Prologis, Inc. (NYSE:PLD) Q1 2024 Earnings Call Transcript

Prologis, Inc. (NYSE:PLD) Q1 2024 Earnings Call Transcript April 17, 2024

Prologis, Inc. misses on earnings expectations. Reported EPS is $0.63 EPS, expectations were $1.28. PLD isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to the Prologis First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Natasha Law, Director of Investor Relations. Thank you, Natasha. You may begin.

Natasha Law: Thanks, John. Good morning, everyone. Welcome to our first quarter 2024 earnings conference call. The supplemental document is available on our website at prologis.com under Investor Relations. I’d like to state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates, and projections about the market and the industry in which Prologis operates, as well as management’s beliefs and assumptions. Forward-looking statements are not guarantees of performance, and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or other SEC filings.

Additionally, our first quarter earnings press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP. And in accordance with Reg G, we have provided a reconciliation to those measures. I’d like to welcome Tim Arndt, our CFO, who will cover results, real-time market conditions and guidance. Hamid Moghadam, our CEO, and our entire executive team are also with us today. With that, I will hand the call over to Tim.

Tim Arndt: Good morning and thank you for joining our call. We’ve had a good start to the year in terms of our operating and financial results in the first quarter. We delivered strong rent change, drove occupancy slightly ahead of our forecast, raised nearly $5 billion in capital, including $750 million in strategic capital, and made important headway in our Energy business. That said, as we evaluate the market, persistent inflation and high interest rates have kept more customers focused on controlling costs. The resulting delay in decision making, easily observed through the first quarter’s below average net absorption, will translate to lower leasing volume within the year. Accordingly, we’ve opted to adjust our guidance early, getting ahead of what looks like a period of occupancy below our forecast in the near term and its effect on same store in a number of our higher rent markets.

This is punctuated, of course, by a more pronounced period of correction still underway in Southern California. New starts, however, continues to be surprisingly disciplined, adding to the expectation for limited new supply in the back half of ’24, but also extending deeper into ’25. When considered alongside muted demand, we arrive at a view that the operating environment has only changed modestly in aggregate, and that demand is simply pushing out by a few quarters. The outcome of this may simply mean moving towards a long-term occupancy expectation more swiftly this year, which sets up for a better next year. Turning to our results for the quarter. Core FFO, excluding promotes, was $1.31 per share and including net promote expense was $1.28 per share, essentially in line with our forecast.

Occupancy in the portfolio ended the quarter at 97%. For context, the US market declined 310 basis points since its peak in the summer of ’22, while our portfolio’s occupancy has only declined 80 basis points, resulting in vacancy today for Prologis that is less than half of that in our markets and reflective of our portfolio quality. Net effective rent change was 68% based on commencements and 70% based on new signings. Following this in-place increase and changes in market rents, our net effective lease mark-to-market stands at 50%, representing over $2.2 billion of rent to harvest without any additional market rent growth from here. Rent growth captured just for the single quarter was approximately $110 million on an annualized basis and at our share.

Our same-store growth on a cash basis was 5.7% and on a net effective basis was 4.1%. The same-store from rent change alone was strong at approximately 9%, but is impacted by a 130 basis point change in year-over-year vacancy, as well as 150 basis points from fair value lease adjustments with the Duke portfolio’s inclusion in our same-store pool. Additionally, there were approximately 175 basis points of items specific to the quarter, including one-time reconciling items from 2023, as well as unfavorable comps from low expenses last year. We started over $270 million of new developments in the quarter, bringing our portfolio to approximately $7.5 billion at our share, with estimated value creation of over $1.7 billion, a number we feel increasingly confident in with value stabilizing.

In our Energy business, we’ve made meaningful progress on this year’s deployment, including the signing of 405 megawatts of long-term storage-related contracts with investment-grade utilities. We also delivered the largest EV fleet charging project in the United States, less than 15 miles from both the ports of LA and Long beach. Finally, we raised $4.1 billion of debt across our balance sheet and funds at a weighted average rate of 4.7% and a term of 10 years. Our debt portfolio has an overall in-place rate of just 3.1%, with more than nine years of average remaining life and liquidity at the end of the quarter of over $5.8 billion. Turning to market conditions. Most broad economic data from unemployment to retail sales to the health of the consumer remain very strong.

And while our tour proposal and other proprietary metrics are similarly positive, overall leasing activity and net absorption are running below expectations. Net absorption in the US, for example, was very low this quarter at just 27 million square feet. So while the macro landscape and supply chains continue to generate a need for space, we think it’s prudent to expect continued headwinds on overall absorption over the next few quarters. The interest rate environment and its associated volatility have weighed on customer decision making, especially as the 10 year has increased 70 basis points from its level just 90 days ago and expectations for Fed rate cuts have moved from potentially six to now possibly zero. In parallel, sublease and space utilization rates highlight that some customers have available capacity, driven in part by the high rate of absorption through the pandemic.

