PCYO - Pure Cycle Corporation

[Gregmal]

For those of you who like hard assets, discount to NAV RE plays, here you go. No, this isn’t like Howard Hughes, where you need a timeline of “decades” after oh so sure of himself Chairman hedgefunder took the company to market hoping for a sale, no this isn’t JOE, where a decade from now you could still be waiting for your regional land holdings to gain traction, no this isn’t CTO, where you have to wait a half decade only to find out that the transformation has occurred and that the company was actually given a higher valuation BEFORE management went and monetized everything in the name of closing the discount to NAV. And no, it isn’t PICO either, which is a good thing.

 

Elevator Pitch on PCYO: Woudnt you like to control the exclusive water rights to a major Denver sub? What about also owning a 5000 home MPC with commercial/retail capacity? How about using the control of the later to enhance the former? Bring in competing business and builders? They can pay for the water too. And whats not used we can monetize via water services for frackers.

 

Pure Cycle, in their own words:

 

Pure Cycle Corporation designs, constructs, operates, and maintains water and wastewater systems in the Denver metropolitan area and Colorado Front Range in the United States. It operates in two segments, Wholesale Water and Wastewater Services, and Land Development Activities. The company offers utility services, including water production, storage, treatment, wastewater collection and treatment, irrigation water treatment and transmission, construction management, billing and collection, and emergency response services, as well as bulk transmission services to retail distribution systems. It also develops raw land by constructing infrastructure, including over-lot grading, wet and dry utility installation, storm water facilities, roads, parks, and open space and other community improvements; and delivers finished lots to national home builders, as well as commercial and retail pad sites. In addition, the company engages in the oil and gas leasing business. It provides its services to wholesale customers, which include commercial and industrial customers, and local governmental entities that provide water and wastewater services to their end-use customers. The company was founded in 1976 and is based in Watkins, Colorado.

 

 

So why this is interesting here is almost by accident. Pure Cycle’s main asset is the Rangeview Supply just outside Denver. The company for much of its existence provided vertically integrated water services and sometime prior hooked up with a developer looking at turning out a nearly 5,000 home MPC. Well, shit went south and almost by accident Pure Cycle founnd itself with the right to a project who’s entire 930 acre base, was in a foreclosure auction. So Mark Harding, a key man here(CEO and face of the company), decided, lets do this. PureCycle purchased the entire lot, which is not only able to support 4000-5000 homes, but also a reasonably sized commercial/retail zone. The parcel was purchased for just over $7M at foreclosure and today is easily worth 3x that amount today, but that is moot because its being developed and Harding has patiently planned, and wisely teamed up with a trio of homebuilders(KBH, Taylor Morrsion, Richmond American) to really get the ball rolling.

 

So that’s the back story and between 2011 and last year, you kind of had your period of “getting things moving”…however homes have now been selling for the past year, are expected to continue closing at about a 16-24 per month clip, and with that, the gravy train only continues to accelerate. Through various development agreements, Pure Cycle makes money in phases, and in two different ways. The first, which in the beginning is not all that material, is on a margin on homes closed by the trio. Right now about $20K per. This, especially once phase 2 kicks off, will increase, but for now simply putting warm bodies in homes is the objective. It is not immaterial and also worth mentioning that the company incurs much of the infrastructure cost up front, and then once the homes get filled, reimbursed through a muni bond issuance. The first $13M or so may be issued by the end of this year. The second, and more lucrative, it’s the water tap fees and then recurring revenue. The multi phase project pegs at least ~4500/5000 homes. The initial tap fee for water and sewer is $31,000 per home which high margin(that only gets higher), and then recurring service fee of about $1,500 per year, per home.

 

So you’ve got a few other businesses here, oil and gas/fracking, whatever. Those make money too but I wouldn’t and don’t care too much about them. Pure Cycle’s main driver, the development of Sky Ranch, is live, and moving and unlike many other situations, much more in control of their destiny. We aren’t talking about bumblefuck Montana either, Sky Ranch is less than 20 minutes from downtown Denver and 4 miles from Denver International. Phase One is probably going to be wrapped up within 18 months, and I would expect a phase two announcement by year end. The entire project, barring severe economic disruption, should likely play out over the next decade with blended economics indicating roughly $20K+ per lot profit to Pure Cycle plus the $30K tap fee, and whats more, is that competing communities are already in the mix, which just accelerates to momentum of water sales given Pure Cycle is the ONLY provider in Lowry Range. 

