Prologis (PLD -0.96%) was a standout performer in 2021. The logistics-focused real estate investment trust (REIT) gained nearly 70% last year, outpacing the REIT sector's roughly 40% average. However, shares have tumbled 26% from their peak this year. Most of that damage has happened in the past couple of weeks.
Here's a look at whether the stock is still a buy following the recent downdraft.
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What's driving Prologis' plunge?
Shares of Prologis started their nosedive right toward the end of April. The initial catalyst was news that e-commerce giant Amazon (AMZN -2.76%) now had more warehouse space than it needed. The company's CFO, Brian Olsavsky, stated on its quarterly conference call that it now has "a chance to right-size our capacity to a more normalized demand pattern." While the CFO said the company believes sales will eventually catch up with capacity, it plans to slow the rate of warehouse expansions in the near term.
Those comments sent shockwaves through the entire industrial real estate sector because Amazon is a major demand driver for warehouse space. Shares of most logistics-focused industrial REITs tumbled on the news:
Meanwhile, Prologis added more weight to its stock slide by going public with its offer to acquire fellow industrial REIT Duke Realty (DRE). Duke rejected the $24 billion proposal, saying it wasn't sufficient, though it remains open to exploring a deal, so Prologis will have to boost its bid if it wants to seal a deal. Paying more money at a time when demand for industrial real estate might cool off caused investors to worry that Prologis could end up eroding shareholder value in an attempt to get bigger.
A firm believer in the future of industrial real estate
While the Amazon news spooked investors, Prologis recently released a research report highlighting that strong demand is driving down available supply. The company noted three important takeaways:
- Competition for space is fueling record rent growth of 8.5% over the past quarter.
- Healthy consumer spending and supply chain issues continue to boost demand for logistics real estate.
- Material shortages are making it hard to build new supply.
The company noted that new supply came in lower than expected in the first quarter, driving vacancy down to a record low of 3.2%. Prologis also pointed out that all the available logistics space in the U.S. will dry up within 16 months at the current absorption rate. For context, there are usually 36 months of available supply in an expansionary period, and rents typically continue rising as long as there are less than 50 months of supply.
The company therefore believes rents will keep growing even as the industry continues to build new supply and Amazon pulls back on adding capacity. In the company's view, rents in the U.S. will surge another 22% this year.
However, Prologis doesn't need rents to rise to continue growing. Because of the long-term nature of its contracts, the average rent across its portfolio currently sits 47% below market rates. The company has an embedded upside of $1.6 billion in annual net operating income (NOI) as those leases roll over to the going market rate, assuming no additional rent growth. That's 45% higher than the current annualized NOI rate.
Meanwhile, there's additional upside potential from its extensive development program and ability to make acquisitions. Prologis noted that its proposed acquisition of Duke would be accretive to its funds from operations per share with significant merger synergies and substantial growth and upside for shareholders of both companies.
An even more attractive buy these days
With shares of Prologis losing more than a quarter of their value in recent weeks, the industrial REIT now trades at 25 times its 2022 FFO estimate, down from more than 30 times last month. That sell-off has also pushed its dividend yield up to around 2.5%. That makes it look like an attractive buy, considering the enormous embedded growth of its legacy portfolio and the upside potential from continued rent growth, development projects, and additional acquisitions.
