Some companies are often good indicators of the overall health of the economy. For example, large retailers can often signal the strength of consumer spending, which is the biggest component of gross domestic product (GDP). Although it's not a retailer, Prologis (PLD 0.34%) is another kind of company that has a finger on the nation's economic pulse. The company just reported third-quarter earnings and withdrew its forecast for 2022. Is this a red flag for the economy?
Prologis is one of the leaders in the logistics industry
Prologis is a logistics real estate investment trust (REIT), serving all sorts of customers, from retailers to manufacturers. If you drive along any of the major highways near big cities, you will see all sorts of massive warehouses with dozens of truck bays. Prologis has 4,914 buildings, with about 1 billion square feet. While Prologis has a global footprint, the U.S. accounts for about 82% of the company's net income.
The COVID-19 pandemic was a wake-up call for many companies and retailers that followed a lean inventory management policy. Extended supply chains do allow companies to operate more efficiently; however, it leaves them vulnerable to shocks. COVID-19 was one of those shocks. Retailers found themselves with empty shelves, and manufacturers had to put production on hold to wait for parts. In the aftermath, corporations sought more storage space for inventory to prevent further supply chain disruptions.
FedEx and Amazon are slowing their expansion
That was then. On the earnings conference call, Chief Financial Officer Tim Arendt said that "certain customers have publicly announced a pause in capex spending, particularly those with more mature supply chains." He is largely referring to Amazon.com and FedEx, which have announced they are slowing the pace of warehouse space leasing. If bellwether corporations like these two are cutting investment, that could be a red flag for the economy.
Prologis Chief Executive Officer Hamid Moghadam put things into perspective with respect to Amazon and FedEx, saying that Amazon was "on a tear" in 2020 and 2021, and "they [Amazon] probably overcommitted to space, and they just reeled that back a bit." He also noted that none of Prologis's leases are affected by Amazon's decision. He mentioned that FedEx was consolidating some of its airport operations and Prologis might end up being the beneficiary of that. So, although the Amazon and FedEx decisions may be a negative indicator for the economy, they aren't going to be an issue for Prologis.
The overall economic environment is difficult
Overall, the macroeconomic environment is experiencing some headwinds given the Fed's steady diet of 75 basis-point (0.75%) increases in the federal funds rate over the past several months. Monetary policy tends to affect the economy with a lag, so a lot of that tightening hasn't had a chance to work yet. That said, Prologis' business seems to be holding up, with occupancy at 97.7% and a nearly 59.7% increase in net effective rent, which is a record for the company.
That said, the company did reduce its projections for core funds from operations (FFO) from a range of $5.14 to $5.18 to a range of $5.12 to $5.14. In the press release, CFO Arendt said the company was "confident as ever about the resiliency of our business, we are exercising caution in the near term...Accordingly, we are taking a more conservative approach in how we choose to allocate our capital, and are therefore lowering our guidance for development starts, dispositions and contributions while we closely monitor the market." This is a cautionary statement about the economy, especially as it heads into the fourth quarter.
Prologis is trading at 21.4 times its estimated 2022 FFO per share, which is about reasonable for a market leader in a rising-rate environment. The $3.16 annual dividend is more than amply covered by the FFO forecast, and at current levels, the stock has a yield of 2.7%. Prologis will continue to benefit from the longer-term change in corporate inventory management, and demand remains strong for space. The reduced FFO estimate probably makes sense in the current economic environment. Holiday retail spending will tell us a lot about the state of the economy.