A warehouse worker using a laptop. Drazen Zigic
For investors looking to construct an unstoppable dividend growth stock portfolio, there is a place for quality real estate investment trusts (REITs) in such an investing strategy. This is because real estate that is mission-critical to tenants often generates rising rents and price appreciation over time that can also be used to fund dividend growth.
REITs arguably don’t get any better or bigger than the commercial industrial real estate company Prologis (NYSE:PLD). The REIT sports a $114 billion market value, which makes it the biggest REIT on the planet. Size aside, Prologis also arguably fits perfectly in a dividend growth portfolio. Let’s dig into the REIT’s fundamentals, risks, and valuation to discover why.
Prologis Is A First Class REIT
Prologis September 2023 Investor Presentation
As a consumer in this day and age, many companies contribute to your standard of living without you even knowing it: Prologis is one of those companies. Anytime you are shopping online for goods, there is a chance that the company’s industrial real estate plays a crucial role in fulfilling your order.
Each year, nearly $3 trillion worth of goods flow through Prologis’ more than 5,500 buildings spanning four continents. For context, that is nearly 3% of the global GDP and about 4% of the total GDP of the 19 countries where the company operates.
Without Prologis’ extensive commercial industrial real estate, the world as we know it and the company’s thousands of tenants couldn’t function. This is why the industrial REIT’s occupancy rate was a robust 97% as of August 31.
As the world grows in population and wealth over time, it’s hard to imagine the need for industrial real estate trending in anything but an upward direction. This is because an expanding global population base supports greater consumption, which necessitates more industrial real estate to handle the higher volume flow of goods. Prologis estimates the U.S. true months of supply for industrial real estate is currently at around 30 months. For context, anything less than 50 months leads to real rent growth for the company (this adjusts for inflation). Alongside lease renewals at much higher rent rates, these factors bode well for Prologis. Outside of the next couple of years of slower economic growth, this should help the company to largely revert to its five-year annual AFFO per share growth rate of 11.6%.
As a bonus, Prologis boasts a debt-to-adjusted EBITDA ratio of just 4.2 and a $6.4 billion liquidity position. For context, the debt-to-adjusted EBITDA ratio is about the same as what it was five years ago in Q2 2018 when it was 4.1. While its liquidity is significantly better than the $4 billion back in Q2 2018. The company’s financial health is gradually becoming stronger over time, which is why it enjoys an A credit rating from S&P.
Prologis is also masterfully managing its debt, more than 90% of it being fixed-rate debt shielded from the currently high interest rate environment. The weighted average interest rate on the company’s debt currently stands at just 2.9%. What makes Prologis even more interesting is that its investment spread is expanding. In looking at its recent $3.1 billion deal with Blackstone (BX), Prologis acquired another 14 million square feet of industrial real estate at a cap rate of 4%. That’s already a 110 basis point investment spread. But it gets even better: Adjusting these rents for what the company could receive at current rent rates, the cap rate jumps to 5.75% – – a roughly 285 basis point investment spread.
Thanks to its low cost of capital and the potential deals in the pipeline, Prologis should have no trouble investing in growth projects moving forward (info in the prior five paragraphs sourced from Prologis June 2023 Investor Presentation and Prologis September 2023 Investor Presentation and Prologis 2018 Bank of America Merrill Lynch Global Real Estate Conference Presentation ).
The Well-Covered Dividend Is Primed For Future Growth
Relative to the real estate sector, Seeking Alpha awards Prologis with a dividend growth grade of A – – a very high mark. Considering that the company has hiked its dividend by an average of 12.6% each year over the past five years, this is a well-deserved grade in my opinion.
The good news moving forward is that Prologis should have many more years left of dividend hikes like its most recent 10% boost announced in February. This is because the company anticipates that it will generate $5.08 ($5.06 to $5.10) in core FFO per share in 2023. Measured against the $3.48 in dividends per share that are going to be paid for the year, this is a core FFO per share payout ratio of just 68.5%.
Prologis’ 2.8% dividend yield is somewhat below the industrial REIT industry average yield of 3.3%, which is why Seeking Alpha grades it a D- on dividend yield. But by virtue of being a REIT, Prologis’ yield is at least measurably above the 1.5% yield of the S&P 500 index.
My best guess is that the company should have no problem delivering 7.25% annual dividend growth over the long run. This forecast blends low- double-digit annual dividend growth potential for the next few years with an eventual slowdown in dividend growth beyond the medium term.
Risks To Consider
Prologis is a REIT with a bright future. But even the best businesses can’t escape risk.
The biggest risk arguably facing the company is the potential that the industrial real estate industry overestimates demand. When an industry is booming as much as industrial real estate, companies can get too eager to develop additional properties. This could result in a glut of industrial real estate supply, which could pressure industrial real estate rents.
Another risk that Prologis faces is more in the near future. As we talked about earlier, higher interest rates aren’t necessarily hurting the company’s investment spread. But the longer interest rates remain elevated, the longer it will take for the stock price to recover to its all-time high share price of around $166 in April 2022. This is because many investors are currently more attracted to the 4.4% risk-free rate of the 10-year treasury than REITs. If interest rates remain unchanged or rise slightly higher in the months ahead, expect Prologis’ stock price to remain flat or dip a bit more. But as interest rates eventually come back down, this should stimulate demand for its shares and spark an eventual rally.
An Amazing Company At A Fair Price
Prologis is a business worthy of a spot in a dividend growth stock portfolio. But at what price? Let’s lean on my inputs into a couple of valuation models for guidance.
Money Chimp
The first valuation model that I will highlight to value shares of Prologis is the discounted cash flows or DCF model. This is comprised of three inputs.
The first input into the DCF model is the last 12 months of core FFO per share. That amount is $6.01 in the case of Prologis.
The next input for the DCF model is growth predictions. Growth will be light for the next year or two. But with a recovery in the latter three or four years, I will assume a five-year annual core FFO per share growth rate of 6%. I’ll then use a 5% rate in the years that follow.
The last input into the DCF model is the discount rate, which is the annual total return rate. I’ll require 10% for this input.
Using these inputs for the DCF model, I arrive at a fair value of $131.80 a share. This suggests that Prologis’ shares are trading at a 6.8% discount to fair value and offer a 7.3% upside from the current share price of $122.80 (as of September 18, 2023).
Investopedia
The second valuation model that I’ll deploy to estimate the fair value of shares of Prologis is the dividend discount model. The valuation model also consists of three inputs.
The first input for the DDM is the expected dividend per share, which is the annualized dividend per share. That is currently $3.48 for Prologis.
The cost of capital equity is the second input, which refers to the annual total return rate. Once again, I will use 10% for this input.
The third input into the DDM is the annual dividend growth rate. I will assume 7.25% for Prologis.
Factoring these inputs for the DDM, I get a fair value output of $126.55. That means Prologis’ shares are priced at 3% below fair value and could provide a 3.1% capital appreciation at the current share price.
When I average these fair values, I compute a fair value of $129.18 a share. This indicates that shares of Prologis are trading at a 4.9% discount to fair value and offer a 5.2% upside from the current share price.
Summary: Not A Table-Pounding Buy, But A Buy Nonetheless
Having upped its quarterly dividend per share for 10 consecutive years, Prologis is a newly minted Dividend Contender. Given its growth potential and viable payout ratio, this looks to be the beginning of an exceptional dividend growth streak.
By my estimates, shares of Prologis are about 5% undervalued. This isn’t a bargain-bin valuation by any means, but it’s a reasonably alluring value. That is precisely why I am initiating a buy rating on the industrial REIT.
