US stocks, for China warehouse boom

ProLogis's - US REIT

BEIJING -- For many investors, the shine has come off U.S.-listed real-estate investment trusts as they look expensive given the uncertain outlook for the American economy and property.

One U.S.-based REIT that is retaining fans is doing so in part because of growing income from a country with an economy that remains hot: China.

ProLogis, which is based in Denver, has been investing in warehouses that play a role in the country's huge trade. The company is involved in operating 7.4 million square feet of warehouse space -- of which ProLogis owns 35% and is in joint ventures for the other 65%.

ProLogis isn't the only U.S. industrial REIT that is already in China, though it has the largest presence by far in the nation. At present, space in China accounts for just 1.7% of the ProLogis portfolio. But the New York Stock Exchange-listed company, which has a market capitalization of more than $16 billion, aims to convert its beachhead into much bigger business.

For ProLogis, China is the only portfolio that is growing 100% a year, Chief Executive Jeffrey Schwartz says. Ming Mei, president of ProLogis China, says the company intends to develop 10 million to 15 million square feet of warehouse space a year. The goal, he says, is for Chinese assets to be 10% of the global portfolio in five to 10 years.

ProLogis already has a substantial presence in coastal cities such as Beijing, Shanghai, Ningbo and Hangzhou. Now it is headed inland. This month, ProLogis announced plans to invest $246 million in distribution centers in five interior cities: Changsha, Chengdu, Chongqing, Nanjing and Wuhan.

That announcement came about the time of a pullback by some investors from real estate. From the end of February through Tuesday, the MSCI U.S. REIT index fell 1.9%, in line with declines in all major indexes.

Shares of ProLogis, which this week had a $1 billion convertible-debt offering, fell 3.8% on Tuesday but were still up 5% for the year. Late morning yesterday, ProLogis's shares were up 11 cents at $63.93 on the NYSE.

Some analysts say the recent investor pullback makes now a good time to look at industrial REITs. These aren't involved in apartment space and thus aren't vulnerable to the subprime-loan-related woes roiling parts of the U.S. real-estate market. And in Asia, ProLogis has a small but notable growth story.

ProLogis "is one of our favorite stocks and one of our largest holdings," said Michael Winer, who manages a $3.3 billion fund for New York-based Third Avenue Management. ProLogis forms 8.55% of his holdings, according to FactSet Research Systems Inc.

On March 8, Merrill Lynch raised its assessment of seven REITs, including ProLogis, to "buy" from "neutral," saying it expects their net-asset value to grow in the next three to five years.

ProLogis tracks the footprints of multinational companies. Many of them are exporting to and from China, helping rev up global trade. Last year, 17 of the world's largest ports cumulatively had an average 13% increase in container-traffic volume, according to Chicago-based Morningstar Inc., which expects trade to be as robust this year.

Because ports and distribution hubs go hand-in-hand, analysts say logistics companies are positioned to gain when trade flourishes. ProLogis entered China in 2004, a year after Beijing freed up the logistics sector under the terms of its World Trade Organization membership.

ProLogis says China has three billion square feet of warehouses -- built by the central government in the 1980s -- that are tiny and poorly located. Mr. Mei says those state-owned warehouses will need to be overhauled, which could mean business for international logistics companies.

However, growth in China for ProLogis may have to come with increased costs. Last year, when the central government moved to reduce the amount of new land made available for industry, ProLogis calculated that its land-acquisition costs eventually would rise 30%. The company still has options on 54.6 million square feet of land.

Not everyone thinks shares of ProLogis are attractive. Heather Smith, an analyst who tracks real-estate stocks for Morningstar, estimates its fair value at $46 a share. "We really like their strategy and their management team, but they are a bit overvalued at this point, like most of the REIT sector," she says. Noting hefty potential, Ms. Smith adds that "Asia is a largely untapped market and [ProLogis] has a head start in China."

On a five-year basis, Thomson Financial has forecast average annual earnings growth of 19% for ProLogis. That is bigger than what Thomson forecast for California-based peers Public Storage and AMB Property, though lower than the 20% it projected for First Industrial Realty Trust of Illinois.

Over time, the China business of ProLogis should benefit from newly approved corporate-tax changes that will be phased in over the next five years. The changes eliminate tax breaks for foreign firms in key sectors, which have been paying a preferential rate of 15% instead of 33%. Mr. Mei says China doesn't consider ProLogis a company in such a sector, so it has been paying the standard 33% -- and will see that reduced to 25% in line with the new tax regime.

"China is a significant driver for us," says Mr. Schwartz, the company CEO.