With the effects of the pandemic beginning to ease on the U.S. economy, investors are taking a new interest in companies that will benefit from more normal demand. But this isn't the only way to play the reopening trade. Another one is to invest in the companies that provide services to these consumer-oriented businesses. One business at the center of this action is Prologis (PLD 2.24%), which is the biggest logistics real estate investment trust (REIT) in the United States.
Companies like Amazon.com, Home Depot, and FedEx lease space in Prologis' facilities to house their inventory. Amazon is the biggest customer, with 6.1% of net effective rents. Prologis' complexes, located along major arteries in the U.S., are massive, containing dozens of truck bays. Inside these facilities, retailers keep much of their inventory for stores and online shopping. The company owned just under 1 billion square feet in its 4,703 global facilities as of the end of 2020. And e-commerce accounted for 25% of new demand for space, which means that Prologis supplies a lot of brick-and-mortar tenants.
Read on to see why I think this is all great news for Prologis investors.
Location gives Prologis an edge
Prologis has acquired prime real estate outside of major urban areas, and this is a significant barrier to entry. Low vacancy rates have been a fact of life for many years, and in Prologis's top markets, like Southern California and Tokyo, vacancy rates are around 2%. Simply put, there is demand for more space, but the land isn't available.
High commodity prices and rising land costs make the cost of replicating a Prologis facility difficult and expensive. This gives Prologis the leeway to increase rents, and the company forecasted a 6.5% increase in expected rental prices in the United States this year.
Corporate America will hold more inventory going forward
The COVID-19 pandemic revealed the vulnerabilities of long supply chains. Major shortages in just about every commodity, along with deficits of finished goods, showed businesses they were operating with too little inventory. Inventory-to-sales ratios are at low levels, and it will take years for this to normalize. This is why Prologis is more than just a "return to normalcy" story. CEO Hamid R. Moghadam said on the company's first quarter earnings conference call that demand for new space is the strongest he has seen in his career.
Prologis' stock has performed well this year, rising more than 25% year to date at Monday's prices. Over the past 12 months, Prologis earned $3.98 per share in core funds from operations (FFO, what REITs use for earnings). This gives the company a multiple of 31 times FFO, which is on the expensive side for a REIT. That said, Prologis has the best real estate, and will benefit from a wave of demand, as retailers restock to normal levels. The company expects that tenants will demand even more space than pre-COVID as they will want a bigger cushion of inventory.
Does a dividend increase signal higher guidance?
Prologis just raised its quarterly dividend by 8.6%, and at Monday's prices, it yields about 2%. Since Prologis is a REIT, the dividend should rise as funds from operations rises. The company has guided for 2021 core FFO per share of $3.96 to $4.02 per share. If Prologis had the comfort to raise its dividend by 8.5%, you have to ask if the company is thinking that FFO is going to rise by a similar amount, which would imply core FFO per share of $4.12. Investors should be thinking there is upside to Prologis' current guidance.
The investment thesis for Prologis is that it is a best-in-class performer that has a long runway of growth ahead of it as companies readjust their optimal inventory holdings. This is more than just a return-to-normalcy trade; investors have a longer-term wind at their backs.