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This Dividend Stock Has Enormous Growth Potential

By Matthew DiLallo – Oct 19, 2021 at 8:43AM

Key Points

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The dividend will probably continue growing at an above-average rate in the coming years.

As a real estate investment trust (REIT), Prologis (PLD 4.05%) must distribute 90% of its net income to investors via dividend payments. However, that dividend requirement hasn't slowed its ability to grow one bit. Instead, Prologis has delivered above-average earnings growth in each of the last five years.

That trend will probably continue, which is one of the clear takeaways from the company's third-quarter results. Here's a closer look at what's ahead for the logistics-focused real estate company.

A person at a computer with financial charts on a desk overlaid by an upward pointing arrow.

Image source: Getty Images.

A top-notch dividend stock

Prologis has been a great stock for dividend investors. It pays a slightly above-average dividend (it currently yields 1.8%, above the S&P 500's 1.3% dividend yield). Meanwhile, it has steadily increased that payout over the past several years.  

Prologis has one of the most sustainable dividends in the REIT sector. While the REIT must pay out 90% of its net income to remain in compliance with IRS guidelines, it has a much more conservative dividend payout ratio overall. Because of depreciation, a REIT's earnings are usually significantly less than their cash flow -- measured by their funds from operations (FFO). Prologis only pays out about 60% of its adjusted FFO, which has it on track to produce $1.25 billion in excess cash after paying its dividend this year.

On top of that, it has one of the strongest balance sheets in the REIT sector as it's one of only a handful with A-rated credit. That enhances its financial flexibility, giving it the funds to continue expanding its industry-leading logistics real estate portfolio. That growth has enabled Prologis to deliver above-average compound annual dividend growth over the last five years.

A growth stock disguised as a dividend stock

Prologis' dividend is only part of its story. It's also a great growth stock. The company has delivered the best core FFO per share growth over the last one-, three-, and five-year periods compared to other REITs and the S&P 500.

That outsize growth is likely to continue. The company delivered 15.6% year-over-year core FFO growth during the third quarter, thanks to "record increases in market rents and valuations," according to comments by CEO Hamid Moghadam in the earnings press release. He further noted that: "Operating conditions are being shaped by the structural forces driving demand. With vacancies at unprecedented lows, space in our markets is effectively sold out." 

Accelerating e-commerce adoption and supply chain issues are driving companies to lock up warehouse space around the world. That's pushing up occupancy levels and rental rates in the company's facilities. Those tailwinds aren't likely to fade anytime soon, suggesting it has lots of growth ahead.

CFO Thomas Olinger stated in the earnings press release: "Our earnings potential is unrivaled. Most of the benefit from the current environment will accrue to the future given our 22% in-place-to-market rent spread, the valuation impact on our promotes, our leverage capacity, the $21 billion of development build-out and, most importantly, the vast opportunity set that our global footprint provides." 

As existing leases expire, Prologis can capture higher market rents, which are more than 20% higher than existing contracts. That will drive significant earnings growth in the coming years. Prologis will also benefit from its real estate investment management business, which will earn it a promote, or a share of the funds' profits as those investments also benefit from rising rental rates and property valuations.

In addition to that embedded organic growth, Prologis has the financial flexibility to continue expanding its portfolio via acquisitions and development projects. The company has several developments already underway and a vast land bank to continue building. That land position gives it a competitive advantage because it's getting harder to find suitable land for warehouses. 

These factors should enable Prologis to continue growing its core FFO at an above-average pace. That should support continued dividend growth. With dividend growth stocks historically outperforming the market, Prologis is in an excellent position to continue generating attractive total returns for its investors.  

A great option for dividend and growth investors

Prologis provides investors with the best of both worlds. It pays a compelling dividend and is growing its earnings at an above-average rate. With demand for warehouse space increasing and supplies tightening, Prologis should continue growing at a fast clip in the coming years. That sets it up to potentially produce market-beating total returns, making it a stock that investors won't want to miss.

Matthew DiLallo owns shares of Prologis. The Motley Fool owns shares of and recommends Prologis. The Motley Fool has a disclosure policy.

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