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

And what do you see your research team, tell you about how long it's going to take to solve some of these issues? Because obviously, the benefits of having production closer to consumption are there are many, right, especially with the wage arbitrage and China kind of closing. How soon do you think it can be that you don't have some of those problems and then you can kind of get more efficient for operators to relocate into Mexico?

I don't think it's binary. I think it's a continuum. I think for a lot of industries like the auto industry, those -- Mexico is not an issue. The infrastructure exists. A lot of it is already taking place, more of it will take place. Electronic manufacturing, flat panel TVs, all of that stuff is already happening and it's well established. On some of the newer stuff, they need to develop the labor, the training, the education, the company base being there, et cetera. So that will take that. But I think it's a matter of 4, 5 years, maybe a decade but it's going to be continue -- it's not going to be a switch 1 day that it's okay and it's not. So it's happening as we speak.

As you mentioned some of the industries that are having successes relocated into Mexico? Or is there anything stand out that have been more challenging where you've seen people kind of go in, I don't really like this, I'm going somewhere else?

I really can't think of any. No. I haven't -- I can't think of any. I'm sure there's some. I can't think of anything that's more than a case-specific example.

Okay. So you talked about automation being more customer-funded, right? So like somebody who's a tenant who's going to lease the space for you, they're going to put their own CapEx into automation. Do you [indiscernible] largest anything to facilitate that process? Do you have a team that kind of understands sort of logistics and process engineering? Or do you rely on other third parties? Like how do you collaborate with your customers in terms of bringing automation into their facilities?

So that's a great question that leads to a very long answer, I'm afraid. So we figured out a number of years ago that when a customer spends $1 on rent with us, they spend $8 or $9 on other things, labor, transportation, energy, forklifts, racking systems, et cetera, et cetera, et cetera. So all of a sudden, we saw an opportunity for us to take a share of that extra $9 of business with our customers. So we started a new line of business about 4, 5 years ago called Prologis Essentials, which allows us to help our customers with capabilities on all these other areas. So those fall into 3 or 4 different buckets. One bucket is energy and renewable energy. So we have covered about 5% of our roofs with solar now. We're the #2 on-site solar producer in the U.S. That's 5% of our roofs. Once we expand that to the majority of our roofs, we can be an 8, 10 gigawatt a year produced power on our roofs. We can be a utility scale player in renewable energy. And we have very ambitious plans and projects underway that will get us there. We think we're going to cross the gigawatt by the end of '25. So that's a very interesting area of opportunity for us, basically renewable solar energy plus storage. That's one line of business. Secondly, EV charger. A lot of these trucks, particularly the short haul, lighter trucks and vans are becoming electrified. That's the only way people are going to get the permits to operate these facilities. Because remember, the people being opposed to trucks and diesel, and all that. Well, the answer to that is the electrification of the fleet. So we started the line of business, helping our customers with EV charging stations at the buildings. What's the best time to charge EV? It's when the van is in the warehouse, getting loaded with goods and is parked. So that's a very interesting area of opportunity. Then we are also helping our customers, for example, with racking systems. I'm procuring ahead of time. Biggest bottleneck for a warehouse user moving into a facility is that the racks have a long-term lead time. When we got a big balance sheet, we have the ability to recommit to some of this stuff. And so our customers don't have to wait around for a couple of months to get the racking install in them in their space, and et cetera, et cetera, et cetera. There's a whole suite of products and services called Prologis Essentials, that span all these different areas that we are working on and having a great deal of success. So those are going to be -- we think those are going to be multibillion-dollar EBITDA businesses in the next 5 or 10 years.

And can you give us a sense for how big part of the business they are today and kind of what the specific growth rates are in those businesses and then relative to the core?

So they're very small right now. So our entire Essentials business is about $150 million of bottom line against the company that has about $6 billion of bottom line a year roughly. But we think each one of those lines of business can be $1 billion or more in bottom line within a 5- to 10-year period. So it can be pretty significant. I wouldn't be surprised if 7, 8 years from now, 1/3 of our business comes from energy, from operations, essentials, mobility, and we have even started talking about the data center opportunities that we see in our business, which is a whole another area of big opportunity that we're spending a lot of time and money on.

Well, why don't we start with mobility and then talk a little bit about that data center opportunity that you see out there?

Mobility is actually a couple of hundred million dollars of EBITDA business. And by the way...

What do ywe mean when we say mobility? Just....