 

Conservatively I think this should double within 12 months. You’ve got a longer term hedge fund owner keeping tabs, and Mark Harding(owner of 3.5% or so of the equity as well) guiding the ship. Interests seem aligned and if you’ve watched the recent season of Goliath with Billy Bob Thornton, you’ll see the necessity of water to areas like this(kidding). There really isn’t anyone who doesn’t want this to happen, so at this point, if you dont think the economy implodes tomorrow, it may be of interest to you to check this out. Heck give Mark a call. The situation is off the radar but primed to transform PureCycle into a recurring revenue machine and over time close the discount to NAV(which is huge).

 

[Spekulatius]

So we got roughly 5000 homes (equivalent) worth 100k each, thats $500M worth  total plus some oils and gas thrown in for roughly $260M right now. The $500M in expected earnings needs to be discounted for present fair value.

 

Seems somewhat cheap, but not egregiously so.

[Gregmal]

The owned MPC acreage and subsequent build out plus servicing is a major component. Basically the spark that lights the fire. However that only constitutes 5,000 homes. The company has acre feet capacity for 60,000 SFE in Lowry. This is a fast developing area with multiple existing projects ongoing and more on the way. Here is a site plan from Lennar.

https://www.lennar.com/images/com/files/new-homes/4/17/4967/spf/Adonea%20Site%20Plan.pdf

 

So yes you need to do some discounting, but if you wall off the 5,000 homes for Sky Ranch, you still have, between now and 2081, roughly 55,000 potential taps at $30K per, that then convert to ~$1500 per in annual recurring revenue. That really the upside that can take you to infinity and beyond. Sky Ranch basically just de-risks the entire investment. Without Sky Ranch, this would basically be PICO(minus Harding, who is head and shoulders above anything PICO ever had).

[Gregmal]

http://archive.fast-edgar.com//20191107/AKAON22CZC22L9Z2222A2ZZGMNPCZS22S2B2/

 

Total blowout. Looks like Phase I will be done at least 18 months ahead of schedule. Munibond issuance on its way. Homes flying off the shelf. Great stuff here.

 

 

"Fiscal year 2019 was an extraordinary year for us, in which we were able to execute our land development business segment and expand our water utilities segment," commented Mark Harding, President of Pure Cycle Corporation. “We are pleased to have closed the sale of 255 finished lots, receiving in aggregate $18 million in proceeds. This amount represents an acceleration of lot deliveries to our home builder customers from our original agreements and a testament to the success of opening our initial phase of Sky Ranch. Given this acceleration, we expect to close the remaining 159 finished lots under our finished lot agreement and 92 lots under our lot development agreements during fiscal 2020, which is more than 18 months ahead of schedule. Subsequent to our fiscal year end, we have delivered and received 2 progress payments for an additional 95 lots pursuant to our lot delivery agreements and closed an additional 22 finished lot sales, due to strong demand from our home builders for us to complete lots to keep up with home sales at Sky Ranch.

 

In addition to lot sales we also received payments for 113 water and wastewater taps in fiscal 2019 for a combined total of $3.5 million. As of October 31, 2019, our three home builder customers have been granted over 120 building permits and closed 11 homes with the new homeowners. Sales from our home builder customers continue to exceed forecasts, and we are thrilled with the success of our Sky Ranch opening” continued Mr. Harding.

[Gregmal]

Tremendous quarter, some great details on the call as well

 

https://seekingalpha.com/news/3530242-pure-cycle-reports-q1-results

[mikazo]

There seems to be some concern about depletion of groundwater and the increasing costs of pumping it to the surface from deeper depths.

 

https://www.denverpost.com/2017/10/08/colorado-eastern-plains-groundwater-running-dry/

[Gregmal]

There seems to be some concern about depletion of groundwater and the increasing costs of pumping it to the surface from deeper depths.

