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

Okay. Thank you, everyone, for joining the Prologis Panel Session here. My name is Ki Bin Kim, Managing Director and Senior Equity Analyst at Truist. To my right is Dan Letter, President; and to his right, Tim Arndt, Chief Financial Officer at Prologis. I'll kick off the meeting with some opening Q&A, and we'll pause periodically to take any questions from the audience.

To -- so to start off, I was just wondering if you can share your perspective on what makes Prologis unique and different from the other industrial peers in the sector?

Yes. Why don't I start and then, Tim, maybe pile on here. So I would look at Prologis in a unique fashion. We have multiple diverse drivers of growth. We own 1.2 billion square feet of the best quality, highest quality, best located logistics portfolio in the world. We're active in 20 countries that represent about 75% of global GDP. Secondly, we had a robust development business. We own or control about 12,000 acres worth of land that embedded in that land portfolio is about a 225 million square foot build-out, representing about $38 billion, $39 billion worth of TEI. So a long runway for growth in the development business. Third is our strategic capital business. Around the globe, we have 11 different vehicles, public and private, that we manage. It represents about $60 billion of AUM. We have very consistent cash flows from the asset management fees to the tune of $0.5 billion a year, as well as promotes that come out of that business. And you can see we've been very successful with those promotes over the last several years. The fourth bucket is what we call Essentials, which is an umbrella of new business lines that were building on top of this incredible platform we have. And the first part of Essentials that is growing, and we put some very robust numbers out at our Investor Day in December is our energy business. We've got 1.2 billion square feet of warehouses, that's 1.2 billion square feet of roofs. So right now, we have about 40 megawatts of solar on these roofs. And that covers less than 5% of our roofs. So we have a long runway for growth in building out that solar business. We also have a storage business that's associated with the solar business, and we're building that out on our fragment land or within our land bank. And then the other piece of the Essentials umbrella is really around mobility. Think about the electrification of fleets that's happening around the world. If you own an EV vehicle, where do you charge it, you charge it at home, or our buildings are the home of these electric -- these EV fleets. And then the last piece of Essentials is what we call Operating Essential. Think of everything that goes into warehouse, racking and forklifts and just other items that our customers use, we were selling them those goods now. We're trying to be a one-stop shop for our customers. And then on top of all of this, or I could say, maybe underneath all of this is by far the best balance sheet in the business.

All that and from a people perspective, you guys also have great reviews on Glassdoor and good employee feedback, which is pretty impressive for a large company. That's what to end there.

Yes. No, great. We have 85 offices around the world, 2,600 employees. And -- yes, we're very focused on our culture.

So with that said Dan, you spoke about being prepared for a solar business environment that is being impacted by macroeconomic uncertainty, which might be weighing on customer decision-making velocity. So can we just start off with an updated view on your business, what you're hearing from customers?

Sure. So since our earnings call in April, we've spent a lot of time with our customers. We also track leading indicators really on a daily basis. We lease 8 or 9 spaces a day. So we actually have the best data in the business as well. What we're seeing in our proprietary data, look at -- we look at our proposal volume. We look at our letter of intent, which is the next stage after the proposal. And those volumes are actually up to a more normalized level. In this quarter, they were a little depressed. And March was actually surprisingly low as it relates to the conversion of LOIs into leases. And we've seen that trend back to normal, which is good news. I would say overall, the business feels very stable this quarter and I'd say, on plan.

And do you think customers have sufficient capacity in their existing footprint. So let's say, even if demand comes back, does it actually translate into net absorption and the bottom line.

Yes. So what we're seeing during COVID, we saw land grab took place. Look at Southern California. Southern California has made really all the headlines over the last 4 or 5 quarters, as it relates to the normalization happening in Southern California. The Inland Empire, it's an 800 million square foot market. The Inland Empire rents grew 280% in a 2-year span during COVID. What's happening now is those rents are settling into a more normal cycle. And what happened during that time frame was we saw this land grab happen, where really there was over-absorption that happened. Certainly the 3PLs out there, which account for about 1/4 of our business. They needed to have the space in order to grow. At the time, they were telling us their growth trajectory as well as a build towards resiliency as we all experienced, when the shelves were empty during COVID, retailers didn't want to be caught without the inventory. And so we heard from our customers that they needed to build this resiliency into their network. What's happened since then with the cost of capital and otherwise, that resiliency isn't really taking place at the level that we thought it was going to. And overall, users just took a little more space than they needed. For instance, typical 3PL contracts are 3 years. And when a user would come to us or a competitor and look for a shorter-term space, maybe an overflow space or a 3-year space, we said, well, here you go, the demand is so strong, you got to sign a 5-year lease. And what we're finding right now is there's a little bit of extra space in the market for that segment of users. And we see them working through that space right now, actually.

