Shares of Prologis (PLD +2.07%) have tumbled 40% from their peak earlier this year. That's largely due to worries that warehouse space demand will cool off considerably.
However, the leading logistics REIT hasn't seen any signs of a slowdown. That's clear in its recent third-quarter report and outlook for what's ahead. Because of that, the steep decline in its share price makes it look like an even more attractive buy since the sell-off pushed the dividend yield up to 3%.
NYSE: PLD
Key Data Points
Strength amid the storm
Investors have a lot of things on their minds these days. "We are clearly in a volatile macro environment where ongoing inflation, steeply rising interest rates, and the war and energy crisis in Europe are pressuring the global economy, " stated Prologis CFO Tim Arndt on its third-quarter conference call. While he said the company is "closely monitoring each element," the CFO noted that "the fundamentals in our business are very strong, and our read of supply and demand in our markets remains out of sync with the headlines."
That's clear in the company's third-quarter financial results. Prologis' core funds from operations (FFO) surged 12.6% after excluding the net promote income from its asset management business (FFO was up over 65% when including those earnings).
A big driver was the strong performance of its existing portfolio. The company reported same-store net operating income growth of 9.3%, which was an all-time high. That's largely due to a staggering 59.7% increase in rental rates for leases signed in the quarter compared to the rate of expiring leases on the same space. It was also a record level for the company.
Meanwhile, occupancy was a record 97.8% as of the end of the quarter. That's up from 97.7% at the end of the second quarter and 97.1% at the end of the year-ago period.
Current market conditions remain strong
Arndt then provided investors with some observations on the current market conditions. He stated:
We continue to see scarcity of available space across our markets. Vacancy rates are at historic lows, and our own occupancy sits at a record high. Market rent growth in the third quarter remained robust in response to this scarcity and continued strong demand.
While recent headlines that notable customers like Amazon and FedEx had paused some of their expansion plans have worried investors, they seem to be an outlier because they already have mature supply chains. The CFO noted that "active dialogue with the majority of our customers confirms an overarching need to increase space as supply chain resiliency remains a top concern."
Meanwhile, as construction and capital costs rise, the company is starting to see the initial signs of a deceleration in development activity across its markets. As a result, Prologis believes the industry could see a gap in deliveries in the late 2023 to early 2024 time frame. As things currently stand, it sees new supply coming down by 15% next year.
These factors should drive continued rent growth. That would add to the company's already sizable embedded upside. It ended the quarter with an average lease rate across its portfolio that sits 62% below market rates. Because of that, Prologis estimates that its same-store NOI will grow at an 8% to 10% annual rate for the next several years as existing leases expire and roll over to market rates. If market rents keep rising, NOI could grow even faster.
Meanwhile, the company expects to start $4.2 billion to $4.6 billion of development projects this year. While that's down from its initial estimate as it takes a more conservative approach given the uncertain macroeconomic environment, these developments should provide an additional boost to its FFO as they stabilize in the future. The company also has ample financial flexibility to fund more developments and make acquisitions as investment opportunities arise to drive additional FFO per-share growth. When added to its embedded rent growth upside, these investments should enable Prologis to continue growing its dividend at a healthy rate for the next several years.
Down despite its continued strength
Shares of Prologis have tumbled this year on concerns that demand for warehouse space would slow down, causing rent growth to stall. However, the company isn't seeing any evidence of this. Meanwhile, even if rents didn't grow, there's a huge gap between its existing rates and current market rents, which should drive steady growth for the next several years. Because of that, the steep slide in its stock price looks like a great buying opportunity for investors seeking growth and income.
