Prologis Poised To Capitalize On Rise In E-Commerce
September 18, 2019
E-commerce is growing at a faster rate than traditional retail.
Industrial REITS provides warehouses for e-commerce companies.
E-commerce companies account for 20% to 30% of industrial leasing.
Industrial REIT Prologis will grow as demand for e-commerce grows.
The reason the place you buy retail goods is called a store is because that's where they store stuff. But, there's a paradigm shift occurring in the retail sector. Shoppers are moving online to places like Amazon.com (AMZN) from brick-and-mortar stores.
As e-commerce grows, so does the need to store the stuff people are buying. This presents a growth opportunity for companies like Prologis (PLD), a San Francisco industrial real estate investment trust ("REIT"). Prologis specializes in warehouses and logistics distribution centers for e-commerce companies.
Brick–and-mortar stores such as JC Penney (JCP), Macys (M), and Bed Bath and Beyond (BBBY) are posting declining sales as consumers move more of their shopping online.
E-commerce Grows Faster Than Total Retail
For the second quarter of 2019, U.S. retail e-commerce sales grew 4.2% from the first quarter to $146.2 billion, according to the Department of Commerce. Total retail sales for the second quarter increased 1.8% from the previous quarter to $1.36 trillion. Year over year, e-commerce sales jumped 13.3%, while total retail grew 3.2%.
E-commerce sales accounted for 10.7% of total sales in the second quarter, up from 10.5% in the first quarter.
In brick-and-mortar stores, the merchandise sits in the store until it's purchased. But e-commerce takes place on the Internet. The merchandise needs to sit in giant warehouses until it's packed in boxes and shipped to the customers. E-commerce has sparked a boon for the industrial REIT sector and it shows no signs of slowing, said Barron's.
E-commerce companies account for 20% to 30% of industrial leasing, said BTIG analyst Thomas Catherwood. With e-commerce sales growing more than 14% a year, Catherwood expects the sector’s vacancy rate to fall to 6.8% from 7.1% by the end of 2019.
Bought For Income, REITS Are Now Growth Stocks
Typically investors buy REITS for their dividend income, which averages a yield of 3.7%. Industrial REITs yield an average of just 2.9%. However, the new paradigm is turning industrial REITs into growth stocks. Year to date, Prologis shares have surged 47%, compared to the 20% rise in the FTSE Nareit Equity REITs Index, as of September 16. The yield on Prologis shares is 2.5%.
Even after that huge gain this year, I think Prologis has a lot of room to grow, as consistent demand for a limited supply of new properties should result in rental-income growth.
Catherwood wrote that he expects Prologis' earnings growth to accelerate in 2020 as “tenant demand continues to outpace new supply”.
Demand for industrial REITs grew 1.9% in 2018 fueled by a strong economy and growing e-commerce sales, said Catherwood. With the supply of new properties unable to match demand, asking rents have jumped 2.5% (more than twice the long-term average). While demand has slowed, rent-growth projections are up 0.6 percentage points to 3.1%, he writes.
Blackstone Deal Highlights Market's Potential
The Blackstone Group, a multinational private equity and financial services firm run by Stephen Schwarzman, is also the world's largest property investor. Of its $500 billion total asset base, almost $150 billion is invested in property strategies. Its primary real estate private equity funds have returned 16% a year, according to the Financial Times.
Blackstone sees the market potential for industrial warehouses. In June, it made the largest real estate private equity deal ever, according to the Financial Times. It bought $18.7 billion worth of U.S. warehouse space from Singapore company GLP. With many of the buildings located in big cities on America’s coasts, the FT values Blackstone's GLP portfolio at $100 per square foot.
Meanwhile, ProLogis calls itself the global leader in logistics real estate focused on high-barrier, high-growth markets. With $104 billion in assets under management, it holds a portfolio of 786 million square feet across 19 countries. The Financial Times gives Prologis an enterprise value of $60 billion, which comes to a value per square foot of $79.
Focus on FFO
In REITS, reported earnings typically have a distant relationship to cash flow. The REIT industry created an alternative earnings metric called Funds from Operations (FFO), as a better representation of recurring cash-generating power. FFO is net income plus depreciation and amortization minus extraordinary gains and losses. REITs use core funds from operations to define the cash flow from their operations.
For the second quarter, Prologis' revenues leapt 27% year over year to $790 million. Core funds from operations (Core FFO) were $980 million, or 77 cents per diluted share, compared with $834 million, or 71 cents per diluted share, for the same period a year earlier. FFO can be higher than revenue because depreciation and amortization are added back in.
After its earnings release, Prologis lifted its 2019 Core FFO per share guidance to a range of $3.26 to $3.30, from $3.20 to $3.26. This would result in year-over-year growth of 9.5%. Value Line predicts FFO will jump to $3.40 a share in 2020.
REITS don't use a price-to-earnings ratio, but rather a price-to-FFO ratio. A share price of $85.22 divided by $3.30 FFO per share gives us a multiple of 26.
The same day as its earnings release, Prologis also confirmed an agreement to acquire Industrial Property Trust in an all-cash deal valued at nearly $4 billion. The FFO guidance doesn't include results from the deal.
"The IPT portfolio, which included 236 properties with 37.5 million square feet, expands the company's position in Southern California, the San Francisco Bay Area, Chicago, Atlanta, Dallas, Seattle and New Jersey," said National Real Estate Investor in July.
Going larger increases economies of scale, lowers costs and strengthens relationships with its largest tenants, e-commerce giant Amazon, FedEx (FDX), and Wal-Mart (WMT). Also, large portfolios give the company a market advantage when current tenants need space in a new location.
Prologis is also rumored to be in negotiations with Blackstone for a portion of the GLP assets valued at about $1 billion, according to Bloomberg News.
Since equity REITs are considered to be cyclical, Prologis could be more volatile than the market over the economic cycle. While a company like Wal-Mart may be recession proof, if a recession hits, Amazon and FedEx may see a significant decrease in shipments, which would affect Prologis' ability to raise rents, and may even result in lowered demand for warehouses.
If we take Value Line's forecast for 2022 FFO of $4.15 and multiply that by our multiple of 26, we get a price target of $108.
In conclusion, I predict the share price will hit a $108 by 2022.
Disclosure: I am long PLD. I have no business relationship with any company whose stock is mentioned in this article.