Mobility means charging stations at our facilities for vans and light trucks today. Eventually, it will mean hydrogen charging for long-haul trucks at the same facility. And it also means hubs that are built not within our buildings but within central areas in our big logistics parks where people can come in and charge their trucks, not on their own site, but had a common. Basically a big gas station for EVs, okay? So that's that opportunity. We think that's a couple of hundred million dollar business by 2030.

So as you think about those businesses, energy and mobility, it does sound like there's more investment that needs to be made, right? Solar panels and buying themselves. Is that stuff that you're putting capital to work on top of the building that is being leased? Is that economic [indiscernible].

We are. We are. Those are investments that will -- I mean, our capital plan is about $8 billion of investments in all of those things in the next 10 years. Those are mid-teen return, unleveraged return investment opportunities, which are quite a bit higher real estate investment opportunities.

Okay. So this is a sweetener on top of the portfolio. Okay. And then data centers. Obviously, lot of demand for data centers and we're starting to hear some more about the -- maybe the Mexico power problem also being a problem in parts of the U.S. Like I'd love to hear your thoughts on what opportunities you see enveloped in data centers for Prologis? And then how do we think about some of those challenges that are going to be in -- for the industry?

So Prologis built its first data center in 1999, actually. So we've been doing this for a while, and we have, I think, 28 or 29 data center facilities already up and operating. We've had a higher and better use business for some time in our company, which means -- what does that mean? That means that warehouse is the cheapest house on the block, okay? So over the last 10 years, we've converted many of our warehouses to office parks and apartment buildings and things that are worth more than their underlying warehouses, life science facilities, et cetera. Data centers are becoming the most important category of higher and better use real estate. So -- and the demand is coming from hyperscalers, they're basically 4 companies, Microsoft, Amazon, Oracle and Google. Those are the big drivers. There were -- the data centers, the old-style data centers that we're mostly fueling the cloud, those still exist. Those are smaller opportunities. But the big opportunities, the mega hyperscale opportunities are from these 4 players. They consume a huge amount of power. And basically, the grid is half as big as it needs to be. The grid and the generation capacity is half as big as it needs to be to fulfill all these needs in the next 10 or 20 years. So there is a scramble for getting access to that energy or frankly utilities today. That will be the short-term answer. In the long term, we've got to develop new sources of power, like fuel cells on site, ultimately, SMRs, modular nuclear facilities and all that. But power -- renewable power that can be stored and converted to baseload power with batteries and storage devices that we're putting into some of the buildings. So this whole energy area is a huge bottleneck on the growth of data centers and AI is fueling data centers like crazy. And I think people haven't solved that problem, and we're working hard at it. At least we have a leg up because we have the facilities, and we have the ability to generate some renewable energy on our own but that's nowhere near enough to feed the ambitions that we have on the data center side. So we have, within our real estate company, 150 people that spend their entire time on energy. Whether that energy is developing renewable energy on roofs, storage, utility grid, storage for the utilities that we work with or trying to procure power for our power -- our data center conversions and new builds. That's the business we are now in. It's just as important as getting entitlements to build a new building is the access to the power that you can provide for the build. And it's not just data centers and AI, it's EVs. Everybody's talking about plugging everything into the wall. Nobody is really worrying about where all this power is going to come from. So it's a huge problem, but we see that's a huge opportunity for us.

So as you think about the data center opportunity itself in terms of order of magnitude relative to the Essentials part of the business? Are they considered the same or they -- do you think about it separately?

It's about -- they're different completely. One is meeting the needs of more of our existing clients. That's the Essentials business, same clients just meeting more of their needs. The data center business is meeting the needs of a whole new set of clients at the end of the day. So it's a new line of business. We're not sure we want to be in the ownership business of data centers in the long term but we definitely are in the development business of data centers. We hope to deploy about $1.5 billion plus a year in building out data centers and we can do those at 30%, 40%, 50% profit margins given the land that we already control and the ability we have to secure power for them. And the demand is insatiable, and some of these companies are actually coming to us and inviting us into situations where they control the land and they control the power, and they just need our help to build it out for them. So it's a very attractive business for us.

Is that as attractive as to helping your own site to? Or would you like...

No, it's not as attractive because they extract some of the profit but it could be a 20% margin business, no problem.

So a good business. Okay.

Yes.

So we talked a lot about Essentials data centers, power and mobility. We didn't talk much about autonomous and autonomy in terms of...

Autonomous, I think, technologically is closer than people think. But I think from a regulatory point of view, it's going to be a while before coming. And it doesn't really, at the end of the affect the warehouses or where they're going to be. It affects the transportation costs. And really, what's going to drive it is the lack of availability of drivers. There's a real shortage of drivers and that's what it's going to drive.

