Prologis, Inc. (NYSE:PLD) Q4 2022 Earnings Call Transcript

Prologis, Inc. (NYSE:PLD) Q4 2022 Earnings Call Transcript January 18, 2023

Operator: Greetings. And welcome to the Prologis Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference will be recorded. I will now turn the conference over to our host, Jill Sawyer, Vice President, Investor Relations. Thank you. You may begin.

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Jill Sawyer: Thanks, Diego, and good morning. Welcome to our fourth quarter 2022 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 fourth quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures and in accordance with Reg G, we have provided a reconciliation for 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.

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Tim Arndt: Thanks, Jill. Good morning, everybody, and welcome to our fourth quarter earnings call. Let me begin by thanking our global team for delivering an excellent quarter and year. We have had outstanding results despite challenging headwinds from the capital markets and the overall economic backdrop. In the face of this, our focus has been to serve our customers and investors putting our heads down and executing on our long-term plan. As you see in our results, our portfolio is in excellent shape, driven by still strong demand and a continued lack of availability. This foundation for our business not only drove our nearly 13% increase in year-over-year core earnings, but it also sets up the company for sustainable growth for years to come.

Turning to results. Core FFO excluding promotes was $4.61 per share and including promotes was $5.16 per share, ahead of our forecast. In the fourth quarter, our operating results again generated several new records. Occupancy increased to 98.2%, with retention of 82%. The Prologis portfolio excluding Duke added 30-basis-point of the 40-basis-point increase over the quarter. While we tend to quote occupancy, it is notable that the portfolio is 98.6% leased, a record that underscores the tightness across our markets. Rent change for the quarter was 51% on a net effective basis. The step down from our third quarter rent change of 60% is a reflection of mix and not market rents. In fact, market rent growth exceeded expectations during the quarter, increasing our lease mark-to-market to a record 67%.

These results drove same-store growth to 7.7% on a net effective basis and 9.1% on cash. The Duke portfolio having closed on October 3rd, is fully integrated in these results, with the exception of same-store growth, which will not be reflected until the first quarter of 2024. On the balance sheet, while access to the debt markets have remained challenging for many issuers, we successfully executed a number of transactions during the quarter, raising over $1.1 billion at an interest rate below 3%, including $700 million of new unsecured borrowings out of Japan and Canada. Our credit metrics continue to be excellent and we have maintained over $4 billion of liquidity at year-end with borrowing capacity across Prologis and the open-ended funds of $20 billion, expanded significantly due to our balance sheet growth from the Duke acquisition.

With regard to our markets and leasing activity, the bottomline is that conditions remain healthy and there is little we see across our results or proprietary metrics that point to a meaningful slowdown. We see a normalization of demand and when combined with low vacancy, it continues to translate to a meaningful increase in rents. Across our markets, rent growth was nearly 5% during the quarter, driving the full year to 28%. Proposal activity for available space was consistent with our recent history, and given persistent low vacancy, there is simply a very small number of units to even propose deals on. As evidenced, over 99% of our portfolio is either currently leased or in negotiation. Utilization remains high at 86%, near its all time record and deal gestation ticked up over the quarter, indicative of more careful consideration and time being taken in leasing decisions.

While we are watching e-commerce carefully, its share of overall retail sales have increased to 22%, which is 600 basis points above its pre-pandemic level. Putting the nuance of mix, timing and other factors aside, as measured by retention, occupancy or rent change, it is clear that customers need to commit to space to market conditions, which offer them very little choice. In terms of supply, the development pipeline across our market stands at 565 million square feet and our expectation for the year is that the pipeline will decline. Deliveries will put modest upward pressure on vacancies from 3.3% today towards 4% later in the year. However, new development starts are slowing in response to the market environment, which will reduce vacancies in late 2023 or 2024.

In Europe, we expect deliveries to outpace absorption by approximately 30 million square feet, expanding the current 2.6% vacancy rate to approximately 3.5%. Finally, and as expected, our true months of supply metric grew to 25 months in the U.S. from 22 months last quarter. As a reminder, this metric has averaged roughly 36 months over the last 10 years. In capital markets, transactions continue to be slow in the fourth quarter, making price discovery challenging. That said, return requirements are trending to the low-to-mid 7% range. This expansion further affected appraised values in our funds, although continued rent growth has mitigated some of the effect. Our U.S. values, which were appraised by third parties every quarter, declined 6% this quarter and 7% over the entire second half.

In Europe, values declined approximately 12% during the quarter and 16% over the half. Our open-end funds have received only modest redemption requests, less than 3% of net asset value during the quarter, totaling 5% across the second half. Our flagship funds have strong balance sheets with low leverage, largely undrawn credit facilities, cash on hand and undrawn equity commitments. While we believe the value declines over the second half reflect market, investors are still adjusting to a new environment. Because we strive to be consistent in our actions and fair to all investors, we will redeem units call equity and resume asset contributions when price discovery has run its course. We expect that to be one quarter to two quarters away likely sooner in Europe.

This will ensure certainty, fairness and consistency to all of our investors. Turning to our outlook for 2023, while our macro forecast assumes a moderate recession, which may put headwinds on demand, our business is driven by secular forces and long-term planning by our customers that should limit the impact unless such a downturn becomes significant and protracted. As mentioned earlier, we believe vacancy will build in the market and our portfolio, both of which are unsustainably low. Putting this sentiment together with our outlook on supply and demand, our 2023 rent forecast calls for approximately 10% growth in the U.S. and 9% globally. We acknowledge that our rent forecasts have proven conservative in recent years, but we are comfortable with this starting point given the environment.

