Description

Pico Holdings has been written up a few times in the past.  It’s an under-followed company that screens poorly due to a lack of (until recently) steady revenues, and lumpy (and often) negative operating profits.  With the Southwest’s drought in the news, PICO is likely to garner attention as one of the better ways to invest in water.  We believe that fair value of PICO’s shares is in the range of $28 to $43 , offering  roughly 20% to 80 % upside from the current market price.   

Quick SOTP table:

“Whiskey is for drinking, Water is for fighting” (1)Vidler Water Company:  

The largest component of PICO’s value lies in their subsidiary (“Vidler”) (http://www.vidlerwater.com/). As many of you know, California is the middle of a nasty drought.  The southwest region is dependent on the Colorado River for much of their water yet annual discharge rates are trending lower.  Lake Meade is 120 feet lower than it was in 1999 and will likely go down another 20 feet by July.  Scientists have been able to conclude that the 20^th century was one of the wettest centuries over the past 1,200 years, yet most, if not all, of the water policies were put into effect over the last century.  Drought conditions and population growth are putting huge strains on water resources.  We believe that it’s only a matter of time before “water rights” becomes a buzz phrase again and companies like PICO will be re-rated.  It happened back in 2006. Shares shot up from $25 to $45 in short order.  It would not be a stretch to see PICO’s shares go back up near $40 if the drought in the southwest gets enough attention.

Vidler owns water rights across Arizona, Colorado, Idaho, New Mexico and Nevada.  Nevada is where most of its value lies.  Vidler owns approximately 45,000 acre feet of water rights, 407,000 acre feet of leasable water (selling of an acre foot vs water rights which is essentially perpetual acre feet), and potentially another 150,000 or so acre feet of water rights in various stages of application for entitlement.   There is no exact way to measure their portfolio of water rights and leasable water.  The company has sold water in Arizona (north of Phoenix) for about $3,000 per acre foot, $8,800 in Nevada as well as potentially selling some 7,000 acre feet to a power plant project for $12,000 per acre.  You can see from the table below, that values range from $3,000 to $12,000 per.  For leasable water, I’m assuming $225 to $300 per.  They bought 126,000 acre feet back in 2010 for $123 per acre foot.  They own about 408,000 acre feet of stored water. We know values are significantly higher but there haven’t been any sales because there is no water.  Pico wants the market to come to them.  I think that time is coming.

The largest water asset on their balance sheet is their 51% interest in Fish Springs, LLC.  It’s on the books for $84 million.  They fronted the developments of the infrastructure (pumps, 35 miles of pipes etc.).  The construction costs that need to be recouped from their partner (Washoe County which includes Reno and Sparks Nevada) are accruing at Libor + 450.   Even though the asset is on the books for $84 million, PICO needs to earn $150 million or so before their partner starts to share in the profits.  In speaking with the company, this kind of a partnership is not likely to be repeated.  I wouldn’t be surprised if they sell it in the next couple of years.

Fair value for the water rights and leasable water is $9.33 to $15.59 per share (see table at bottom of report).

Agriculture Division (Canola).

It’s been a bit of a disaster since coming online in 2012.  Just as they were starting the canola oil plant, canola prices went through the roof due to supply shortages.   They buy canola seeds and hedge the canola oil with soybean meal / oil futures.  Unfortunately, there was a bumper soybean crop at that time leading to historically low crush margins. The hedges didn’t work and they lost a bunch of money right out of the gate.   Crush margins have been getting better but still below historical averages.  Q3 margins looked to be around $65 per ton.  As of the September 10Q, the company believed there was further improvement for the end of 2013 and early 2014 but it was still too early to know definitively.  Nonetheless, they have increased their daily capacity to 1,300 tons. Assuming $65 to $70 crush margins, they should be able to generate close to $8mln per quarter ($32 million annually).  Historically, crush margins are closer to $125 a ton.  If, or when, they get back to historical averages, $32 million in ebitda is easily achievable.

Given how new the plant is and its agreement with Land O'Lakes, we can value Pico’s 88% equity share in the Canola plant at their cost of $80 million.  If they get back to normal crush margins and ebitda gets to the $32 million they projected when they first announced the investment, you can value it at close to $175 million.  If they expand the capacity and reach the high end of $50 million of annual ebitda, the high end value could be $325 million.  Per share, the range is $3.50, $7.70 and $14.30.

UCP, Inc.

UCP, Inc. is a homebuilder in Northern California and Washington State.  Pico carved it out in July of 2013.  Pico owns 57.7% of UCP (or 10.593 million of the 18.73 million Class A shares).  Market cap is $255 million against $218 million of book (which consists of $105 million of cash).  They own 5,613 lots in Northern California and 1,046 lots in Puget Sound, Washington.

Gross margins on land sales have been around 32 % while homebuilding margins have been around 22 %.  We haven’t spent much time on this part of the business.  Toll and Lennar trade around 1.8 to 1.9 x book vs UCP at just under 1.2.  You can get a borrow on UCP if you want to hedge it out.  On a per share basis to PICO, it is about $6.50.

Mindjet:

We have not spent much time on this asset.  The owned the majority of Spigit which merged with Mindjet.  Pico's interests decreased to 29% ownership and they booked a $22 million gain on the merger. It's roughly $1 a share of value.

Cash, Investments, Debt:

Cash (ex UCP) is ~ $53 million and investments were $77 million in equity and debt investments.  Book Value debt is $153 million, but only about $17 million is recourse to Pico. The Canola Plant debt is non-recourse (~$91 million) and UCP’s mortgage debt is another $45 million.  NOLs are about $30 million.

Conclusion:

You can hedge out UCP and be long cash, investments, a canola plant (that is getting closer to historical norms) and water.  The water assets will likely have some large sales, including the potential exercise of the 7,000 acre feet at $12,000 per that will let investors get more comfortable with the potential value of Pico’s water assets. 

Catalyst