Well, if I could just maybe push back on it just a little bit, right? So if you think about the autonomous trucking technology and getting rid of the 8-hour driver day, and be able to extend reach. I would think that would have some implications for the real estate business and where you want to have -- how many warehouses you might have? And if all of a sudden, you can cover 600 miles in a day instead of 300 miles in a day, you want to put more capital into one building than the trade-off between transport and warehousing but I do think that autonomous might impact that a little bit.

It might, but let me give you counterarguments for that. Everything about the world of purchasing goods is about increasing choice and increasing immediacy. If you look at the trends in the last 10 years, the most important thing has been every time you go on Amazon and order something, you wanted in 26 different color choices and you wanted there this afternoon. Pretty hard to do that. Unless you're close to the customer. So I think proximity to the customer trumps in savings and driver costs. It's all about getting it to the customer immediately. And there's a race, and Amazon has to set the pace on that race, and everybody else has to fall online because they've trained the customer to wanted immediately and with a lot of choice.

Interesting. Okay. So we talked about the Essentials business. We talked about the data center business. I want to come back to the core for a minute. We've seen interest rates reset higher. We've seen a period of time when vacancy rates were down to 1%. That obviously had an impact on rents during that period. Can you help talk -- help us understand what the repricing opportunity is on your existing book? Because I'd imagine market rates today are way above where they might have been 5, 10, 15 years ago, duration of leases, I'd imagine there's a pretty steady flow of repricing opportunity for Prologis?

Yes. We capture -- I mean, if you do the math, our average lease is a little under 6 years. So there is 15% -- 15%, 16% of the space that rolls over and we can capture the new rent. And by the way, 75%, 80% of those renew. So both can capture the new rent from the renewals as well as the new leasing. So the mark-to-market on our portfolio today on a cash basis, not a GAAP basis, the gap is higher. On a cash basis it's kind of around 45% today. And obviously, that number is going down because every quarter that goes by, we capture more of it. And -- but that's significant. That means there is embedded in the company, somewhere around $2.5 billion of embedded FFO growth, earnings growth embedded without runs going anywhere, is waiting to capture those. So that's pretty severe.

And if you're right that the new development cycle has ended, you're going to have another catch-up opportunity?

Oh, for sure. The new building, you're going to earn higher rent because your next competitor can't build that building for the same price that you can. And obviously, we're not going to price our product according to our costs, we're going to price it to the next marginal players cost.

Yes, absolutely. That's helpful. So a couple of questions from the audience around competitive advantage, right? What makes you different relative to other industrial REITs or other development companies?

Well, for one thing, we have 1.2 billion square feet of space. We're the largest real estate company in the world and that gives us tremendous G&A efficiency and cost of capital advantage. So just to put some numbers around that. Our G&A across the company is about 34%, 34 basis points of our assets. The average company has 70, 80 basis points. That's a huge cost of differential in G&A costs. When you're looking at a 6% return on capital type of business initially and maybe at 8% or 9% unleveraged IRR business. That's huge. We're a single A borrower. We have ample access to capital and our spreads is as tight as anybody and tighter than anybody else in the marketplace. So we have access to capital and very low cost of capital. We have an amazing team of people in the most desirable markets around the globe and we are global, we're in 20 countries, that know the players, they know the politics, they have access to the best land opportunities, they have the access to execute and get the entitlements. The name of the game is all about the entitlements. And entitlements go to people who invest in the community and our permanent members of that community. They're not -- they don't go to developers that are going to flip the building the next day to somebody else. And we've invested in these communities for 30 years now. So that's a tremendous advantage. And fourth and perhaps most important we've been dealing -- doing business with these customers. Our customer relationships and our repeat customer relationships are bar to none because we've invested and we've delivered for these customers. And remember, if you -- you would know this better than anybody, if your [ PC ] is supposed to open up on November 1, and it opens up on December 1, you're dead, you cannot afford to take that chance. Now when there are 15 people accessing 0% capital that can do that for you, it's one thing. But when that goes away, then the reliability of your provider becomes super important. So those are the things that we've really worked hard on creating that.

Okay. And what about competition from private equity for space and for development opportunities?

Private equity has become very interested in the logistics sector, and they're putting a lot of money. By and large, that money is going into acquisition of existing assets. Private equity is also in the business of investing in office buildings and shopping centers and apartments and those property types have fallen in popularity because some of the issues that particularly [indiscernible] happen. So a lot of that capital has been shifted to the logistics space. And I think over time, that will put pressure on cap rates and yields, and we'll make logistics real estate even more valuable. They are not in the business of creating new real estate because they don't have land, they don't have people who can get entitlements, they don't have people who can build buildings. They've got to go find partners that can do that and those partners don't have the scale and the existing customer base that Prologis has.