Specific to our portfolio and on an our share basis, we expect average occupancy to range between 96.5% and 97.5%, roughly 50 basis points lower than the 2022 midpoint. Combined with rent change, we forecast to generate net effective same-store growth of approximately 8% to 9% with casting store growth between 8.5% and 9.5%. Given these assumptions, we believe our lease mark-to-market will be sustained or even increased over 2023, ending the year between 65% and 70%, and providing visibility to an incremental $2.9 billion of NOI after the more than $300 million that will become realized over the course of this year. We expect G&A to range between $370 million and $385 million, reflecting not only inflation in wages and other corporate costs, but also additional investments we are making in our Essentials business particularly in the energy teams.

In that regard, we expect the contribution to FFO from Essentials to range between $0.07 and $0.09 this year. This reflects 70% growth in revenues and tax credits from 2022, but offset in the near-term by our higher Duke related share count and the G&A investments just mentioned. In terms of operational metrics for the business, we expect to add 115 megawatts of solar power over the year driving the portfolio to approximately 540 megawatts by year end. It’s worth noting that we closed 2022 as the second largest on-site power producer in the U.S., a position we will build upon with our plan for 1 gigawatt of production and storage by 2025. We also forecast to have over 20 EV charging clusters installed and operational by year-end. In deployment, we will continue to be disciplined in our approach to new starts.

We have over $39 billion of opportunities to select from in our land bank and between our expectations for build-to-suits and logical markets prospect, we see an active year of starts initially to range between $2.5 billion and $3 billion with a real opportunity to grow as conditions warrant. As mentioned earlier, we plan for redemptions to be cleared out over the year and private fundraising to resume. Accordingly, we forecast contribution activity to occur primarily in the second half and resulting in combined contribution and disposition guidance of $2 billion to $3 billion. Finally, in strategic capital, we forecast revenues excluding promotes to range between $500 million and $525 million, which is impacted by valuation write-downs across 2022 and the first half of 2023.

We are forecasting net promote income of $0.40 based on an assumption that U — that values in USLF, primary source of 2023 promotes will decline further from values at year end, every 1% change in asset value equates to slightly less than $0.02 of net promote income. Putting this all together, we expect core FFO excluding promotes to range between $5 per share and $5.10 per share. At the midpoint of our guidance, this represents approximately 9.5% growth over 2022. We are guiding core FFO including promotes to range between $5.40 per share and $5.50 per share. In closing, this guidance builds upon an exceptional three-year period of sector-leading earnings growth. At our 2019 Investor Day, we presented a three-year plan, targeting 8.5% annual growth, we achieved nearly 14% over this period, 550 basis points of annual outperformance.

We expect 2023 to be a year where headlines continue to be disconnected from our business and ability to deliver strong growth and valuation. While there are many unknowns generally, there are more knowns in our business that are clear, such as our lease mark-to-market, significant and visible opportunity in our land bank, a need for excitement for — a need and excitement for a new generation of sustainable energy solutions, and a dedicated team that is the best in the business and laser focused on delivering leading results. We will now turn the call over to the Operator to take your questions.

Q&A Session

Operator: Thank you. Our first question comes from Steve Sakwa with Evercore. Please state your question.

Steve Sakwa: Yeah. Thanks. I guess good morning out there. Tim, I just wanted to clarify in your kind of going through your guidance, you throw out a lot of numbers. I just want to make sure on the mark-to-market numbers that are embedded in your same-store NOI growth of 8% to 9% GAAP and 8.5% to 9.5% cash. Just what are you expecting for cash and GAAP leasing spreads and I just want to make sure that’s different than the kind of overall portfolio mark-to-market you talked about 65% to 70%?

Tim Arndt: Yeah. They are going to be stronger. As you think about the lease mark-to-market, it’s all of the leases, so it represents old leases and leases just done. So, clearly, everything that will roll next year is going to be above the 67% reporting today. It’s a little bit flatter than you might expect as we have looked at it. I think leasing spreads next year are going to be in the high 70s to low 80s on a net effective basis and then as we know that the cash basis of that has trended towards about 1,500 basis points or so inside of that.

Operator: Thank you. Our next question comes from Craig Mailman with Citi. Please state your question.

Craig Mailman: Hey. Good morning, everyone. I just want to hit on the capital deployment side of things, maybe a two-parter here. Just first on the stabilization, so just the kind of the — what you guys have stabilizing the $2.8 billion at your share, can you just bridge that gap versus the $5.5 billion that you have on page 20 of expected deliveries or completions in 2023? And maybe just give us some sense of timing on that, I know I think about 30% of those are build-to-suits. So also how you are thinking about where the preleasing is on the balance of that as well and kind of how that layers into your occupancy assumption?

Tim Arndt: Yeah. I will take — Craig, it’s Tim. I will take the first half and Dan can help with the second. This is really a date issue, I would say, not even an issue, but just a function of the date. We have a large amount of that group of stabilization we believe will occur in the first quarter of 2024 and I think there is a very real possibility that if we improve some of the leasing timing by just a month or two, we could see a decent amount of that actually fall back into 2023. So it’s just a function of crossing over a calendar year to lay up the mix of all of our projects is landing.

Dan Letter: And this is Dan. I will just pile on there. The pre-leasing in that portfolio, as you see, there’s 29% of that that’s in there as a build-to-suit. The pre-leasing is better than that 29%, and I would say, on track with historical averages even on a bigger data set here. So we feel really good about delivering our stabilization at this year and next.

Operator: Thank you. And our next question comes from Ki Bin Kim with Truist. Please state your question.