The COVID-19 pandemic exposed some flaws in modern corporate thinking, especially around the vulnerability of extended supply chains. Investors who wish to take advantage of that sea change might want to take a look at Prologis (PLD 0.69%), which stands to benefit from this change.
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Prologis touches 2.8% of global GDP
Prologis is a global logistics real estate investment trust (REIT). If you drive down the interstate near any major city, you'll often see massive structures with dozens of truck bays. These are generally operated by logistics REITs like Prologis. Prologis has 1.2 billion square feet of facilities, and it estimates that 2.8% of global gross domestic product (GDP) flows through its distribution centers.
Prologis focuses on facilities in high-barrier, high-growth markets. This means that they are generally located close to major urban areas where real estate is scarce. E-commerce has been a tailwind for logistics companies like Prologis, because these businesses use three times the logistics space that brick-and-mortar retailers do. This is due to the requirement to hold higher inventory to account for items that aren't carried in stores, along with returns and consumer shipping.
Corporations are building inventory
Another tailwind for Prologis is that the COVID-19 pandemic exposed the business risks of having extended supply chains with minimal inventory. Ever since the 1980s, businesses have strived to minimize inventory in order to maximize efficiency. Inventory is a cost, and excessive inventory can be a business risk. That said, the supply chain issues of COVID showed that not only was too much inventory a risk, so was too little inventory.
Businesses are now rebuilding inventory, and Prologis estimates that the 1990s levels of inventory will become the new normal. This would translate into businesses keeping a 10% buffer. Currently, the buffer is about 2%. While the correction is in progress, it still has some ways to go.
Prologis is experiencing elevated occupancy rates, with 2022 occupancy at 98.2%. Occupancy has since slipped to 98% at the end of the first quarter of 2023 -- and to 97.5% as of the end of May. Still, this is above pre-pandemic levels. Rental rates have been robust, surging 87.5% on new signings. This is an acceleration since the end of March. Fundamentally, Prologis's business is doing well, and there are plenty of short-term and long-term reasons to like the business itself.
The stock is not terribly cheap at the moment
In terms of valuation, Prologis is currently near the middle of its historic range, at least if you look at price-to-earnings (P/E) ratios. Like most REITs, Prologis has reacted negatively to rising interest rates. This is because REITs tend to borrow a lot of money, and when rates rise, so does interest expense, which causes investors to reduce the multiple they are willing to pay.
PLD PE Ratio data by YCharts
That said, price-to-earnings ratios are not the best way to look at REITs; price relative to funds from operations (FFO) per share is much better. Funds from operations excludes depreciation and amortization, and other non-cash charges, to better approximate cash flow. Prologis is guiding for 2023 FFO per share to come in between $5.42 and $5.50 per share. Thus, Prologis shares are trading around 22 times 2023 FFO, which is a reasonable multiple for a high-quality REIT. The dividend yield of 2.73% is on the low side for a REIT, but Prologis is still expanding.
Prologis isn't necessarily a great stock for income investors (you can get better yields elsewhere). However, the REIT is a stalwart that lets the investor sleep at night.
