Charles Dickens could have been describing Prologis' (PLD 0.17%) year when he penned that "it was the best of times, it was the worst of times." That's because, on the one hand, the warehouse operator is enjoying a record year. Demand for warehouse space has been nearly insatiable, causing rental rates to skyrocket and vacancies to plummet. However, it was the worst of times for investors, given that the stock lost a third of its value.
Here's a look at why the stock lost so much ground this year and whether it can rebound in 2023.
NYSE: PLD
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Heavy headlines
Prologis stock started its nosedive in late April. The culprit was Amazon's (AMZN +2.17%) first-quarter report, where the e-commerce giant proclaimed that it had more warehouse space than it needed. The company had overexpanded during the pandemic, growing its warehouse footprint by about 50%. With demand starting to slow, it had too much capacity. Now the company has started shedding some of its excess warehouse space.
That news sent shivers down the spine of investors in industrial REITs like Prologis. That's because Amazon is one of the sector's largest tenants (it's Prologis' top client at 5.2% of its annual rent). Further, its expansion had been a key catalyst driving demand for warehouse space. With it pulling back, investors feared demand for warehouse space would cool off, which would impact rental growth and occupancy levels.
NASDAQ: AMZN
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Shares of Prologis faced another headline-driven sell-off following FedEx's (FDX 2.13%) fiscal first-quarter report in late September. The global logistics giant was experiencing a difficult operating environment because of reduced demand. That led FedEx to unveil several actions to reduce costs, including plans to close several facilities.
As Prologis' second largest tenant at 1.5% of its rent, FedEx's news put additional downward pressure on the stock price. It caused more concern that warehouse space demand could decline, negatively impacting rental rates and occupancy levels.
NYSE: FDX
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Prologis' operating results tell a different story
Despite those negative headlines, Prologis is having an excellent year. The global warehouse giant reported record third-quarter results in October, showcasing the continued strength of its business. Occupancy remained high at 97.7%, while rental rates on new leases signed in the period were 59.7% above the prior rates (an all-time high) on expiring leases covering that same space. That drove record cash same-store net operating income (NOI) growth of 9.3% in the period. While Amazon and FedEx have pulled back on leasing, other companies have more than filled in the gaps.
Because Prologis has yet to capture the full impact of rising rental rates as a result of the long-term nature of its leases, the company has significant embedded NOI growth as legacy leases expire and reprice to current market rents. The company currently estimates that there's a 62% gap between market rates and its existing rents. As a result, Prologis projects that its same-store NOI will grow at an 8% to 10% annual rate for the next several years as leases expire and it signs new ones at higher rents. That forecast assumes no further increase in market rents, which seems unlikely since demand remains healthy and supplies are constrained.
In addition, the company took advantage of the negative headlines to swoop in and acquire its largest rival, Duke Realty, for $26 billion. That deal will be immediately accretive to its core funds from operations (FFO) per share. On top of that, Prologis expects to capture significant additional value from the combination through capital cost savings, essentials income, and other factors.
The company also has a significant development pipeline underway. It has over $4 billion of projects it should complete starting next year and has already pre-leased 46% of this space. These developments will provide incremental income as the leases commence.
Putting everything together, Prologis is in an excellent position to grow its core FFO per share at an above-average rate in 2023 and beyond. That should enable the company to continue its track record of delivering leading growth rates. Over the last five years, Prologis has grown its core FFO at an 11% compound annual rate while increasing its dividend at a 12% yearly pace.
If the headlines change, Prologis stock should bounce back
Prologis continues to be the victim of negative headlines, which could continue next year if there's an economic downturn. That could put even more pressure on the stock.
However, Prologis' underlying business should continue to perform well thanks to its growth catalysts. The stock is likely to bounce back sharply as soon as headlines start turning positive again. In the meantime, investors can scoop up shares of this unstoppable growth stock at a lower valuation and higher dividend yield, positioning them to capitalize on its eventual rebound.
