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Morningstar | Prologis Posts Strong Quarter After Merging With DCT Industrial

After integrating DCT Industrial into its warehouse portfolio, no-moat Prologis posted a solid third quarter that was mostly in line with our expectations. We think the key takeaway from this quarter is that although the firm did not hit our revenue goals, management beat our expense targets. Given this information, we are planning on maintaining our $67 per share fair value estimate while we watch revenue growth in the fourth quarter. Although management has asserted that revenue synergies will exist between the Prologis and DCT portfolios, we did not include them in our model and largely added DCT’s expected revenue to Prologis’ expected revenue. At this point, it looks like management will need to develop these top-line synergies to meet our revenue goal. That said, we were impressed that the expense synergies are further along than anticipated, with year-to-date interest expense, rental expenses, as well as general and administrative expenses, being materially below what we expected. Prologis’ quarterly funds from operations of $0.72 missed our estimates by two cents, but management raised the annual FFO guidance for the third time this year and our bottom line estimates are now below guidance. Our annual FFO estimate currently prices in 4.2% FFO growth in the final quarter from the third quarter, which we think is an ambitious enough target because management would need to either cut costs substantially or realize the revenue synergies to meet our goals for the company. Overall, we think that Prologis has a strong business, but the company’s valuation shows that the market already understands Prologis’ importance in e-commerce, and we would advise investors to wait for a larger margin of safety before investing in this no-moat name.

Fundamentals for the warehouse industry are likely to remain strong in the medium term as e-commerce is continuing to grow much more rapidly than the infrastructure supporting it, but we do not think the industry is conducive to sustainable economic advantages. Demand is outstripping supply, as Prologis beat our occupancy targets by completely leasing out the incremental square footage gained from the DCT merger in a quarter and is posting 11.6% cash releasing spreads, which are below our estimates but still impressive. On an industry level, we continue to think that in the long run warehousing will be a competitive business because Prologis’ warehouse product can be replicated by alternate providers and that the top 25 customers, which make up about 20% of net effective rent, can exert buyer power to limit price increases, both of which we think will eventually limit pricing power.