more specific to Prologis about large-scale M&A in the current environment and kind of thoughts today and the opportunity to further consolidate.

I told you about the one deal we have outstanding right now and tell you about anything else down the road. We look at everything. It's the same answer. We're pretty choosy on markets and product type, but we're always watching.

I think, Hamid, you were as close to emphatic as the CEO probably wants to be at the Investor Day about nothing in the U.S. looks interesting. Should we take away that if you were to do something maybe international, not whatever regions that you already invest in would be more of where that interest lies going forward?

You could conclude that, but that's not what I meant to say. All I meant to say is that we've done 5 pretty major public and large private U.S. M&A deals going back to KTR. We've actually done 5 of them, 3 of them have been public. And we'll continue to look, but I think there are going to be more of those opportunities in the U.S. on the private side than on the public side. There aren't that many public companies that can move the needle on our company. I mean we literally deploy more capital in 6 months that the market cap of these companies combined. So that's not where we're going to be looking. It doesn't mean that we're going to do deals overseas. I mean, yes, we see an interesting opportunity in Mexico, and we've been pursuing it through our FIBRA there. But we're looking all over. The great thing about being a global company and having a presence in all these places is that you play in a bigger sandbox. But boy, we're disciplined. I mean there's a lot of stuff around and there's a temptation to go out and buy everything. And unless it really adds value to our bottom line, we don't need to be bigger. We just need to be better, and we're very, very picky in that regard.

Maybe moving to the private capital business. Could you talk a little bit about what the queues are looking like there? And also, where you are on kind of restarting some of the contributions to the European funds that have been kind of intentionally put on high this year for a little bit last year.

Yes. The reason they've been on higher is that I think it's not fair to the existing investors or the departing investors, redeeming investors if the valuations are not right. So instead of spending all our time in the last 2 years trying to talk the appraisers into holding up to values. We've been spending all our time trying to get them to be more realistic about applying today's higher discount rates to those cash flows and get real about the values so that the market can start functioning. That's the right thing to do. And we think we're awfully close to that having been reflected. This quarter, I think -- the valuations are going to be reasonably flat within plus or minus 1% of where they've been. Cumulatively in Europe and in the U.S., the valuations have been written down about 20-ish, 21-ish percent return. We think the market is attractively priced at that point. And to answer your first question, our redemption queues are totally clean, and we actually have some new money coming in, not a fire hose, but more than a trickle. And I expect that will speed up. And if anybody is going to get benefit of that money, I would think properly valued funds are going to get it first. And we're not shy about using our balance sheet to invest in our own funds. It's -- we like our own cooking, and it's the portfolio that we know the best and like the most.

If I would just pile on there, we've now done. We've added equity interest into our vehicles, either via contributions last year, taking back solar units. We made cash infusion -- I shouldn't say infusion -- investment into USLF this quarter, which was -- this was the one we announced last summer. We'll probably do additional time throughout the year via contributions continuing to take back consideration partially in units to keep up that interest in what are our premier vehicles.

And as we think about your commentary around valuations coming down and being reflected in the funds, promotes the last couple of years outside of this year have been very outsized. And I recall you guys are changing the measurement periods for investors within the funds to be more rolling. So how should we think about -- as you get back past '25 an approximation of where promote income could be either on like a percent of AUM or what have you, kind of a longer-term run rate?

Yes. First of all, we haven't changed the methodology at all as a result of this downturn. We changed the methodology 3 or 4 years ago when we knew that we should make the promotes investor-specific as opposed to fund specific because people were coming in and going out at different times. So it's -- the reason it's spread out more is that different investors come in and go out at different times. And it actually has an effect of smoothing the promotes more than the way we had it originally. And with the passage of time, it will become smoother. Secondly, promotes were really high because we had unprecedented rent growth and cap rate compression sort of around the COVID era. I don't think that's sustainable. And when we were getting it, we were telling you guys don't count on this forever. And in fact, we report on core FFO, which doesn't include any of that stuff. Having said that, I think we'll continue to earn promotes and the sooner we get the properties -- valued property and get the fund flows to work, the better an opportunity we will have to earn those promotes down the road. So -- but to answer your question, before the run-up in 2020, my standard answer to promotes was going to be about 25 basis points a year of third-party AUM would be promotes. And the company under our comp plan would get 60% of that and the employees would get 40% of that. So 15 basis points of AUM, third-party AUM would be one way of looking at it, although we've exceeded it over time by [indiscernible], even ignoring the last couple of years of super high promotes.

That's helpful. And then Tim, maybe one for you around earnings and the cadence of earnings in '24. Sequentially from 4Q to 1Q, are there any things that we should be thinking about that could be a little bit different than the full year kind of trajectory?

Yes, I think there's -- I'm glad you asked, there's a number of tough comps really across the board in Q1 compared to last year. So you've got an occupancy comp that's tough. Asset management fees, we saw value reductions over the course of '23. Now we're sitting at what we think is pretty much near the bottom for our early commentary, but that creates a comp issue. So it's a little bit slower in the first couple of quarters, much more ramped as rent changes, mounting same-store amounts and also development stabilization. There's a large bucket of development stabilization and leasing occurring throughout the year that will obviously be in full force in the fourth quarter and not so much here in the first quarter.

Yes. I wouldn't judge our year by the first 2 quarters. We're signaling that as strongly as we can. It's going to be a lot of the last 2 quarters.

And moving on to the rapid fires. What do you think same-store NOI growth could be for the Industrial Group in 2025, not PLD specifically the one group...

5.5%.

The number of public industrial companies a year from now, the same few or more?

About the same.

And then lastly, best real estate decision today, buy, sell, build, redevelop or repurchase stock.

Take our land bank, develop a building on it, put solar panels on top of it and storage in the basement and fill it up....

Thank you.