Share of Prologis (PLD 0.69%) fell around 4% across two days after the company's first-quarter earnings release. Normally, that would be an indication that a company had a bad quarter, but that wasn't the case at all. It seems investors are ignoring the obvious strength in the company's business and management's indications that the robust performance is likely to continue into the future.
What's going on here?
In fairness, Wall Street got a story in its head during the early days of the coronavirus pandemic. Basically, more people hiding out at home meant more people shopping online. And more online shopping meant an increased need for the warehouse properties that Prologis owns and operates as a real estate investment trust (REIT). The story was on target and resulted in a huge stock price advance.
Data source: YCharts
But once the world started to get back to normal, the rush to secure warehouses slowed. And investors cooled on the shares of the once-hot warehouse REITs it had bid up. That's why Prologis's stock price is down roughly 25% from its 2022 highs. Only a funny thing happened along the way here that doesn't seem likely to change: Market rents for warehouse properties have increased, and those rates appear to be holding up.
That means older leases that are rolling over are being repriced to the new, higher market rates. And that's leading to a massive opportunity for growth at Prologis. To put a number on that, in the first quarter of 2023 the REIT signed new leases that were 69% higher than expiring leases. In the second quarter, that number was 79%.
Plenty of room to run
Only a relatively small portion of leases roll over in any given quarter, so the impact on funds from operations (FFO), which is analogous to earnings for an industrial company, isn't as dramatic as the lease increases it is seeing on rollovers. But, still, first-quarter 2023 FFO increased nearly 12% year over year. Second-quarter FFO, removing a one-time benefit of around $0.58 per share, increased 12.5%. This is not a company that is struggling; it is one that's doing quite well. Indeed, that level of FFO growth for a REIT is fairly impressive.
But here's the interesting thing: Prologis isn't warning shareholders that the current strength is winding down. Quite the opposite: It is telling Wall Street to expect more of the same. For example, if the REIT was able to mark all of its leases up to market rents, it would increase rental income by 68%. But since that's something that will take shape over a number of years, management is expecting net operating income growth to be between 8% and 10% for at least another few years. That, in turn, should support material FFO growth.
Data source: YCharts
In fact, during the second-quarter earnings conference call, management noted that its first-quarter estimates for the future remain in place even though more leases have rolled over since that point. That's because the REIT continues to acquire new assets that it can roll over to higher rents, effectively extending out the flywheel on rent rollovers. Wall Street is downbeat on Prologis and its warehouses even though the story continues to be quite good.
Nothing has changed
What's most interesting about Prologis is that its business prospects haven't changed. What is happening today has been baked into the cake for a while at this point. The difference is that Wall Street has moved on to other "hot" stories, like artificial intelligence. For long-term investors interested in owning a fast-growing REIT that's also rewarding dividend investors with rapid dividend growth, Prologis is worth a deep dive despite what appears to be the market's disdain for the stock.
