Several leading indicators of recessions are flashing warning signs these days, and many investors are growing increasingly concerned. A recession could negatively impact corporate earnings, likely putting even more downward pressure on stock prices.
However, some companies with durable businesses that benefit from dynamic growth drivers are relatively immune to the economic cycle. Real estate logistics giant Prologis (PLD 0.66%) looks to be one of them. While demand for warehouse space tends to fall during recessions, a combination of catalysts has positioned this REIT to continue growing its earnings and dividend at a healthy pace in 2023 and beyond, even if a recession occurs.
Built-in growth
The pandemic has had a lasting impact on the industrial real estate market. It accelerated the adoption of e-commerce and led companies to adjust their inventory management practices to combat persistent supply chain issues. These catalysts have driven increased demand for warehouse space around the world. Because of that, vacancy levels are at record lows, and rental rates on available space have skyrocketed.
Prologis has yet to capture the full impact of surging rental rates because it signs long-term leases. As a result, however, it has significant embedded growth.
Image source: Prologis Investor Relations Presentation.
As the slide above showcases, Prologis estimates its same-store net operating income will grow at an 8% to 10% annual rate for the next several years as its existing leases expire and it leases those spaces at higher market rents. This forecast assumes no further increase in the market rates for rents, which seems unlikely even during a recession. For example, despite the current macroeconomic headwinds, Prologis conservatively estimates that rents will rise by 9% across its global markets this year, including 10% in the U.S. That would further increase the gap between its current rent base and its projected future rental income as it captures higher market rents.
For 2023, Prologis estimates that economic headwinds will cause its occupancy rate to fall slightly to between 96.5% to 97.5%. However, when adding in rent change, its same-store net operating income will grow by 8% to 9% this year. When adding in its other growth drivers -- accretive acquisitions and development projects -- its core funds from operations (FFO) should expand by 9.5% per share at the midpoint of its guidance range. That's an impressive growth rate, given the company's macro forecast that assumes a moderate recession this year. That growth outlook recently led management to increase the dividend by another 10%.
Dynamic growth ahead
Prologis' embedded rent growth is one of many drivers it can take advantage of. The logistics REIT can also enhance growth by making accretive acquisitions, completing value-enhancing development projects, and growing its essentials platform.
The company completed a large-scale deal last year, acquiring rival Duke Realty for $26 billion. That acquisition will enhance growth over the coming years. Prologis expected an immediate boost to core FFO per share during the first full year following the deal. In addition, it anticipates capturing $375 million to $400 million of annual earnings and value accretion in the future. The company has an exceptionally strong balance sheet, giving it the flexibility to continue making accretive acquisitions as opportunities arise. A recession could increase its opportunity set since property valuations should come down, potentially making future acquisitions more accretive.
Prologis also has an excellent track record of creating value through development projects. The company has a vast land bank to support new projects. Meanwhile, given the current demand forecast, it should have plenty of opportunities to start new developments.
Finally, Prologis has started offering additional services to its tenants through its essentials platform. These include access to renewable power, electric vehicle charging capabilities, workforce training, and maintenance services. While the essentials platform supplies a relatively small portion of its revenue, it is incremental income, and those services make tenants more likely to renew their leases. It also makes acquisitions more accretive because it can offer those services to the new tenants it gains. For example, the company expects to generate $70 million to $90 million of incremental property cash flow and essentials income from its Duke Realty deal.
Resilient growth ahead
Prologis anticipates there will be a moderate recession. However, the company has so many growth drivers that it still expects to deliver nearly double-digit percentage cash flow per share growth this year. Those tailwinds should continue driving growth in future years, positioning the company to continue increasing its dividend at a healthy pace. Because of that, it's a fairly recession-resistant dividend stock, making it a great investment amid the current environment.