Interesting. A little bit of an alternative scenario question. So let's say rates go up, inflation is not under control. We end up in a situation where we do push ourselves into a world of 6% rates and then an eventual recession. How does that impact your business? Like what's the...

Well, if it causes a recession, that recession could translate into anemic or negative demand before our business. In 40 years of doing this, we had 1 quarter of negative demand in the dot-com collapse in 2000, and we had 3 quarters of negative demand after the global financial crisis. So you do the math. 40 years is 160 quarters. We have 4 quarters of negative absorption. I think that -- those are pretty good odds to operate in. Our business is not conducive to negative absorption because population grows, people eat more, people need more cloths, people consume. So there's a pretty significant base of demand that's there. That's necessities. These are not luxuries. These are things that people need every day. So I'm not saying that demand will always be robust but I'm saying it hardly ever goes negative and has ever -- in the past has not gone negative more than 4 quarters that I can think of. So if interest rates go up, that means required rates of return on investment will go up. That means that rent that the next building needs to get to come online is higher and higher. And thankfully, we own 1.2 billion square feet of existing product that can be mark-to-market over time.

So got a little bit of a cushion against that just in terms of the formula.

For sure. And to replicate that 1.2 billion square feet, that cost is going to go up with inflation. So that would be a real issue for somebody who didn't own the assets, almost trying to get into this business. Look, other than the potential temporary downturn or recession, it's not a bad pricing umbrella to operate on there.

Especially if you're coming out of a period where you have been [indiscernible].

By the way, I don't think that's going to happen. Just -- I don't think we're going to be in a period of negative absorption. Not based on anything I'm seeing.

Anything you're seeing. Okay. So when we think about the U.S. market again for a second, are there any particular markets that were overbuilt or areas in the country where it could take longer to absorb?

Well, there are some markets that there are too many developers and too many pieces of land that get overbuilt across the cycle. Indianapolis would be a classic example of that. There are markets that are actually very tight markets normally. But because they've been so tight, people overcommitted to real estate just to not be caught short. And now that vacancy rates are going up, those people find that they're not needing that space and are putting that space on the market, on the sublease market. And that is having a disproportional short-term effect on vacancy rate. Southern California would be the classic example of that. Rents tripled in the last 5 years in Southern California. Vacancy rate was under 1%. So what would happen after the user lost the third building, he or she probably turned to the real estate procurement officer and said, you're not going to lose the next one because we're going to be out of business. So they committed to more space to get the next deal. And they probably paid more for it than they should have. That's why rents tripled. That stuff is going to come on in the subleasing market, and it's going to have to get absorbed. So vacancy rates in Southern California went from 0% to 1% to maybe approaching 5% and that will take a couple of years to normalize again. But rents have tripled. I mean I will take that market over any other market if I had to do it all over again in the last 3 or 4 years.

Do you worry a little bit about the California market and some of the CARB limitations in terms of what impact that can have on industrial activity?

It will have a lot of impact on supply of new industrial space because there are all kinds of moratoria that are being proposed in Southern California against warehouses. Again, would I want to see that happen? No, because I'd like to be an active participant and developer in the marketplace. But let's assume it happens. We have over 100 million square feet of the best real estate in Southern California with no potential future competition coming online. So I think we're going to be in pretty good shape because of the position that we already have. And you asked about the other companies, I mean, literally, Prologis have 1.2 billion square feet. It's bigger than the rest of the sector together and, therefore, in more liquid investment and best customer relationships. So I don't like to sit here and brag about our business but it's a pretty good base that we've built.

Well I'm going to ask you to, Hamid, about your business because we come to the end of our time together here on stage. Could you maybe give it a high level the algorithm for shareholder return over the next year, couple of years? Why is this a good time for investors in the audience to be looking to put capital to work in Prologis?

Two reasons. One, we reduced our guidance by 1% and the stock went down 20%. Okay. So I don't know about that, but that sounds like a pretty good entry point for us. Secondly, we pay a 3.7% dividend and we have consistently grown at high single digits, low double-digit returns on growth with 20% leverage for decades. So I think that's an overall low teens rate of return is a pretty good business in my book.

Excellent. Well, thank you so much for joining us today. Thank you for the team for coming out. Thank you all for supporting the Bernstein Conference, and I wish you luck with the best of your meetings and the rest of your time here.

Thank you.