And sticking to that topic, 3PLs like GXO recently commented that they are seeing customers starting to restock. And perhaps we've seen the bottom of this inventory destocking environment. Can you just share some of your observations and how meaningful can this be to your business?

Yes. It's great. We heard about that last week. We think it's great news. We're glad to hear that. We -- at any given day, we're having hundreds of interactions with our customer around the globe, and we track these interactions through Salesforce, and we obviously commute -- or communicate with one another as to what we're hearing. And what I would say is there's a tale of 2 different stories. Our GXO seems to be in front of other users right now, we're hearing from other 3PLs that they have a 3% or 4% of space that they need to work their way through. So -- but we do think that's great news. And we are certainly seeing demand from other sectors. We're seeing demand from the e-commerce sector. There's been -- our biggest customer has done a fair amount of leasing already this year, and we think we'll see more track -- more follow -- following those big leases on the e-commerce side.

And Tim, you've mentioned in the past that about 6% vacancy rates, the market is at equilibrium. Obviously, your portfolio composition is very different than a national average industrial portfolio. But with that said, I think we're close to that 6% vacancy rate for the sector. How is PLD's portfolio faring? And ultimately, when do you expect to see some market rent growth?

Yes. So yes, we are about 96% occupied at the end of May as an update from the first quarter where were 97% occupied. So that's in keeping with our overall forecast for the year, so we're tracking there. We have a page in our presentation published yesterday that does a correlation between market vacancy rates and rent growth. And what it shows is it's clearly not a hard switch in terms of, well, where is there opportunity for rent growth versus not. It's a continuum and a lower amounts of vacancy. Clearly, pricing is going to be better. But on that chart, you can see all the way down to really 7% or even 8% vacancy, you can still have positive rent growth. So that is our expectation that we will have positive rent growth over the next 3 years. That's in our forecast. Out the gate here, we certainly have had a change in our view just due to how soft SoCal has been. And many of you, I'm sure, are aware of those conditions About 20% of our portfolio is in SoCal and some of the rent adjustments there have been significant enough to put us at a pretty low number for '24. But we believe with that rebuild of occupancy going into '25. We'll be in position for overall positive rent growth again.

And sticking with that topic, maybe you can just paint the picture for us, what was rent growth for PLD's portfolio last year, what does it look like next year or 2?

So last year, we wound up somewhere between 6% or 7% on a global basis. We had put out a forecast of a CAGR, a 3-year average between '24 and '26 of 4% to 6% on average. We said in our April call that what we had seen sort of out the gate here with just, again, this continued softness in weighing down by SoCal that we'd likely be at the low end of that range, and we might be even below it. So much of what we're seeing right now depends on SoCal. We would characterize the rest of the 80% of our portfolio at around 0 this year, which is 1/3 of it is some very strong markets where we see very positive market rent growth. LatAm, Mexico and Brazil, both southern parts of Europe, the Sunbelt in the U.S., there's a lot of bright spots on market rent growth. Maybe another 1/3 of our portfolio is 0 on the year. And then we do have some other markets that are a little softer like Seattle. We mentioned some of these on our call. That group of markets, we would call that a 0 here in 2024. So this year, it's going to be -- mainly a function of whatever we assume occurs in SoCal. You could -- if you pick a number for yourself on that, multiplied it by 20% are weighting. That's probably what we'll see this year. But the real story is about incoming supply from here and kind of a reversal of that -- those dynamics and better pricing into next year.

So can you update us on SoCal, supply and demand, when do you think we start to reach equilibrium in that market?