This dynamic of available space intersecting with the desire for cost containment is what leads to lower absorption and is playing out at different rates across submarkets and customers. For example, while slow leasing has persisted so far this year for less capitalized customers and 3PLs, we see a handful of large e-commerce and retail customers further along in this process, such as Amazon, who voiced caution two years ago, but is now active in several global markets and has openly discussed plans to commit to significant amounts of new space. The overall leasing slowdown is most felt in only a handful of markets. Southern California and the Inland Empire being the most acute. In fact, rents in most of our US markets are generally flat, several are up, and it is mainly elongated downtime affecting near-term occupancy and NOI.

While Southern California leasing has been challenging, it has not slowed the tremendous uplift we realize every single quarter from rent change on rollover, which was 120% for the market in the first quarter, with the Inland Empire at 156%, nearly the highest in our portfolio. In Europe, rents grew overall during the quarter, which we believe will remain the case over the balance of the year. And of course, LATAM continues to impress with very high occupancy and market rent growth that has led the globe in recent quarters. Overall, global market rents declined slightly over 1% in the quarter, driven mostly by Southern California, and would have been slightly positive if excluded. I’d like to spend a moment on Baltimore, where we own over 18 million square feet and has been a dynamic market of ours for decades.

Our employees, customers and properties are all safe following the bridge collapse last month and our customers expect to be able to withstand the disruption with little impact to their businesses. Shifting to capital markets. Valuations increased in all of our geographies, except for China, which saw a very small decline. Over the last 1.5 years, global values have decreased despite increases in cash flow due to cap rate expansion. As cap rates have stabilized, cash flow growth now has the ability to translate to value growth. Even though modest, the value uplift in the US and Europe are important as strategic capital investors have been looking for values to not only bottom, but actually turn upwards before committing new capital. With Europe a bit ahead of the US in this regard, it is indeed where we’ve seen stronger fund-raising interest in recent quarters.

We also had a successful equity raise in FIBRA Prologis, raising over $500 million for deployment into both assets to be contributed from our balance sheet, as well as pursuits of third-party acquisitions. Transaction volumes and activity have ticked up in recent weeks and pricing has certainly improved. As always, we are actively looking at acquisition opportunities across all of our markets, but our focus remains on the development of our land bank, which provides an opportunity for over $38 billion of build out with a return on incremental capital of approximately 8.5%. In terms of guidance, in light of our views on demand and leasing pace in the coming quarters, we are reducing our average occupancy guidance to range between 95.75% and 96.75% of the 75 basis point adjustment from the midpoint.

It’s important to understand that approximately two-thirds of this change stems from our higher rent markets, meaning they create a disproportionate impact on same store in 2024. Same-store growth on a net effective basis will range between 5.5% and 6.5%, a reduction of 150 basis points, which accounts for the average occupancy decline, slightly lower rent change for the year as well as 30 basis points of annualized impact from the one-time items in the first quarter mentioned earlier. Our revised range on a cash basis is now 6.25% to 7.25%. We are maintaining our guidance for strategic capital revenue, excluding promotes, to a range of $530 million to $550 million and reducing our G&A guidance to a range of $415 million to $430 million. We are adjusting development start guidance for the year to a revised range of $2.5 billion to $3 billion at our share, reflecting our discipline in speculative starts and the timing impact this has in the calendar year.

As we’ve always said, we don’t consider our guidance to be a target internally and each deal ultimately needs to be rational and accretive on its own. In the end, we are forecasting GAAP earnings to range between $3.15 per share and $3.35 per share. Core FFO, including net promote expense, will range between $5.37 per share and $5.47 per share, while core FFO, excluding promotes, will range from $5.45 per share to $5.55 per share. Our updated guidance calls for core earnings growth of nearly 8% at the midpoint. As we close out, I’d like to underscore the message of the call, which is that while we have only a modest change of view in the intermediate term, our confidence in the long term is intact. And putting timing aside, we are encouraged by the outlook for supply in the back half of this year and ’25, have tremendous lease mark-to-market to harvest in the interim, and are pleased to see valuations, fundraising and transaction activity all picking up.

With that, I’ll turn the call over to the operator for your questions.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And the first question comes from the line of Caitlin Burrows with Goldman Sachs. Please proceed with your question.

Caitlin Burrows: Hi. Good morning, everyone. It seems like, I guess, occupancy and maybe pricing are coming in a little lower than you had previously expected. So I was wondering, could you go through how much or what pieces might be more macro driven and how much is certain markets weighing on the outlook? Tim, you did mention how some of the high rent markets are having an outsize impact. So wondering if you could just go through what might be more macro versus market specific. Thanks.

