Earning season is upon us, and Prologis (PLD 0.69%), as usual, was one of the first real estate investment trusts (REITs) to report numbers. It's a bit of a bellwether for the U.S. economy, so even investors who don't have a position in it will often look to its results to get a read on the status of the domestic consumer and industrial production. But based on its just-reported second-quarter results, is the stock a buy?
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Prologis is a bellwether for the global economy
Prologis is one of the premier logistics REITs in the world. It owns and operates 5,563 buildings with 1.2 billion square feet of warehouse space. If you drive along a major artery surrounding any big urban area, you will see giant warehouses with dozens of truck bays. Many of these properties belong to Prologis.
It is hard to understate the REIT's role in the global economy. The company estimates that $2.7 trillion worth of goods pass through its facilities each year, which represents 2.8% of worldwide gross domestic product. In many ways, the company's condition offers a great indicator of the state of global growth.
Prologis earnings beat the Street
On July 18, Prologis reported second-quarter results that beat Wall Street's estimates. The company's core funds from operations (FFO) were $1.83 per share, which was a big increase from the $1.11 per share it reported in the prior-year period.
REITs and their investors focus on FFO as their most important earnings metric because net income tends to understate the cash-flow-generating capacity of these types of companies. This is because generally accepted accounting principles (GAAP) require companies to deduct depreciation and amortization -- something REITs have a lot of -- from revenue. Since those are non-cash charges (you don't write checks for them), it makes sense for REITs to leave them out of the earnings picture. To give you an idea of how much of a difference it makes, Prologis reported GAAP earnings per share of $1.31 versus FFO per share of $1.83.
Prologis's 65% increase in FFO per share was driven primarily by its acquisition of Duke Realty, which closed last October. The net effective rent increase on new leases was 87%, and in some areas such as Phoenix and Southern California, the increases were more than 100%. Net effective rent change compares the rents on expiring leases with the rents received on the new ones.
The post-pandemic bump is fading
Prologis shares have been on a roll since the pandemic, and the operating environment is returning to something more normal. The supply chain issues that occurred during the pandemic exposed a lot of cracks in U.S. corporate infrastructure. As a general rule, companies want to minimize the amount of inventory they hold because inventory ties up capital, and can be an inefficient use of corporate assets. The COVID-related supply chain disruptions forced companies to reassess the size of the inventory cushions they needed, and led many to build up those reserves. This in turn fueled increased demand for warehouse space, and Prologis was a big beneficiary of this adjustment. Now that corporate America has adjusted its inventory levels, the increases in demand for logistics space are leveling off. So rent growth rates, which were exceptionally high in the past couple of years when demand surged, are returning to normal.
Prologis is premium company trading at a premium valuation
Prologis upped its core FFO forecast for 2023 to a range of $5.56 per share to $5.60 per share. At current levels, this gives Prologis a price-to-FFO ratio of 22. That's high for a REIT, but Prologis has always traded at a premium multiple. It has some of the best real estate located close to major urban areas, and it isn't easy for smaller players to compete with its portfolio. At current share prices, its dividend yields 2.8%, which is low for a REIT.
Even though Prologis's Q2 earnings beat Wall Street's expectations, the stock slid by 3% on the day of the release. So investors now might have a chance to pick up this quality REIT at a bit of a discount. Prologis is still a richly valued stock. However, as long as the company continues to boost its forecasts and its rental growth holds up, it will continue to command a premium multiple.