Yes. Overall, I think Southern California is probably 3 or 4 quarters behind the rest of the U.S., vacancy and the Inland Empire is around 7%. We see that actually trending up a little bit throughout this year. The closer in L.A. base is sitting at 4%. And to put in perspective, both these markets were 1% or less vacant during COVID and right after COVID. So what we've seen is a fair amount of supply come on Inland Empire, and then in our portfolio, we see 3PLs are more pronounced in Southern California. It accounts for about 33% of our overall portfolio. If you look at the U.S. ex SoCal, it's about 18%, 19% 3PL. So with that 3PL space, and they were taking more of the space up during COVID, we need that to settle out. So we think that we'll see that recovery happen maybe later 2025 into '26.

Let me pause your momentarily. Any questions from the audience? Okay.

What is [indiscernible] Amazon, you still [indiscernible] and so forth [indiscernible] out there in the market [indiscernible]?

Yes. So the question was around Amazon and Amazon's growth. They've been the first out of the gate again in signing a lot of leases this year. Depending on who you ask, I mean, there's upwards of 2 dozen major leases that they've signed. And in their annual report, they came out and talked about significantly growing their last mile portfolio. I think they said doubling, and we saw their CEO on CNBC said the same thing. And then, we've actually heard numbers even bigger than that tripling or maybe quadrupling. So that's good news for that growth profile. And there is certainly other users that are -- that still have a lot of work to do to modernize and update, optimize their e-commerce supply chain. So we expect to see a number of other groups following Amazon certainly in the e-commerce sector.

Any other questions?

On Southern California, can you talk about, how you contain and the exposure you have? Are you looking to grow on all that [indiscernible] your acquisition earlier this year. And it gives a lot more exposure, is it more likely to be in a higher risk from a stress developer type or more cash flow [indiscernible].

Well, Southern California has been the best market for Prologis, it's probably for any REIT. If you look over the last 20 years, we will continue to invest in Southern California. We have dozens of development sites in Southern California that we'll build out. We will look at our transaction, including ones you've seen that have closed. And -- but we're going to stick to our discipline, and we're going to be very focused on quality and location. And certainly, we'll take it through our returns filters, and we're going to make sure that -- maybe right now, we want to be more opportunistic down there. We focus on a discount to replacement cost. But I would absolutely see us investing more in Southern California. Just we're -- we look at every opportunity on a case-by-case basis.

Just a few thoughts on the [indiscernible] 2026, '26 for a churn in Southern California, given where we are in the interest rate cycle, starts and shorter construction cycle, which is -- can you elaborate on [indiscernible]?

2024 or '25?

Yes, sorry. Yes.

Yes, I do want to -- I think I've heard that same way. I think Dan said late '25, '26, late '25, '26, I think we meant to say late '24 into '25.

Yes. So...

Glad to answer your question. I'm glad you asked.

Yes. Yes. Sorry about that. Yes. So we see that recovery as not being that far up.

And Prologis has invested through various cycles. Where do real estate acquisitions rank in the capital deployment total [ poll ] today? How do you compare it versus development?

Yes. So acquisitions, we've had some success buying on an opportunistic basis, whether it'd be a broken development or there were a lot of new entrants into the market during COVID and when the demand was through the roof. So we've been, again, opportunistic and trying to uncover some of those opportunities. So like I said before, we're looking at every deal. The most attractive incremental yield and return would really be in our development business. We own or control 12,000 acres worth of land. So the incremental yield, the marginal return on that is significant, well into the double-digit IRRs. So that's where you'll see us grow more.

Great. And can you touch on cap rates or IRR expectations in this environment?

Yes. I would say market IRRs and cap rates are tough because what's the in place, what's the mark to market. Right now, our market as a company is 50% is what we published at the end of March. So we focus a lot more on total return in IRR. And so those IRRs right now are in the low 8s. I think they were probably in the high 8s to 9, 6 months ago. Some of these deals that we've been -- the opportunistic deals we've been uncovering are closer to 9. But we do see market deals happening in the high-7 IRRs right now.

And can you touch on your energy and mobility investments. I think your goal is to invest about $2 billion or more over the next couple of years. Is that still the case? How can things like tariffs or tariffs on solar panels or changes in electricity pricing to change your plans?

