Could Prologis Be in Trouble?

prologue (NYSE:PLD) is one of the largest warehouse owners in the world, controlling a global collection of vital assets in key transportation hubs. The stock is down around 30% so far in 2022, as investors seem to be worried that big-picture trends will bring the company’s growth to an end. That’s possible, of course, but there’s so much good news built into the portfolio that the real estate investment trust (REIT) is likely to do just fine even if there’s a recession or a warehouse-sector downturn.

Here are the problems that are facing Prologis and why it will most likely take them in stride.

PLD data by YCharts.

The bad news

Warehouses are vital cogs in the world economic order. Prologis owns more than 4,600 properties across North America, South America, Europe, and Asia. That’s all well and good, but warehouse demand is subject to the ebb and flow of the global economy. Recessions lead to less demand. But that’s just par for the course, and there’s nothing that Prologis can really do about it. The weak stock price at least partly reflects concerns among investors that the world is heading toward an economic downturn thanks to high inflation, rising interest rates, and geopolitical tensions.

Adding to the concern here is that (NASDAQ: AMZN) recently announced that it had too much warehouse space. That was a frank admission that it overspent on space during the pandemic-driven demand spike. The fallout from this announcement is that Amazon is looking to sublease locations, increasing the amount of warehouse space that’s on the market. Given the retailer’s size, that could clearly have a negative impact on the entire warehouse sector.

For Prologis in particular, Amazon is by far its largest tenant, roughly double the No. 2 tenant by both occupied square feet and rents. That means that Prologis could end up competing with Amazon for tenants over the REIT’s own assets.

Plenty of good news

The coronavirus pandemic likely brought forward demand for online sales that abnormally increased demand for warehouse space over the near term. Tenants might have to work through that excess, but what is unlikely to change is the generally higher trajectory of online sales over the long term. So even if there’s an adjustment period in which excess warehouse supply exists, it will likely be absorbed eventually. That’s true even with Amazon looking to sublease space.

It’s also important to highlight that the increase in online shopping, though headline grabbing, isn’t the only trend that will impact Prologis’ business. For example, brick and mortar stores are still a huge business. The current supply chain disruptions have retailers, and many other businesses, reconsidering just in time inventory practices. That means an increased need to store extra inventory to ensure that there are enough products to sell, or for non-retail companies supplies to keep operating. In fact, some manufacturers are bringing operations back closer to home or placing them in more stable regions, another potential demand driver.

Meanwhile, newer, more modern properties are likely to remain in high demand. And Prologis has 10,600 acres of land on which to erect the types of modern assets that will attract the most customers. It can sell older assets and, effectively, upgrade its portfolio with properties that generate higher rents.

As for rents, in the first quarter, the REIT was able to increase rental rates on expiring leases by a huge 37%. That’s because existing leases were for rates far below the currently prevalent rates. Even if rental rates don’t increase any more or even fall a little bit, there’s a huge chasm to close between in-place lease rates and current ones as leases roll over. So there’s still rental growth to be had even if the warehouse market stagnates from here.

ups and downs

Both the market and businesses move in pendulum fashion, swinging from good times to bad times. Those swings can be caused by actual business conditions or simply by investor emotions. Right now, a mixture of both is impacting Prologis. (The planned acquisition of a peer is also in the mix, but management expects it to be accretive to adjusted FFO in year one, so it seems like a net plus.) All in all, however, the positives seem to suggest that the long -term picture is much brighter here than what short-term fears suggest.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon and Prologis. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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