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

Prologis, Inc. (NYSE:PLD) Q4 2023 Earnings Call Transcript January 17, 2024

Prologis, Inc. misses on earnings expectations. Reported EPS is $0.68 EPS, expectations were $1.26.  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 Fourth Quarter 2023 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 to you, Jill Sawyer, SVP with Investor Relations. Thank you, Jill. You may begin.

Jill Sawyer: Thanks, John. Good morning, everyone. Welcome to our fourth quarter 2023 earnings 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. 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 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’ll hand the call over to Tim.

Tim Arndt: Thanks, Jill. I’d like to start our call by recognizing and thanking our team for the incredible effort given over 2023. While it was a turbulent year in many ways, we ended it by delivering nearly 11% earnings growth and driving our 12-year earnings CAGR since merger to 10.3%. We deployed over $7 billion into new investments, raised nearly $2 billion of strategic capital in a very challenging environment and delivered excellent operating results while serving and growing customer relationships. We’re also appreciative of the opportunity we had at our Investor Forum last month to share our vision and outlook for the company over the coming years. The environment is setting up in line or better than our expectations with development starts across the market continuing to decline by two-thirds from peak and an improvement in customer sentiment that appears more constructive than just 90 days ago.

That said, we still see challenges in some submarkets as near-term outsized deliveries are met with still recovering demand. But our thesis remains the same as we’ve been describing for over a year and detailed last month in New York, which is that the supply cliff will converge with normalized demand later this year, delivering an environment conducive to strong market rent growth. We believe that annual market rent growth will average between 4% and 6% over the next three years, with 2024 being modestly positive and ramping thereafter. Turning to our results. We finished the year strong with quarterly core FFO, excluding promotes of $1.29 per share, bringing the full year to the top end of our guidance $5.10 per share. While market occupancy declined by approximately 100 basis points, our portfolio gained 10 basis points to end the year at 97.6%.

Net effective rent change over the quarter was 74%, bringing the full year to a record of 77%, with another impressive results out of Southern California at over 150%, a reminder that it remains the strongest market for cash flow growth despite near-term choppiness given the large quantum of its lease mark-to-market. In the end, same-store on a net effective basis was 7.8%, while cash was 8.5%. We started over $2 billion of new developments in the quarter across 46 projects in 27 markets with nearly 50% of the activity in build-to-suit. In Energy and as seen in our new supplemental disclosure, we stand at year end with approximately 515 megawatts of solar and storage in operation with an additional 70 currently under construction. We had a quiet quarter on the financing front, raising approximately $300 million, but our full year of activity closed out at over $12 billion at a weighted average rate of 4.5% and term of 10 years.

Our total debt portfolio remains at an overall in-place rate of just 3% with more than nine years of average remaining life. Turning to market conditions. The increase in fourth quarter market vacancy was in line with our expectations and driven by demand that remained moderate as customers exercised caution in their spending, while completions hit an all-time high. Development starts, however, have continued to fall across the U.S. and Europe, extending and deepening the future supply shortfall. On the ground, our teams are seeing revived customer interest with healthy showing activity to start the year. This includes build-to-suit inquiries, which we expect to remain active for Prologis following a strong year in 2023. Our proprietary metrics point to normal levels of activity with proposals and gestation timing in line or a bit better than historical norms.

Utilization declined in the quarter to approximately 83% and keeping with this morning’s report a decrease in the inventory to sales ratio. We view this positively because utilization also increased from here as stronger than expected retail sales over the fourth quarter and holiday season drove lower inventories, which will need to be replenished. Turning to market rents. Our global view is that rents declined this quarter by 90 basis points, but predominantly impacted by an estimated 7% decline in Southern California. Our full year view is that global market rents grew by 6%, just below our expectations, ultimately driving our lease mark-to-market to end the quarter at 57% after capturing approximately $100 million in realized NOI growth from leases rolling up to market.

