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Prologis Stock: Do Strong Financial Results Justify Its Valuation?
Stock Analysis & Ideas

Prologis Stock: Do Strong Financial Results Justify Its Valuation?

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Prologis has unique qualities that could prove quite valuable during the current market environment. The company’s latest results were robust, with demand for industrial properties remaining at sky-high levels. Still, investors should be wary of the stock’s current valuation, which doesn’t appear to be particularly attractive.

Prologis, Inc. (PLD) published another excellent quarterly report for its Q2 results, including consistent top-and bottom-line growth despite the underlying challenges. Regardless, investors should be wary of the stock’s valuation, which is not particularly inviting. For this reason, I am neutral on the stock.

Prologis is, by a wide margin, the largest industrial U.S. REIT, operating approximately one billion square feet of real estate in 19 countries. To put its size into perspective, the second-largest industrial REIT in the country is Public Storage (PSA), whose market cap stands at $57.5 billion, 61% of that of Prologis.

Prologis’ Positive Qualities

Due to its enormous operating space, Prologis accommodates more than 5,800 tenants. Therefore, its cash flows are quite diversified, minimizing counterparty risks.

Another great quality that comes with Prologis’ size is that the company can unlock economies of scale, which includes declining operating expenses as a percentage of total revenues. In addition, it can secure favorable financing terms as debtors have limited demands from such a credit-worthy company.

To illustrate this, Prologis’ EBITDA margin gradually expanded from 56.8% in 2014 to 69.7% last year. Further, Prologis’ weighted average interest rate stands at 1.8%, exhibiting the company’s capability to attract dirt-cheap financing.

Even in a rising-rate environment, the company will likely attract the cheapest financing among its peers. This makes for another great competitive advantage and a very attractive characteristic during the ongoing macroeconomic environment.

Q2 Results: Strong Demand for Logistics Properties Despite Market Challenges

Real estate investors have grown increasingly worried regarding the performance of industrial REITs. This is due to the ongoing macroeconomic frenzy and the possibility of slowing economic growth, which could reduce the demand for industrial properties. Yet, backed by unwavering demand for logistics space and Prologis’ multi-year leases, the company’s results remained vigorous in Q2.

Specifically, revenues rose 8.7% to $1.25 billion, while FFO/share advanced by 9.9% to $1.11. Overall, Prologis keeps riding the powerful demand tailwinds for industrial properties created by the pandemic, experiencing unprecedented rent growth.

Supply-chain bottlenecks also remain, resulting in distributors striving for enhanced fulfillment rates and operational soundness, thus increasing rents for Prologis’ properties.

Prologis’ balance sheet remains quite healthy, with debt as a percentage of its total market cap dwelling at a reasonable 18.5%. As mentioned earlier, the weighted average borrowing rate came in relatively low, at 1.8%, illustrating the strength of the company’s balance sheet.

Moreover, Prologis’ weighted average remaining lease term stood at 4.2 years at the end of Q2, stretching sequentially (from 4.0 years) as tenants aspire to secure logistic properties further into the future.

This doesn’t only further verify the persistently high demand for Prologis’ properties but also enhances the REIT’s medium-term cash flow visibility. Even if rents were to ease in the next couple of years, Prologis’ revenues would likely hardly be affected.

However, it’s unlikely that a decline in rents would occur in the first place. In fact, as management noted during the post-earnings conference call, in light of very low vacancy and healthy demand, PLD increased its overall market rent growth estimate for the year to 23% on a global basis and 25% in the United States.

Another important metric that illustrates the overall dynamics Prologis is currently experiencing is the REIT’s occupancy rate. Particularly, occupancy rose from its already impressive 97.4% in Q1 to 97.6% in Q2.

With Prologis retaining its strong momentum, management once again boosted its Fiscal 2022 outlook, forecasting an FFO/share between $5.14 and $5.18 (up from $5.10 to $5.16 previously).

Prologis is Not Cheap Despite the Recent Correction

While shares of Prologis have corrected by just over 24% year-to-date, and management further boosted its Fiscal Year 2022 FFO/share outlook, I believe that shares remain modestly pricy. By applying the midpoint of management’s FFO/share outlook, the stock is currently trading at a P/FFO of 24.7x. This multiple is at the very high-end of Prologis’ historical P/FFO, which has ranged between 15x and 25x.

On the one hand, it is not senseless that investors are willing to pay a premium for the stock. The company comes attached to many qualities that distinguish it from its peers, especially in an increasingly uncertain trading environment.

The fact that PLD’s dividend growth prospects remain very strong is also another catalyst that pushes the valuation higher. Back in February, management stunned investors by declaring an accelerated 25.4% dividend hike.

On the other hand, the current multiple is simply too rich in a rising-rate environment, even if Prologis’ growth were to be sustained in the high single digits. Investors appear to have no margin of safety against a valuation multiple compression.

Further, despite last year’s massive dividend hike, Prologis’ 2.5% dividend yield hovers below its average of around 3% due to the current valuation premium. Thus, the dividend hardly offsets any losses caused by a possible correction in the valuation.

Wall Street’s Take on PLD Stock

Turning to Wall Street, Prologis has a Strong Buy consensus rating based on 11 buys and two Holds assigned in the past three months. At $162.25, the average Prologis stock forecast suggests 27.24% upside potential.

The Takeaway: There Likely are Better Opportunities Elsewhere

Prologis is a high-quality company that should remain on investors’ watchlists. Few companies among REITs can come close to Prologis’ broad set of qualities. That said, buying at the current valuation doesn’t appear to be the wisest decision, especially with so many stocks trading at a discount these days.

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