This article was co-produced with Nicholas Ward.
The world can be a scary place.
Right now, we’re seeing headlines highlighting the spread of the continued Omicron variant, and uncertain monetary and fiscal policy in the U.S. (and from other central banks around the world) which could disrupt economic growth.
The premiums applied to equities in the stock market and supply chain issues are still leading to historic inflation, and just this week President Biden said publicly that he expects to see Putin invade Ukraine, which is likely to result in an actual hot war in Europe, which is something that we haven’t seen since the fall of the Soviet Union.
All of these serve as bearish catalysts for the market, which has begun to sell off during 2022 (thus far).
No one knows what the future holds.
It’s unclear how bad any one of these issues might become… and therefore, what sort of bear market event might follow.
However, the fact is, investors are running for the hills, with the rotation out of growth and into value names accelerating. And to us, this move makes sense.
There’s certainly no shame in reducing speculation and focusing one’s attention on the highest quality assets during times of uncertainty, and, when it comes to defensive REITs, in terms of quality, at least, it doesn’t get any better than Prologis (NYSE:PLD).
PLD receives a 100/100 quality score on the iREIT IQ index, making it one of just two companies to earn that distinction (Alexandria Real Estate (ARE) is the other).
Now, the issue with PLD is its valuation.
Everyone knows that this is a best-in-breed company which benefits from strong secular tailwinds (due to the steady rise of eCommerce) and therefore, the market has been willing to pay a massive premium for PLD shares for years now.
Historically, we’ve been unable to justify the multiples attached to PLD, which is why this stock - even with its immense quality score - has been rated as a “Sell” within our tracking system for quite some time.
Yet, that doesn’t mean that we ignore its results.
PLD shares are down approximately 8.5% year-to-date and the company just reported its Q4 earnings, which beat Wall Street’s estimates on both the top and bottom lines.
Therefore, we wanted to take the time to update subscribers on the company’s operational success and discuss whether or not it’s time to update our B/S/H recommendation.
Prologis is an industrial REIT, which owns and operates large footprint warehousing and logistical infrastructure buildings.
The company has built out a global portfolio (which is something that we like to see because it enables the company to take advantage of the most attractive global rates when it comes to the debt markets) with properties and development projects that span 1 billion square feet of physical real estate.
As you can see below, PLD’s operations are highly concentrated in the United States, which accounts for approximately 81% of its NOI. However, the growing eCommerce trend is certainly not a United States specific growth market and therefore, PLD has done a wonderful job of establishing a global footprint which makes it the clear leader in this space.
You’ll see that PLD’s portfolio is fairly well diversified when it comes to the size of buildings that it owns/operates. In short, PLD has expertise up and down the logistical supply chain, allowing itself to invest in high demand areas, regardless of the potential footprint.
And, as you’ll see in a moment, this portfolio continues to produce strong results for the company, which is exactly why PLD’s quality scores are so high.
But, before we hop into the Q4/Full-Year results, we want to highlight the strength of PLD’s balance sheet, which certainly factors into our high iREIT IQ scores, and also plays an important role in PLD’s ability to continue to operate and grow its global industrial property footprint.
This is an A- rated company (using Standard and Poor’s credit rating) and during the Q4 report, the company highlighted its balance sheet strength saying:
“During the fourth quarter, Prologis and its co-investment ventures issued $2.9 billion of debt at a weighted average interest rate of 1.1 percent, and issued $11.5 billion of debt for the full year at a weighted average interest rate of 1.3 percent, including $906 million in green bonds. The company maintained its leading liquidity position with approximately $5.0 billion in cash and availability on its credit facilities at year-end.”
“As of December 31, 2021, debt as a percentage of total market capitalization was 13.5 percent and the company's weighted average interest rate on its share of total debt was 1.7 percent with a weighted average term of 10.0 years. The combined investment capacity of Prologis and its open-ended ventures, at levels in line with their current ratings, is approximately $15.5 billion.”
Those low single digit rates are simply amazing. With such a low cost of capital in mind, it’s no wonder that this REIT is able to generate such reliable profit figures.
And, moving forward, we don’t expect to see this change.
While management stayed aggressive throughout 2021, investing roughly $4.2 billion into new acquisitions, development stabilizations, and development starts, it also maintained a disciplined eye on its capital structure, showing that ongoing growth, via acquisitions and development, remains a sustainable form of growth.
Frankly, PLD’s Q4 results were outstanding.
This isn’t hyperbole.
The company is showing growth across all primary metrics that we use to track results. And, during the Q4 report, PLD provided 2022 guidance which points towards more strong growth ahead.
During Q4, PLD produced core FFO of $1.12/share, up 17.9% on a y/y basis.
For the full-year, PLD’s core FFO came in at $4.15/share, up 9.2% on a y/y basis.
And, as you can see below, the company’s AFFO was up as well, which allowed PLD to continue to return more cash to shareholders during 2021 (keeping the strong trend that we’ve seen since 2014 here intact).