The outlier on rent growth is clearly Southern California. While our portfolio was only 2.6% vacant at year end, growing availability has made leasing very competitive. Combined with a 110% increase in rents since 2020, the rent retracement is understandable. Historically, there has never been a market where the delta between expiring and market rents has been so large that it provides ample room for property owners to deviate from market in order to attract customers. But looking ahead, the positive news is that we are launching two trends reverse. The first is that the supply pipeline is clearly emptying with little in the way of new starts. And the second is that the escalating issues in both the Suez and Panama canals together with the resolution of the West Coast labor negotiations are moving shipment volumes back to the West.

While this bodes well for SoCal and still early, we are watching East Coast port markets more closely. In any event, all of these disruptions are reiterating the underlying need for resiliency and the just in case approach to inventories. Summing this all up globally, we recognize the high volume of near term deliveries that need to be absorbed into our markets over the next few quarters. But we are very pleased with our ability thus far to build occupancy, drive rents, and illustrate more differentiation in our portfolio as market vacancy grows. As for Strategic Capital and Valuations, we saw U.S. values decline approximately 5.5% during the quarter, which was our expectation and the reason we paused our appraisal based activity, which includes calling and redeeming capital as well as asset contributions.

We run an industry leading franchise in which we aim to set the standard for governance, including timely, accurate, and independent valuations. Calling out when pronounced lags and valuations emerge has protected investors and demonstrated how we stand apart as a responsible partner. With this quarter’s value declines in a more stabilized rate environment, we’ll resume activity in USLF including the funding of our $250 million commitment announced in the second half of ’23. Turning to guidance and all at our share. In terms of operating metrics, we are guiding average occupancy to range between 96.5% and 97.5% with occupancy likely to step down in the first quarter and rebuild over the course of the year. Cash same-store will range between 8% and 9% and net effective same-store growth will range from 7% to 8%.

We are forecasting net G&A to range between $420 million and $440 million and Strategic Capital income to range from $530 million to $550 million. We have a very big year of stabilization activity ahead of us with a range of $3.6 billion to $4 billion, and expected yields of approximately 6.25%. On the new deployment front, we are guiding development starts to range between $3 billion and $3.5 billion with the estimated build to suit mix of 40%. And we plan to take sale portfolios to the market over the year with expected proceeds to range between $800 million and $1.2 billion and additionally forecast $1.75 billion to $2.25 billion in contributions to our Strategic Capital vehicles. In the end, we are forecasting GAAP earnings to range between $3.20 and $3.45 per share.

Core FFO excluding promotes will range from $5.50 to $5.64 per share, while core FFO including net promote expense will range between $5.42 and $5.56 per share, each a bit higher than our preliminary guidance at the Investor Forum. While we do not forecast any promote revenue at this time, there are some small opportunities that do exist in FIBRA Prologis and our new PJLF vehicle in Japan. In closing, we know that the market is not yet out of the woods with regards to incoming supply, but the combination of a stronger backdrop continued low level of starts and a calmer capital markets environment has us optimistic that 2024 will be another great year. As you know from our Investor Day, we have many initiatives in flight designed to add value beyond our real estate and because of our real estate.

We look forward to continuing to execute on our plan and providing you updates throughout the year. And before we move to Q&A, I’d like to get ahead of questions which have grown a little more frequent in recent quarters surrounding market rent growth. Unintentionally, we set an expectation that we could forecast market rents to a single point of accuracy in increasingly short time periods, and honestly, we’re just not that good. We’ve gotten away from a practice that was originally aimed at being high level and directional. So what we’ve elected to do in order to help investors without perpetuating the issue is to simply provide high level rent growth expectations on a rolling 12 month forward view. As mentioned earlier, in terms of our three year CAGR of 4% to 6%, we believe we’ll see modestly positive rent growth aligned with inflation over the next 12 months and we’ll continue to update this rolling view on our future calls.

With that, we will now take your questions. Operator?

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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 Tom Catherwood with BTIG. Please proceed with your question.