Yes. You're quoting some numbers that we presented at our Investor Day just in terms of capital, we see that will invest in both solar, the energy business that Dan described and mobility. We would be on track on those. We're proving large programs for those teams programmatically and they're plowing through them now around the globe. The question of tariffs, there's some proposed tariffs here on solar panels. As we look at that, when we look at the overall component of the cost of these energy investments and what those proposed tariffs might be. We would see some erosion in the potential 12% to 14% IRR as we threw out in that business of maybe 100 basis points or so. But that would be before, I would say, considering what might happen in the longer run to set some equilibrium again, meaning if those tariffs wind up serving to slow down the overall amount of power generated, that's just going to put more stress in the system and maybe have the impact of increasing power prices, again, which would, on the revenue side, probably get us back to where we would expect. So we're not concerned with what we've seen so far, and we're just monitoring.

And turning to your data center investments, I think you're seeking to invest about $7 billion to $8 billion over the next 5 years. How do you weigh long-term ownership in this business versus monetization. Do you see upside to some of these targets that we've seen, given the strength that the tech companies going to do posting?

Well, so this came up at Investor Day as well. So we are looking at this as higher and better use opportunity kind of plain and simple. Something that Prologis and Dan and I both come from AMB 20 years back now has always been a key part of our investing strategy. And I think the emergence of all this data center need has just really landed at a property type that we own that lends itself very well to data center conversion. So that's great. It doesn't mean we now want to switch business model and suddenly own a property type that's a little different to us. Our expertise is in logistics. Our expertise is in development and energy. So there's a nice symmetry between those things where it makes sense for us go ahead and convert these assets. There's a tremendous amount of value to create and unearth in that. And that's really what we're after both -- for both just the bottom line. But as Hamid described it in December, it's also you can think of it if nothing else as a really important source of capital recycling for our logistics business. Ultimately, if we develop these assets and sell them or when we develop these assets and sell them, that's going to be reinvested back into our core business.

And Tim, let's turn to the balance sheet. Your leverage stands at 4.9x, excellent balance sheet leverage. Can you discuss the sources and uses over the next couple of years and your ability to self-fund capital needs?

Yes. So our business model, if you're unfamiliar just high level, is to build 3, 4, we've had $5 billion development years on our balance sheet for the most part. And then when these assets are built and leased, we offer them to these strategic capital vehicles that Dan mentioned. Those vehicles have an option to buy those assets, they typically do and returns capital back to Prologis for next year's development. That program has been running through the last 3 years, even though private capital fundraising is as much discussed out in the news is slow for all asset managers. But we've been able to raise capital in a number of our vehicles and have kept up contribution. So our Sources and Uses model has not really slowed. There has been a plugging of the gap in terms of proceeds that we've been very fortuitous -- been lucky to utilize that capacity that sits at Prologis. So when you hear that we have 4.9x debt-to-EBITDA or 20% leverage, that's one thing. There's a number of REITs, frankly, that have leverage stats that look like that. What you have to apply as another dimension that we have that on a $150 billion balance sheet. So the scale of the quality of that balance sheet is just immense. So we've been able to tap the debt market consistently over the last 2 years, and just plug Sources and Uses in that way without altering our debt-to-EBITDA whatsoever. So we've been in a great spot. And I'll say I see that as continuing because, again, debt-to-EBITDA probably being the main metric folks look at to understand balance sheet health in REITs. Our EBITDA is growing 8%, 9%, 10% something on that order. So if you did nothing else, we could increase our debt capacity by that same amount. We have $35 billion of debt. So we could raise $3.5 billion of debt and not affect our ratios, and that's what we've been doing.

And you don't have any significant maturities until '26. But if you had to raise money today, what would that cost look like? I know you have a lot of different options.

I would say, on a global basis, that number would be something like 4.5% perhaps. That's going to be underpinned by 5.25% in the U.S., maybe 1 in 3 quarters in Japan, we tap that market as much as can. Euro is probably our third largest capital market about 4%. We have this luxury of tapping global capital markets, not just to help arbitrage some rates where we can and is appropriate. But just the amount of investors and the quantum of capital access is completely unique.

And turning to your fund business, you have about $90 billion of AUM. Can you just provide an update on where asset values seem to be trading -- trending and how fund flows might begin to benefit Prologis?

