One of the most successful value investing strategies is to buy profitable companies that are all around us but nobody sees. These invisible businesses often provide essential support services to industries.
A classic example of this strategy is Warren Buffett’s Berkshire Hathaway (NYSE: BRK.B), which famously owns pipeline companies; the McLane Company, which distributes products to retailers; and the Burlington Northern Santa Fe, or BNSF, railroad, all of which exist to service other companies. Not surprisingly, many modern value investors have focused on Prologis (NYSE: PLD), a hybrid company that combines a real estate investment trust, or REIT, with logistics and warehouse services.
The thinking here is that Prologis will provide services to online retailers in much the same way that McLane services brick-and-mortar convenience stores across America. The giant warehouses or fulfillment centers owned and operated by companies like Prologis are the ecommerce equivalent of McLane’s infrastructure of semi-tractors and warehouses.
What Is Prologis Anyway?
Okay, the thesis is both logical and fascinating, but is it good financial advice? The answer is, well, sort of. Prologis is far cheaper than the incredibly overpriced Amazon Inc. (NASDAQ: AMZN), which was trading at $662.99 a share on December 24, 2015. Prologis was trading at $42.37 a share on the same day.
Prologis is also a highly diversified company; it is a combination real estate developer, REIT and warehouse operator. Naturally, that can reduce risk by operating in a number of different industries and geographic areas. Prologis has operations in North and South America, Europe and Asia.
Its resources are also vast. In the Americas it owns 2,430 buildings, 6,470 acres of undeveloped land and 441 million square feet of warehouse space in four countries: the United States, Canada, Brazil and Mexico. That’s just its holdings in one hemisphere; it also owns 76 buildings with 51 million square feet of space and 286 acres of developable land in China, Japan and Singapore.
What Do Prologis’s Financial Numbers Say?
The holdings seem to make the argument for Prologis, but what do its financial numbers say? As is so often the case with such unusual companies, the financials are actually a mixed bag.
On September 30, 2015, Prologis reported the following numbers for Third Quarter 2015:
- Revenues of $2.005 billion
- A net income of $1.16 billion
- A profit margin of 44.89%
- A diluted earnings per share number of 2.207
- A dividend yield of 3.58%
- A return on equity of 8.17%
- A free cash flow of -$288.85 million
- Cash and short-term investments of $310.43 million
- $903.56 million in cash for operations.
So yes, folks, Prologis does make money and offer healthy returns for investors. Now for the all-important question: How safe is it? For that, I will perform a quick and dirty Political, Economic, Social, Technological and Environmental (or PESTLE) Analysis of the factors that could affect Prologis.
A Quick and Dirty PESTLE of Prologis
Obviously, a company such as Prologis is highly vulnerable to outside factors, many of which are beyond its control. Therefore PESTLE is the best way to examine its future prospects.
Political Developments That Could Affect Prologis
- Chronic underinvestment in infrastructure in the United States could lead to transportation delays, gridlock and other bottlenecks. Particularly devastating to Prologis could be the crumbling freeway and highway systems. This is a political problem because Congress has refused to adequately invest in basic transportation infrastructure and next generation technologies such as high-speed rail, for questionable political reasons.
- Conflicts between the U.S. and China or Russia or terrorism could disrupt international trade and the supply chain. An underappreciated danger is that terrorists could target shipping or the supply chain could be shut down by blockades as occurred during the two world wars. A related danger is that navies could target shipping for submarine attacks as both the United States and Germany did during the two world wars.
- Economic nationalism, which encourages protectionist trade policies, is growing in popularity in some nations, such as the United States. Two economic nationalists, Bernie Sanders and Donald Trump, are attracting widespread support in the U.S. presidential campaign.
Economic Factors That Could Affect Prologis
- The continued growth of some economies, particularly those in the U.S. and China, should lead to increased volumes of freight, particularly in the retail sector. Growth of China’s consumer market should dramatically increase demand for fulfilment services in the world’s largest economy.
- Economic stagnation in Europe and Japan limits future growth prospects in those markets. At some point, it could lower demand for fulfillment services there.
- Continued economic growth in developing nations such as India could open up new markets for Prologis.
- Prologis is vulnerable to national economic problems, including growing income inequality in the United States and inflation in Brazil.
Social Factors That Could Affect Prologis
- Growing hostility to foreign products in some nations could lead to a hostile political environment and restrictive trade policies.
- There is a strong potential for labor unrest and violence in China that could disrupt trade or business operations.
- Growing income inequality in the United States, Brazil and Europe could lead to social or political unrest and violence that could disrupt trade.
- Labor shortages, particularly of truck drivers, could disrupt Prologis’s operations in the United States. Such shortages could also increase operating costs; CNN reported that salaries for truck drivers could soon reach $73,000 a year.
- Growth of ecommerce could produce a backlash from persons that blame it for unemployment or income loss.
- Increases in crime could disrupt the supply chain or lead to expensive inventory losses. One result of rising crime, such as that in Mexico, could be the need to hire expensive, armed security forces to protect facilities, particularly if they become targets for terrorists or organized crime.
Technological Factors That Could Affect Prologis’s Business
- Growth of ecommerce should increase demand for fulfillment centers and logistics services.
- Advances in robotics and other technologies could increase the efficiency of operations and possibly lower Prologis’s operating costs. Lower operating costs could lead to increased demand for services and higher profits for investors.
- New transportation technologies, such as the Hyperloop, drones and self-driving trucks, could disrupt the supply chain and make portions of Prologis’s infrastructure redundant. Such technologies could also open up new markets and increase the demand for centralized logistics services.
- Next generation weapons technologies and cyberwarfare could make it easier for terrorists or criminals to disrupt the supply chain and increase risks. This could necessitate costly increases in security.
- New energy technologies, such as solar power and electric vehicles, could lower Prologis’s operating costs.
Legal Factors That Could Affect Prologis’s Businesses
- Antitrust action could force the breakup of large corporations like Amazon and disrupt Prologis’s business.
- New laws demanding increased benefits and wages for workers could increase Prologis’s operating costs.
- Regulatory changes prompted by popular demands for stricter environmental and labor laws could force expensive changes in business practices.
- Environmental laws could force a changeover to expensive new energy sources.
Environmental Factors That Could Affect Prologis
- Extreme weather triggered by global warming could disrupt the international supply chain.
- Energy shortages could increase operating costs or disrupt the supply chain.
- Efforts to reduce greenhouse gases could force shippers and Prologis to adopt expensive new energy sources, raising operating costs.
What Investors Need to Keep in Mind about Prologis
Investors need to realize that a company like Prologis is highly vulnerable to a wide variety of outside factors beyond its control. All it would take is a few changes to the regulatory or political environment to make Prologis’s business model unsustainable.
Despite that, Prologis seems like a good investment because it is undervalued and underappreciated by Mr. Market. It had a market capitalization of $22.39 billion and an enterprise value of $37.31 billion on December 24, 2015. So if you are looking for a cheap way of cashing in on the ecommerce boom triggered by Amazon and others, Prologis is well worth the risk.