 

https://www.denverpost.com/2017/10/08/colorado-eastern-plains-groundwater-running-dry/

 

This is in eastern Colorado and not really in an area relevant to Pure Cycle's operations. The did, some time ago, own Arkansas River/Fort Lyon Canal assets and were debating potentially building a pipeline to transfer water to their core markets near Denver, but ultimately decided against that and sold of those interests maybe 5 years ago or so.

 

I would think in fact that a big piece not touched on in that article is the private land and water sales being done in that area for the purpose of moving the water to the Front Range.

[Gregmal]

http://archive.fast-edgar.com//20200406/AEZ2T622H222VZZ2222K2ZZETRSVJ22SV222/

 

Total animal this guy is. Bought tons of shares from the previous largest shareholder and now is filing every week on open market purchases.

[Gregmal]

Excellent stuff on the earnings call. Worth a listen for those interested here. Much talk about "pent up demand" which was an area brought up in another thread. Commercial optionality sounds very exciting. Biggest take aways was "0" contract cancellations to date and continued robust demand for Sky Ranch phase 2.

[PJM]

The owned MPC acreage and subsequent build out plus servicing is a major component. Basically the spark that lights the fire. However that only constitutes 5,000 homes. The company has acre feet capacity for 60,000 SFE in Lowry. This is a fast developing area with multiple existing projects ongoing and more on the way. Here is a site plan from Lennar.

https://www.lennar.com/images/com/files/new-homes/4/17/4967/spf/Adonea%20Site%20Plan.pdf

 

So yes you need to do some discounting, but if you wall off the 5,000 homes for Sky Ranch, you still have, between now and 2081, roughly 55,000 potential taps at $30K per, that then convert to ~$1500 per in annual recurring revenue. That really the upside that can take you to infinity and beyond. Sky Ranch basically just de-risks the entire investment. Without Sky Ranch, this would basically be PICO(minus Harding, who is head and shoulders above anything PICO ever had).

 

Hi Gregmal - Is my understanding correct on revenue from SkyRanch excluding the water/wastewater tap fee of around ~$$30K and recurring annual revenue of ~$1500. As per their latest 10Q, the initial 506 lots will require capital of $36m which includes $28m of reimbursement cost, so net capital cost of $8m generating $37m of revenue, so net revenue ~$57K/lot (SFE). Does that mean income of ~$285m from 5000SFE Skyranch in next 3 years plus ~$150m of tap charges?

 

[Gregmal]

The owned MPC acreage and subsequent build out plus servicing is a major component. Basically the spark that lights the fire. However that only constitutes 5,000 homes. The company has acre feet capacity for 60,000 SFE in Lowry. This is a fast developing area with multiple existing projects ongoing and more on the way. Here is a site plan from Lennar.

https://www.lennar.com/images/com/files/new-homes/4/17/4967/spf/Adonea%20Site%20Plan.pdf

 

So yes you need to do some discounting, but if you wall off the 5,000 homes for Sky Ranch, you still have, between now and 2081, roughly 55,000 potential taps at $30K per, that then convert to ~$1500 per in annual recurring revenue. That really the upside that can take you to infinity and beyond. Sky Ranch basically just de-risks the entire investment. Without Sky Ranch, this would basically be PICO(minus Harding, who is head and shoulders above anything PICO ever had).

 

Hi Gregmal - Is my understanding correct on revenue from SkyRanch excluding the water/wastewater tap fee of around ~$$30K and recurring annual revenue of ~$1500. As per their latest 10Q, the initial 506 lots will require capital of $36m which includes $28m of reimbursement cost, so net capital cost of $8m generating $37m of revenue, so net revenue ~$57K/lot (SFE). Does that mean income of ~$285m from 5000SFE Skyranch in next 3 years plus ~$150m of tap charges?

 

The accounting gets a little complex with some of this, for instance listen to the Q1 call explaining the muni bond breakdown. But generally speaking, there are a few ways to look at it. Of the $28M reimbursement, they've gotten $10M and until the next muni sale, the outstanding reimbursements accrue interest IIRC at around 6% or so a year. The net on the lots comes to about $20k per for phase 1 and is expected to rise substantially for phase 2. I think you are counting the entire 5000 SFE MPC however this will not occur over 3 years. 506 homes basically wrap phase one by August. What I'd expect is phase 2 you're looking at 2500-3000 SFE and potentially 2 million square feet of commercial with time lines of 3-5 and 4-7 years respectively. Each SFE generates a $30k one time tap and $1500 per year following. The commercial is generally 4-5x that number, maybe even higher. They are also starting to work on providing non company owned developments, a further boost. So for a 3 year model I'd probably look at the delivery of last phase one lots, so about 125, plus maybe 1500-2000 new lots on phase two, although keep in mind phase one came in two years ahead of scheduled so you could also see these numbers higher. But at 1500 and I'd figure $80-100M on the lots plus tap fees around $50M-$60M and then the massive compounding of the recurring revenue base.

