One of the biggest themes of the past year and a half has been shortages. The COVID-19 pandemic depleted corporate inventories, and now companies are struggling to fill increasing demand. This demand from consumers has created competition between e-commerce and traditional retailers for logistics space.
Prologis (PLD -0.14%) is at the epicenter of this, and it's resulting in increased rents and occupancy. The company just reported second-quarter earnings, with funds from operations in the core real estate business increasing 13.4%. The company gave a rosy outlook for the industry in general. The current environment is signaling higher rents going forward, and with space at a premium, this trend should continue.
A leader in the global logistics space
Prologis is a global logistics real estate investment trust (REIT) with 4,715 buildings containing almost 1 billion square feet in logistics space. If you have traveled along the big interstate highways, you have probably seen these massive buildings with dozens of truck bays. It serves two main markets: business-to-business and retail/e-commerce. Its biggest customers are Amazon, XPO Logistics, and Geodis. Prologis has been diversifying its e-commerce exposure from Amazon, which will make the company less exposed to a big customer.
One of Prologis' key advantages is that it has some of the best real estate, located on major arteries close to major cities. This makes its portfolio extremely difficult to replicate for a competitor. Proximity to the big cities is a key factor for e-commerce companies that are trying to shorten delivery times.
The COVID-19 pandemic stressed supply chains for just about all businesses. Companies that were used to running "lean and mean" with minimal inventory found themselves with empty shelves as inventories were depleted. Now that the economy has reopened, companies are restocking and there is intense competition for space. Hamid R. Moghadam, chairman and CEO of Prologis, said, "Demand for logistics space is robust and diverse, and operating conditions remain the healthiest in our 38-year history. Vacancies in our markets are at all-time lows, contributing to record rent growth and valuation increases."
Consumer demand is making inventory rebuilding difficult
Retail inventories have only risen 3% from the pandemic trough, as retail sales are up 19% from pre-pandemic levels. The company noted on the earnings conference call that space utilization levels are below the long-term averages, which is another indicator that inventory levels are generally lower than usual. Despite low utilization rates, occupancy rose 1.1% to 96.8% at the end of June. Customers have to move quickly to secure space, and that is showing up in higher rents and faster lease gestation times.
For the second quarter, Prologis reported a decrease in core funds from operations (FFO) from $1.11 a year ago to $1.01 today. The decrease was primarily due to an unusually strong result from Prologis's strategic capital revenues a year ago. These revenues come from joint ventures with other investors. Earnings before interest, taxes,, depreciation, and amortization (EBITDA) was flat compared to last year. The core real estate operations business increased its FFO from $0.82 to $0.93.
Prologis also raised its 2021 forecast due to the stronger business conditions. The company now expects to see rent rise 10.3% in the United States, and 9% globally. The difference between in-place rents and new rents is 16.9%, which is up 3.3% from the first quarter of 2021, and it's the highest in the company's history. This statistic measures the difference between current leases and new business and indicates the potential rent increases when older leases roll off. This should translate into an additional $0.90 in net operating income per share. The company forecasts core funds from operations (FFO) to increase to $4.04 to $4.08 per share. Excluding promotes (which is the company's term for income from joint ventures), core FFO will rise about 13% this year.
At Wednesday's prices, Prologis was trading at roughly 31.5 times forecasted FFO per share, which is expensive for a REIT. The stock has been a stellar performer this year, rising about 28%. The dividend yield is 2%, which is on the low side for a REIT; however, that is a function of Prologis' continued investment in real estate. The payout ratio (which is the dividend divided by funds from operations) is 62%, which reflects the growth investment. Prologis may be fully valued at these levels, however business is great, and it should be for several years further as company inventory restocking continues. Current investors should probably hold, while potential investors might want to wait for a better entry point.