Chris Caton: Hey, Caitlin. It’s Chris Caton. I’ll start by saying I think it’s a combination of factors. For sure, as Tim described, Southern California and a handful of other high rent markets, the leasing velocity has been subdued and rent growth has been a little bit below expectations. So there is that softness. But we also want to point to a couple of quarters of deferred decision making leading aggregate customer demand across the United States to be a little bit below what we previously expected. The other thing I might add, Caitlin, would be just nominally in the sense of dollars and the impact in same store. We do see about half of our adjustments as coming from SoCal.

Operator: And the next question comes from the line of Steve Sakwa with Evercore ISI. Please proceed with your question.

Steve Sakwa: Yeah. Thanks. Good morning out there. I guess, for Tim or Hamid, can you maybe just help kind of flush out sort of maybe the timing of when some of these things became a little bit more evident? I guess I’m thinking back to some of the conferences and the like in March, and my sense was the tone and concern about the business maybe wasn’t as acute as it is right now. And I know you have confidence in the long term, but it sort of feels like there’s a sea change in your outlook in maybe the last 30, maybe 45 days. So I guess, what is prompting that other than maybe saying hard data? But maybe just help flush out kind of the timing of this. And are there other factors at work here?

Tim Arndt: Steve, let me take a stab at that. If you are sensing any acute change in our outlook, you’re not reading our call correctly. We have picked a three-year window, I think, in our Analyst Day to give you our expectations. And the first year of that window has moved around. So our outlook for the back period of second and third year essentially the same and could be even better given how much deferred demand is building up. If our proposals were down, if our tours were down, I would be more concerned. But companies are out looking at this space. And if you think nothing has changed in the last 45 or 90 days with respect to the Fed outlook, you must be reading different newspapers than I am. So I would tell you that people are just scared of pulling the trigger until the Fed gives the all clear sign with the first rate cut.

So, yes, we are not instantaneous in our data transmission to us and to you, but I can assure you that you will always hear our views immediately as we form them and as we get them from the marketplace.

Operator: And the next question comes from the line of Michael Goldsmith with UBS. Please proceed with your question.

Michael Goldsmith: Good morning. Thanks a lot for taking my question. It sounds like demand has been pushed out or the rebound in demand has been pushed out of a few quarters. So I was wondering what evidence do you have that would support that? And then how do we compare that to some of the proprietary metrics that you put together, which seem to indicate that things are actually pretty positive or accelerating? Thank you.

Chris Caton: Hi, Michael. Chris Caton. Thanks for the question. As we’ve kind of covered in the script, and I think we are pointing out here, whether it’s consumer resilience as revealed by economic indicators like the labor metrics or retail sales, whether you look at our own customers and supply chain momentum as revealed by our RBI volumes through the ports and our proposal volumes. The broader economy is generating a normal amount of demand. A couple of things to consider though. One is as you can see in utilization data and in sublease space, some customers have spare capacity that they are utilizing to accommodate some of this growth. We also have these leading indicators. We needed to simply see customers convert space requirements into signed leases.

So just the simple conversion of investigation into signed leasing. And indeed, we already are seeing the front edge of some leading global e-commerce companies and other retailers begin to make space. It’s just not broadly yet occurring across the whole marketplace.

Tim Arndt: Yeah. The only thing I would add to that is that the effect is not uniform in all markets. And I think what’s going on — and this is a theory. This is not a fact. It’s a theory, but it’s based on 40 years of looking at this stuff. Southern California has over 30% share for 3PLs and the rest of the US market has a little under 20% share of 3PLs. 3PLs are serve two purposes. One, they provide outsourcing of for logistic activities, but they also create surge space. In other words, companies use 3PLs as a way of flexing up and down. So markets that have a bigger exposure to 3PLs are likely to feel the impacts of shifts in sentiment sooner than other markets on the way down and on the way up. Also, there are certain customers who have instantaneous access to sales data and activity.

And I would say the e-commerce players, the big ones, have the best data on that, because they see the trends on a daily minute-by-minute basis. Those guys were early in terms of curtailing their demand. And I got to tell you, they’re out there pretty aggressively and don’t listen to what we say, listen to what they say in their own annual reports, in their own interviews with the press. And I think you’ll see that they feel pretty confident about their business and they’re a bit ahead of the curve. Now, all of this is subject to missiles not flying in the Middle East and the Fed not going crazy and God knows what else can happen in this world. So but as far as we see, the indications are really good. And this certainly does not feel like any of the other downturns that I’ve been part of.