Thomas Catherwood: Excellent. Thank you. Kind of, maybe taking a look at your leasing spreads, obviously very strong performance during the quarter, but also a big spread between Prologis share and the kind of overall portfolio performance, which suggests a stronger performance out of the U.S. Going forward in the ’24, are you expecting this gap in performance to tighten at all or should the U.S. continue to lead the way as far as spreads go this year?

Tim Arndt: I’ll take that. I think, Tom, that it will actually be relatively similar. There’s a pretty long tail on how the lease mark-to-market is going to affect quarterly rent change. It will sustain for quite a while in other words. And since it’s much more pronounced in the U.S. than anywhere else in the world, I would expect we do see that continue to stay wide.

Operator: Thank you. And the next question comes from the line of Ronald Kamdem with Morgan Stanley. Please proceed with your question.

Ronald Kamdem: Hey, just two quick ones from me. So one, we’ve been looking at a lot of the broker reports talking about rising availability rates. You guys have flagged it as well. So just curious what you guys are seeing in sort of the Sun Belt markets versus sort of the Coastal. And if that’s trending sort of in line or with your expectations and so forth, would be the first. Thanks.

Chris Caton: Hey. It’s Chris Caton. I’ll take that. So the year is — or the year closed out with market vacancy rates at mid-5%, just like Tim described, and the vacancy rates remained lower on the coast, excuse me, so both East Coast and West Coast and higher in the Sun Belt. What we are seeing as it relates to pricing is there was better pricing, better rent growth in the Sun Belt markets outperforming the Coast in 2023.

Ronald Kamdem: Great. And if I could just follow up on the market rent growth comment. I think you said, rolling 12 months sort of inflationary plus or minus. So, clearly, that’s implying sort of an acceleration in ’25 and ’26, as supply comes down to that. Is that sort of how you guys are thinking about it?

Tim Arndt: That’s exactly right.

Operator: Thank you. And the next question comes from the line of Craig Mailman with Citi. Please proceed with your question.

Craig Mailman: Great. Thanks. Two quick ones here. I guess, first question would be, could you guys just go through what the uptick in property improvements in the CapEx section were? There’s a pretty big jump in 4Q versus prior quarters. And then just second, Tim, you had kind of touched on this that tenant sentiment is improving here and there may be better traffic going back to the West Coast with everything going on the Red Sea, and the realization that just in case maybe a more prudent inventory method. But I’m just kind of curious because big tenant leasing has been kind of slower over the last 12 months to 18 months. Are you seeing any early green shoots on that improving as you guys are talking with customers?

Tim Arndt: Yeah. I’ll take the first part here, Craig. On the CapEx, if you take a look at the supplemental, I’d first start by widening out on overall CapEx before staring at property improvements and there is just a good example here of the need to look at annual or trailing numbers as this can be a pretty volatile number quarterly. Here, you can see on the full year as a percentage of our NOI, we are about 14%, roughly 15% the prior year. And yeah, focusing in on property improvements, I’d suggest the same that you have to look at a trailing basis. We do tend to see higher levels of property improvement activity in the fourth quarter, just by nature. But we are catching up on the full year. You can see we averaged $0.12 on the year versus the $0.21 that we had in the quarter.

So that’s really just a timing issue. One more thing that you can see here is the year-over-year averaged on that basis $0.12 versus the prior year $0.10, and I’d explain that differential as just some inflationary piece. And then, the second would be some deferred maintenance and work that we’re executing on the Duke portfolio.

Dan Letter: And maybe — this is Dan. Craig, on the second part of your question related to tenant sentiment, I would say, at the Investor Day, we had talked about a marginally better tenant sentiment from the Q3 earnings call. And I would say, it’s even marginally better than that in the last 30 days. This is fueled by our healthy proposal volumes. Customer dialogs have been strong. 45% of our available space is in discussion right now with active proposals. We’ve anecdotally had just a number of conversations with our customer-led solutions group. Our build-to-suit conversations are improving as well. Our overall build-to-suit pipeline has grown quarter-over-quarter. So, whether that be some of the issues related to the Red Sea issues and the Canal issues or not, I think Chris will have some comments on that.