[PJM]

How did you get 20k net on the lots?

 

As per their Q4FY19 presentation and transcript, they are making about ~100K per SFE, so for 506 lots they expect 50.6m and for the whole Skyranch around 500m, which includes reimbursable. The timing of the bonding of these reimbursable may vary, so you may see the income with a lag, but that pays them 6% interest. Plus you have $150m of tap charges and ~$7.5m of recurring revenue. What I don't understand is how to get the net of each lot, i mean what are the costs involved in development of these lots apart from the initial ~7m land cost?

[Gregmal]

The net figure on the lots is complicated, to say the least. Again referring to the accounting aspect. The company has cited this figure as basically your "after adjustment" margin once reconciling the reimbursements. The raw margin on lots for phase one was mid single digits, which was misleading because it didn't include consideration for the reimbursement. Total ballparks based on phase one have been $100k per lot broken down but $30kish tap fee, $70k lot value. Cost to prep to the company has been about $50k per. My understanding is that these figures will definitely improve on phase two now that theres demand and much of the infrastructural stuff in place. Mentioned on the call they've got 7 builders vying for a piece of it, and likely won't be able to accommodate all of them. As the build out furthers, the companies leverage increases.

 

On the accounting front, the company also just hired a CFO, previously an EY Denver Partner.

 

[Gregmal]

https://seekingalpha.com/article/4336550-pure-cycle-corporation-pcyo-management-on-q1-2020-results-earnings-call-transcript

 

Good stuff here.

 

This is an insulated powerhouse in the making who's timeline for development renders the current virus situation immaterial.

[keerthiprasad]

Thanks for sharing. This is a very unique company. I am having trouble determining a fair multiple for this company.  Curious how others are  approaching this?

[Castanza]

Lots of volume on this today. Anyone hear any news?

[Gregmal]

Nothing other than a few funds still likely liquidating, which is what Ive been hearing for a while now. There was huge concentration amongst 3/4 funds who were investors back from the GFC-shortly thereafter periods. Many took part in the private placement that funded the Sky Ranch purchase and have very low basis.

 

Not sure what the urgency would be here at $9 or why if you own it, and understand it, there'd be any reason to support selling it. But whatever. Wouldn't be shocked to see another Form 4 from Plaisance soon.

[Castanza]

Nothing other than a few funds still likely liquidating, which is what Ive been hearing for a while now. There was huge concentration amongst 3/4 funds who were investors back from the GFC-shortly thereafter periods. Many took part in the private placement that funded the Sky Ranch purchase and have very low basis.

 

Not sure what the urgency would be here at $9 or why if you own it, and understand it, there'd be any reason to support selling it. But whatever. Wouldn't be shocked to see another Form 4 from Plaisance soon.

 

Financials are strong, guidance is strong, crushing deadlines, single family housing is starting to boom and Denver is a very attractive city. Outside of some totalitarian water regulation implemented from the governments, it's hard to understand what would cause funds to liquidate.

[Gregmal]

Only risk I have on the radar is a bad acquisition. Harding has a good track record with capital allocation, but acquisitions are always a risk and they seem active in terms of buying something, whether it be local infrastructure assets, or land. Personally I'd prefer land.

[bizaro86]

Yeah. Best case is land to monetize the existing water. Tuck in water utility assets to add scale in that building would be ok. Last choice would be more raw water rights- they have decades worth, so adding more doesn't seem necessary.