Yes. So asset values, we have written down our U.S. and European portfolio, 21% and 22% from the peak. They have been relatively flat this year. We expect values in the second quarter to tick up of just a little bit. So we think these values are stable and, on their way, up. And we are seeing more capital come in, in Europe. Europe is probably 2, 3 quarters in front of the U.S. We're kind of running a place a little bit because maybe we're a victim of our own success here and the fact that we are also the most liquid. And when investors need to find that capital. They're definitely coming to the logistics sector to do so. So we have capital coming in. We do have some redemptions out there. We've been in front of the redemptions from day 1. We haven't had any issues as it relates to redeeming when we believe the time is right to redeem. But I would say we see that business picking up steam in the back half of the year as it relates to capital raising. And we just think investors want to see a quarter or 2 of the increase in valuations versus just sitting flat.

And part of what makes our business model unique is that you have the ability to sell some assets into the funds that you manage yourself. Can you just talk about the capacity within your funds that you have to absorb more assets sales?

Yes. So it's a great point coming off of Dan's answer there that so in many of the funds because we're redeeming out actively and sort of in real time with all of our LPs, which they're very pleased about. It does mean that the equity portion of fundraising has been slower or almost essentially neutral, I would probably characterize it. But it hasn't stopped the vehicles from being able to invest because they, themselves, have great debt capacity and access to capital. So our 2 flagship funds are open-ended vehicles, 1 in the U.S., USLF, the second in Europe, which is PELF. They are both now public issuers. USLF entered the 144A market this year. They have A3A- balance sheets on their own as well. So they've got great access to capital, great debt capacity between that and some committed capital we had coming into this downturn, we've been in the capital front for about 7 quarters. They've been able to keep their leverage metrics in check and continue to invest.

And covering your company for so many years, I've always thought of you guys as looking for interesting ways to grow, and you've done a good job. One of the areas where you've put more attention into is Prologis Ventures. You've made about investments in 40, start-ups or various stages. But you probably evaluate hundreds of more deals that you've passed on. And I think there's quite a lot of lessons learned from that. Can you just provide some insights into that business and things you've learned? And ultimately, when things going to start, possibly scale.

Yes. And so we have the investments that [ Kevin ] described. I think the origin, the inception of this what, 6, 7 years ago now -- 2016 -- was really about learning, staying close to emerging technologies that could help our customers or potentially disrupt our business. And that's definitely what we have done. We've had a few of the vehicles exit, not many at this point, a few that we think will exit, meaning some kind of public or other capital raising exit for the [ seed ] capital this year as well. I think we actually have more to do internally. I would say I don't think we have perfectly connected the dots between all those earnings for our customers. So I think there's a lot of untapped potential in that. So I'm critical of it internally, but I also think there's much ahead that we can do with everything that, that group is bringing to the table.

And any early thoughts on how AI or robotics might impact your business? We have 1-minute left, and I doesn't do it justice, but whatever kind of early thoughts you can share?

Yes. So AI, we're definitely not just buying into the hype of AI, right? But it's not new to us either. We've been building different models as it relates to our revenue management, for instance, and using AI. We use it for optimizing a number of different processes. We have 12,000 leases. You just think about all the different ways we can improve 1 process that saves time and FTEs throughout the company. We have about a dozen projects right now in pilot that are AI focused. Let me give an example. There's a group actually that we've invested in through Prologis Ventures called TestFit and you look it up, it's pretty interesting. You can go out to a site, and you can basically take a picture of the site and you can -- it will instantly draw and create the building that we would build on that site, and we're building it out so we can actually get the underwriting right there. So the investment officer and team on-site can go see the project, to understand what they can build quickly with the zoning and otherwise, and then actually have the underwriting and make an offer before they even get back to the office. So that's very AI focused. We're also using it for site selection. Basically, proprietary data and tools to help us be swifter, faster with decisions that we're making on the acquisition front. But I don't want to say too much because some of this is in the secret sauce. And I think it's just going to make us better and faster and smarter for sure in our core business.

If I can pile on, I know we're late. I would just say we are all going to have the same AI technology and tools, and everybody knows that this is about what data is proprietary in those systems and -- on our scale, no one is going to have better data than Prologis for that.

And with that, I want to say thank you to everyone for joining the PLD session.