During the Q4 report, PLD’s co-founder and CEO, Hamid R. Moghadam, was quoted as saying,
"Demand for our 1 billion square foot global portfolio shows no signs of slowing and we are positioned ideally to meet our customers' most critical real estate needs.”
In interviews since, he’s noted that he’s never seen a stronger operational environment, in terms of continued demand for the industrial properties that PLD owns, and therefore, he remains very confident that the growth that we’re seeing here will continue into the future.
Looking at the graphic below, you’ll see that PLD’s occupancy ratio and y/y same store rent growth continue to rise, showing the strong demand that exists in this industry.
During Q4, the company reported seeing net effective rent rise by 510 basis points, with same-store cash NOI rising by 7.5% overall (this metric was up 8.1% in the U.S. and 5.3% in PLD’s international markets).
As the world continues to recover from the COVID-19 pandemic and supply chain issues get sorted out, we expect to see these rents continue to increase as production and shipping volumes ramp up to meet consumer demand.
Furthermore, we see that these demand-related trends are fairly widespread, with properties in nearly all of PLD’s geographic segments (with the exception of the Asia region) showing increasing occupancy results.
This is all great for the company and management made it clear that it is bullish on the macro environment right now, providing full-year 2022 guidance, which calls for high single digit Core FFO growth (7.7% at the midpoint) and continued same-store-rent growth.
Regarding 2022 guidance, during the Q4 report, Thomas S. Olinger, PLD's CFO, said:
"While 2021 was a year of many records, most of the benefit from the current environment will be realized in the future. Our high-quality growth profile is driven by our lease mark-to-market, profitable Strategic Capital business, development build-out potential and leverage capacity, all of which provide a clear, tangible runway for sector-leading growth for many years to come."
Overall, it appears that the steady growth story that PLD has become known for throughout the last 8 years or so (basically, a period of time which coincides with the eCommerce boom) is expected to continue into 2022.
And now, with that being said, the question remains…
...what sort of premium does this A-rated company, which is expected to post high single digit bottom-line growth in the future, deserve to trade with?
While PLD is a winner in terms of its 100/100 iREIT IQ score, it is not a top performing when it comes to the iREIT IV (valuation scoring metric).
Even though PLD is down nearly double digits from its recent 52-week high, the stock’s iREIT IV score sits at just 16/100.
Today, PLD shares trade with a blended P/FFO multiple of 36.9x. That is well above PLD’s 5-, 10-, and 20-year average P/FFO multiples of 28.3x, 23.05x, and 21.7x, respectively.
As you can see on the chart above, we highlighted the current 36.9x blended multiple with the pink line, showing clearly that even after PLD’s recent pullback, the stock is trading at a valuation level which is unprecedented in its long-term history.
While it’s true that PLD deserves a premium multiple (the stock is expected to post FFO growth of 12% this year, 6% next year, and 10% the year after that, showing very reliable growth at a high level which would make its peers envious), we believe that a ~37x multiple is too rich for a company expected to post ~10% annual FFO growth.
Generally speaking, it’s tough to stomach forward PEG ratios greater than 2.0x and here, when looking at FFO estimates, we’re talking about a forward PEG of approximately 3.0x.
Using the current 2022 FFO consensus estimate (of $4.66/share), we see that PLD is trading for 33x forward earnings.
That’s still far too high, in our opinion, and therefore, because of the poor margin of safety that we see here, we continue to maintain our “sell” rating on PLD shares.
Remember, in terms of a high quality, defensive investment, quality is just one part of the due diligence screening process. We firmly believe that investors should not ignore valuation.
In PLD’s case, while we’re happy to acknowledge that management is doing a wonderful job running the company and is producing amazing results, we’re of the belief that the market has it wrong when it comes to the valuation multiples that it has been willing to pay for PLD shares and therefore, the risk/reward here remains unattractive.
Therefore, as investors attempt to embark upon flights to safety in today’s volatile market, we believe that they’re best suited to look elsewhere.
We’d love to buy shares of PLD for various portfolios, but the recent 10% pullback isn’t enough to change our bearish stance. We’ll be watching closely to see if this sell-off accelerates so that we can become buyers at an attractive price.
But, shares have a long way to fall before they cross down below our ‘Buy Up To” threshold of $85.00/share.
Meanwhile, we'll keep fishing here at iREIT, casting nets in other areas (perhaps Lodging - we're working on a deep dive now for our members).
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This article was written by
Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 15,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) iREIT on Alpha (Seeking Alpha), and (2) The Dividend Kings (Seeking Alpha), and (3) Wide Moat Research. He is also the editor of The Forbes Real Estate Investor.
Thomas has also been featured in Barron's, Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox.
He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2021, and 2022 (based on page views) and has over 108,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley) and is writing a new book, REITs For Dummies.Thomas received a Bachelor of Science degree in Business/Economics from Presbyterian College and he is married with 5 wonderful kids. He has over 30 years of real estate investing experience and is one of the most prolific writers on Seeking Alpha. To learn more about Brad visit HERE.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Author's Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: written and distributed only to assist in research while providing a forum for second-level thinking.