[nspo]

I saw this writeup on TPL by Black Bear Value

 

"TPL is a royalty company with 100% of its acreage located in the Texas Permian Basin. In a nutshell, it makes money when drilling activity occurs, but DO NOT have the capital needs as it simply provides access to land. Think of it as a franchisor of fast-food energy and the drillers and/or midstream as the actual restaurants. If you drill oil on its royalty-land, you pay a portion to TPL. Need a road to drive to the site? You pay a fee/easement. Need water? Need a pipeline? Need electricity transmission lines? I think you get the picture. If you want access to the assets underneath the ground or to travel on top (oil/natural gas/water), you must pay TPL."

 

While there are some obvious differences, do any of you think TPL can be used to model PCYO's business and likely outcome?

 

 

[Gregmal]

I dont know if you can use it and a model, but there are similarities. TPL was basically a land bank that happened to be located in oil territory. Being able to bleed the land while collecting royalties is an incredible combination. You also didnt need employees, which is great. Pure Cycle does not really have material royalty/subsurface assets, at least that we know of. They do periodically make some money in that area but I dont think it will ever become a significant value driver. Its more or less a free call. The growth driver for Pure Cycle and eventual profit engine will be the tap fees/lot sales which then convert to recurring revenue, and then also probably a significant CRE asset that I am hoping is monetized through ground leases and triple net leases. The water rights will be monetized gradually as the buildout takes off. So its in more need of direction and execution than TPL, which kind of just ran itself. I started losing interest in TPL as the company(and others) started getting greedy and trying to convert it to a business.

[nspo]

Thanks for the insight!

[DW1234]

Nice idea, I have a couple Q and I'm curious about your thoughts:

 

* How many SFEs can their current water facility serve? There's a lot of cost involved in building these things, so ideally you'd want them to be able to serve the entirety of Sky Ranch with their current facilities.

 

* What do you estimate net margins on recurring water revenues to be? Numbers look a bit disappointing right now, given there's relatively high operating costs, SG&A, D&A and taxes. $1500/household sounds good but I do wonder how much of it will go to FCF.

 

* They're talking about 2500-3000 SFEs for Phase 2. Does this equal potential lot sales, or will certain lots have multiple SFEs? Probably doesn't matter in the grand scheme of things since they'll get $31K/SFE.

 

* The economics of lot sales almost sound too good to be true. Buy land for $7M --> incur ~$30M in costs developing lots --> meanwhile get reimbursement for this because these are public utilities --> Sell these for ~$70K/lot.

 

It looks like there's a bunch of demand and they can keep repeating this, what am I missing?

[Gregmal]

Nice idea, I have a couple Q and I'm curious about your thoughts:

 

* How many SFEs can their current water facility serve? There's a lot of cost involved in building these things, so ideally you'd want them to be able to serve the entirety of Sky Ranch with their current facilities.

 

* What do you estimate net margins on recurring water revenues to be? Numbers look a bit disappointing right now, given there's relatively high operating costs, SG&A, D&A and taxes. $1500/household sounds good but I do wonder how much of it will go to FCF.

 

* They're talking about 2500-3000 SFEs for Phase 2. Does this equal potential lot sales, or will certain lots have multiple SFEs? Probably doesn't matter in the grand scheme of things since they'll get $31K/SFE.

 

* The economics of lot sales almost sound too good to be true. Buy land for $7M --> incur ~$30M in costs developing lots --> meanwhile get reimbursement for this because these are public utilities --> Sell these for ~$70K/lot.

 

It looks like there's a bunch of demand and they can keep repeating this, what am I missing?

 

Ill do my best here.

 

They have water rights that would cover about 60,000 SFE so they are easily covering the entire Sky Ranch, as well as capable of tapping nearby developments which is something they hope to do.

 

My understanding on the margins is that they will improve in time as much of the major infrastructure and buildout occurs up front. Much of the infrastructure costs for Sky Ranch have already been incurred. The number suggested a few times on the $1500 yearly fees was about 70% margin.

 

The lot sales would more or less be equivalent to the 2500-3000 SFE number. They have yet to announce, but its been said that the economics of this phase will be greater, for obvious reasons.

 

The land cost is exaggerated as it was an opportunistic purchase. They bought the plot in a bankruptcy auction in 2012 or so, from the original Australian based development company. This would be equivalent to about a $40M or so purchase now. But yes, otherwise its an attractive proposition and a low risk strategy as they are not actually developing or building but rather subbing out to national builders with the only real company responsibility being the infrastructure and grading.