Bear markets can be incredibly brutal for investors. Stocks seem to be on an unending downward spiral with no bottom in sight. That can make it paralyzing to take the plunge on new investments, since prices could continue plummeting.
However, shares of high-quality companies sometimes fall so far that you have to hold your nose and take the plunge, since it seems highly likely they'll eventually recover. That appears to be the case for leading industrial real estate giant Prologis (PLD -1.30%). Shares were recently more than 40% below their 52-week high. That pushed the stock price to around $100 a share, driving the real estate investment trust's (REIT) dividend yield up over 3%.
Given the company's financial strength and embedded growth prospects, it looks like such an incredible value right now that investors will probably regret not buying shares at the current levels.
What's weighing on Prologis?
Shares of Prologis started their nosedive in late April after e-commerce giant Amazon (AMZN -2.54%) said it had more warehouse space than it currently needed. The news caused concerns that the red-hot demand for warehouse space would cool off.
Meanwhile, logistics giant FedEx (FDX 1.27%) put additional pressure on the warehouse sector by providing a dismal outlook in September. That led FedEx to take immediate action to reduce costs, including canceling planned network expansion capacity. Investors fear this move could further reduce demand for warehouse space, affecting occupancy levels and rent growth for companies like Prologis.
It's not as bleak as it seems
Despite all the negative headlines, Prologis hasn't seen any meaningful effect on its business. Occupancy in the third quarter rose to 97.7% by the end of August, up from 97.6% in the second quarter. While Amazon didn't lease any new space from the company in the early part of the third quarter, other e-commerce companies and those operating in different industries like transportation, manufacturing, and retail more than picked up the slack.
Because of that, rents signed in the period were 52.1% above those on expiring leases for the same space. That's an increase from 45.6% in the second quarter.
With most of Prologis' space secured by long-term leases, it's only capturing a fraction of the current market rents. The company estimated in the second quarter that the spread between its existing rents and market rates was nearly 56% across its portfolio. That's over $2 billion of embedded net operating income (NOI) potential for the company to capture as existing leases expire and roll to market rates.
To put that into perspective, Prologis believes its same-store NOI will grow at an 8% to 10% annual rate for the next several years without assuming any further rent growth. Meanwhile, it seems unlikely that rents won't keep rising, though likely at a more moderate pace, since the demand for warehouse space remains robust while supplies continue to be constrained.
In addition to that embedded rent growth, Prologis has several other growth drivers. The company has an extensive development pipeline, with several projects under construction and a vast land base to support additional development. It also recently acquired fellow industrial REIT Duke Realty in a $26 billion deal. The acquisition will be immediately accretive to its funds from operations (FFO) per share while enhancing its development pipeline. These investments will further boost its FFO per share growth rate.
Growth for a bargain price
Prologis expects its core FFO to rise to between $5.14 to $5.18 per share this year (11.5% above 2021's level), thanks to its embedded rent and portfolio growth. At the recent stock price of around $100 per share, Prologis trades at 19.4 times its FFO. That's slightly below the peer group average of 21.9 times and much cheaper than the 36.1 times FFO multiple the company fetched at the beginning of this year.
That lower valuation has Prologis' dividend yield up over 3%. That's a level we haven't seen since the early days of the pandemic. It's an enticing level for a company with Prologis' dividend track record. It has delivered double-digit compound annual dividend growth over the last one-, three-, and five-year periods, outpacing the REIT sector and the S&P 500.
Meanwhile, that payout is on rock-solid ground given Prologis' A-rated credit and a business on track to produce $1.7 billion of post-dividend free cash flow this year. Add that financial strength to its embedded growth, and Prologis should have no problem continuing to increase its dividend in the future.
An incredible value these days
Shares of Prologis have been under tremendous pressure on concerns that warehouse demand will cool off. However, the company isn't seeing any evidence of this yet. Furthermore, it has tremendous embedded growth due to the wide gap between market rents and its current leases, its extensive development pipeline, and the acquisition of Duke Realty.
Because of that, Prologis looks like a bargain at less than 20 times its FFO and a 3%+ dividend yield. While shares could keep falling, the value proposition offered right now is so compelling that investors might regret not taking advantage of the opportunity to buy shares of Prologis at these levels.
