Description

Pico holding has been written up twice on VIC. PICO started as an insurance company that was put into run-off mode in 1995, Mr. Hart used the proceeds to invest in publicly traded companies initially. In 2012 PICO sold its remaining legacy insurance business. The Pico managers self-describe themselves as long term value investors creating shareholder value by investing in undervalued assets. Later Pico expanded its investment activities into real estate and into water rights through a series of reverse mergers.  It owns an undervalued portfolio of unique hard assets that provide investor leverage to rising real estate market. Unlike most of the real estate related names, PICO hasn’t yet enjoyed the bull run. Its shares have done nothing in the past two years, while the home builder index has rallied nearly 100% during the same period. The equity was consistently trading at a premium to the tangible book value before the financial crisis. It is now at around 1 times book and I believe the true economic value is much higher than their book.

PICO holdings operates in the following segments:

• Water Resource and Water Storage Operations;

• Real Estate Operations;

• Agribusiness Operations;

Through its Vidler water business, PICO acquires undeveloped water rights in southwestern states.  A water right is the legal right to divert water and put it to beneficial use. Water rights are real property rights which can be bought and sold. water rights are commonly measured in acre-feet which is a measure of the volume of water required to cover an area of acre to a depth of one foot and is equal to 325,850 gallons.

Vidler develops new sources of water for municipal and industrial use, either from existing supplies of water, such as water used for agricultural purposes, from acquiring unappropriated (previously unused) water, or discovering new water sources based on science and exploration Vidler also develops and operates water storage facilities.  Vidler leases some of its water, farmland or ranch land while further developing the water resource. Vidler can generate revenues by selling its developed water rights to real estate developers, power generating facilities, other commercial, industrial users water utilities, municipalities and other government agencies. It can also sell its stored water to commercial developers or municipalities that have either exhausted their existing water supplies.

Vidler currently owns 39786 acre-feet of water rights and 8800 acre of farmland in the following states: Arizona, California, Colorado, Idaho, Nevada and New Mexico. Vidler also owns various water storage and other related infrastructure. The value of a water right depends on a number of factors, which may include location, the seniority of the right, whether or not the right is transferable, or if the water can be moved from one location to another.

I think the true economic value is much higher than their book value for the following reasons. 1, From the few transactions Vidler has done, the water rights were all sold at a significant premium. Due to the complexity of the variables, it is impossible to value the water rights from the past transactions. Vidler has sold water rights for $8000-9000 per acre-feet.  Using $8,000 per acre-feet price, PICO’s water rights along worths more than 50% premium to the book (I admit this is not a good assumption by any means). 2 like other resources, the value of water rights is determined by supply and demand. The population growth rate in the southwest has consistently been higher than the national rate for the past several years. According to the 2010 U.S.Census, in the decade from 2000 to 2010, the population of Nevada grew by a total of 35.1% (703,000 people), Arizona grew by 24.6% (1.3 million people), Colorado grew by 16.9% (728,000 people), Idaho grew by 21.1% (274,000 people), New Mexico grew by 13.2% (240,000 people) and California grew by 10% (3.4 million people). On the other side, the water supply is not expected to be sufficient to meet the future demand. Currently, a significant portion of the Southwest’s water supplies come from the Colorado River. And the rest is provided by other surface rights, such as rivers and lakes, groundwater. the U.S. Department of the Interior projects water supply and demand imbalances throughout the Colorado River Basin and adjacent areas over the next 50 years. The average imbalance in future supply and demand is projected to be greater than 3.2 million acre-feet per year by 2060. The Colorado River Basin currently provides water to some 40 million people, and this number could nearly double to approximately 76.5 million people by 2060, under a rapid growth scenario. The recovery in housing market is a catalyst for population growth. The price of the water rights will lag the rising housing market. Water is cheap when it is plenty. It is replenished naturally. However once demand crosses a certain threshold, the price will skyrocket, due to the limited nature and prohibitive cost to transport from other locations. Until such tipping point is reached and PICO is able to regularly sell its water rights, market is less likely to give PICO full credit of this unique assets.  3, Under GAAP certain of  water resource assets, unlike other real estate assets, are considered to be indefinite-lived intangible assets. The carrying values of such assets is assessed periodically with a discounted cash flow model.During the Great Recession, southwest experienced significantly decreasing the rates of population, economic and housing growth in 2008, 2009 and 2010 compared to earlier years in the decade 2000 to 2010. PICO has recorded $16.2M and $10.3M charges against those water assets in 2011 and 2010 respectively. I do not believe the actual economic value is significantly impaired due to the recession. Admittedly  the delay in potential demand reduces the NPV, however I will argue that the expected future value is higher due to the massive money printing by central banks. 4, the 8,800 acre of farmland that was bought initially  to apply for the water rights should also worth significantly more than its book, given the bull market in farmland in the past several years

Real estate operations

During the recession, PICO devote most of its cash into real estate, when the price of unfinished residential lots was depressed. Through UCP, it acquired finished and entitled residential lots in and around the Fresno Metropolitan Area, the Central Coast region of California, in particular, the Monterey region, and the Bay Area of California.  and various residential lots in the Central Puget Sound market area of Seattle, Washington. UCP now owns 4,916 lots. Of these lots, 63 are completed homes.

As the housing market recovered, UCP is able to sale undeveloped lots to other home builders and developed houses to home buyers at 28% gross margin. Their GM compares favorably to recently IPOed Taylor Morrison (at 22%) and the home builder industry (average is around 18%). On April 5th, PICO announced plan to raise up to 125M through the the UCP IPO. Given the home builders are trading multiple of their book value, UCP should achieve a similar or better valuation as a stand alone public company.

AGRIBUSINESS OPERATIONS

Northstar Agri Industries (“Northstar”)  operates a canola seed crushing plant near Hallock, Minnesota. The construction of the plant was completed in 2012 and production of canola oil and canola meal started iin the third quarter of 2012. The initial crushing capacity of 1,000 tons per day and it can be increased to 1,500 tons per day at a cost of approximately $10.5 million. Canola harvest declined 15% in 2012, which leads to a decline in crush capacity utilization is below historical normal. And also the plant was operated in a start up mode, both margin and crushing operation are below its potential. The long term average of Canola crush margin is around $80 per ton (right now it is around $40).

Similar food processors generally trade around 1 times revenue. However it is difficult to evaluate the business based on the short operational history of this business. Assuming the management did not waste capital ( given their decent track record of capital allocation), I will just use the book value for the base case.

Corporate :

The corporate segment, holds 82.2M in cash, 17.3M in security and a portfolio of small-capitalization value stocks publicly traded in Switzerland and in the U.S valued at 17M. It also carries 27% equity interest in Spigit (at 0 book value), deferred compensation assets and liabilities held in trust for the benefit of several officers and non-employee directors of the Company, and other parent company assets and liabilities.

Valuation:

  PICO’s water resource gives investors an unique way to benefit from rising housing market. Pricing of the water resource provide investors a good leverage on  the rising housing development and the population growth. Ironically the water resource is also the reason for PICO to remain unloved by the market. It is one of the few related names that has not significantly appreciated in value since the bottom of the housing market. Admittedly it is extremely difficult to price these water rights with any kind of precision. The value of the water rights should appreciate together with housing market and possibly at faster rate.

Management has been consistent buyer of the stock. Insiders together holds 5.7% of the company.Their interest should align with shareholders.

Catalyst