Prologis: Strong Market Fundamentals Should Continue In 2020 – Prologis, Inc. (NYSE:PLD)

Investment Thesis

Prologis (PLD) delivered another solid Q4 2019 with top and bottom lines growth. The REIT continues to perform well thanks to strong demand for logistics and distribution centers. Looking forward, this strong demand is expected to continue due high-teens growth rates in e-commerce sales in the next few years. We continue to expect solid growth in 2020 thanks to favorable leasing spread in its markets. Although its shares are not cheap anymore, we think a pullback will create a solid buying opportunity.

Data by YCharts

Recent Developments: Q4 2019 Highlights

Prologis delivered another solid quarter of strong growth in Q4 2019. Its total revenues increased from $807 million in Q4 2018 to $826 million in Q4 2019. This was driven primarily by strong same-store net operating income of 4.6% year over year. Similarly, its core funds from operation also increased from $526 million in Q4 2018 to $551 million in Q4 2109.

Source: Q4 2019 Supplemental

Earnings and Growth Analysis

Global e-commerce sales should continue to grow rapidly in the next few years

Prologis focuses on logistics industrial properties in both the U.S. and other parts of the world. This focus is beneficial as this sector should benefit from the rise of e-commerce. In fact, tenants that are related to distribution and e-commerce sectors represent about 80% of Prologis’ net rentable area. The rise of e-commerce and the demand for fast delivery has created strong demand for warehouses and fulfillment centres where Prologis has a large exposure. As can be seen from the chart below, e-commerce sales have grown at an annual rate over 20% in the past 3 years (2017-2019). While this growth rate is expected to decelerate a little bit, this growth rate is still expected to be in the high-teens through 2023 (see chart below). As can be seen from the chart below, total e-commerce sales is expected to reach $6.5 trillion by 2023 from 2019’s $3.5 trillion. This means that many businesses will still need to set up a lot of distribution centers and warehouses around the world to meet the demand.

Source: E-Marketer

There are more rooms to grow its rental rates

Management continues to push hard to increase its rental rates. This has resulted in a slight decline in occupancy from 97.3% in Q4 2018 to 96.4% in Q4 2019 (it was 96.5% in Q3 2019). However, Prologis’ net effective rent change of 29.5% (year over year) in Q4 2019 was more than enough to offset the decline in occupancy ratio. Management estimates that the difference between its in-place to market rent is now over 15.5%. This means that there is still plenty of room to grow its rental rates in the future. Given the forecasted strong growth in e-commerce in the next few years, we expect this favorable leasing spread trend to continue in 2020.

Source: Q4 2019 Supplemental

Valuation Analysis

Prologis estimates it will generate about $3.67-$3.75 of core funds from operations per share in 2020. Using the midpoint of its guidance, Prologis’ price to 2020 core FFO is about 25.9x. This is comparable to its peers that are also trading above 25x but higher than last year’s 24x.

A growing 2.2%-Yielding dividend

Prologis currently pays a quarterly dividend of $0.53 per share. This is equivalent to a dividend yield of about 2.2%. The company has increased its dividend every year since 2015. In the past 5 years, its dividend yield has been in the range of 2.2% and 4%. Hence, its current dividend yield of 2.2% is towards the low end of its 5-year yield range.

Chart

Data by YCharts

Risks and Challenges

Supply and demand risk

Demand and supply are one of the factors that investors need to consider when investing in industrial REITs (and other types of REITs as well). Light industrial buildings are not difficult to build. Hence, a lengthy period of short supply may trigger lots of development activities. This may result in excessive supply quickly.

Global macroeconomic risk

Since Prologis has properties in 19 countries worldwide, the company is also exposed to macroeconomic risks associated with geopolitical conflicts and trade tensions.

Investor Takeaway

We continue to like Prologis and its strong market fundamentals thanks to strong projected e-commerce sales growth. The company pays a growing dividend with a dividend yield of 2.2%. Although its shares are trading at a high valuation already, we think any pullback will provide an attractive entry point, especially given its strong growth profile.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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