PCYO - Pure Cycle Corporation

[wisowis]

Maran Capital declared this as a top 5 position in their Q3 2020 letter, here is how they summarized it. Not as good as Greg's posts of course, but still thought I'd share because I find it nice to read what others shareholders think of the company:

 

As  a  Colorado  native,  I’m  certainly  biased  about  the  virtues  of  my  home  state.  But  the  data  seem  to  indicate that my bias is not completely misplaced. US News and World Report’s list of top places to live in the US in 2020-213 begins with:

1.Boulder, CO

2.Denver, CO

3.Austin, TX

4.Colorado Springs, CO

5.Fort Collins, CO

 

According to the Denver Metro Association of Realtors, September was the “toughest month to buy a house in Denver Metro’s history,” with just 5,301 total active listings, and 3,041 detached single family listings (almost half of the previous low). The median house stayed on the MLS for just six days. Inventory – especially at the entry level – is scarce, mortgage rates are low, and Denver’s population is growing.

 

Given  this  incredibly  bullish  backdrop,  could  any  stock  exposed  to  this  theme  still  have  a  reasonable  valuation?  Could  a  pure-play  Denver  real  estate  and  water  company  be  trading  at  an  extreme  low valuation below where it closed on March 23rd,  the day the S&P 500 reached its Covid-panic lows, and down over 30% year-to-date? Incredibly, the answer is yes.

 

Pure Cycle is a Denver area land developer and water utility. The company owns a nearly 5,000-single-family-lot-equivalent-development 25 minutes from downtown Denver that is delivering lots to a number of  national  homebuilders,  as  well  as  ~30k  acre  feet  of  water  supplies  and  significant  additional  water  infrastructure in the area. Its balance sheet is pristine, with a large net cash position and de minimis total liabilities. I  believe  PCYO  is  a  “fifty  cent  dollar,”  with  approximately  $10/sh  of  value  in  land  and  lots,  and  approximately  $10/sh of  value  in  water  rights  and  infrastructure,  against  the  current  sub-$9/sh  stock  price. Importantly, the value of the “dollar” is growing as the company is commencing phase 2 of its real estate development and as more people move to the Denver area, proving out the scarcity value of entry-level homes and water rights in the region.

 

There is an element of special situation here. A former 25%-owner of PCYO has been exiting its position for the last year, which I believe has been weighing on shares. Once this seller is cleaned up, I believe the stock has 50% upside in the near term, and 100%+ upside over the next few years. We have owned a number of real estate-related companies over the years (see our Q1 2016 letter, for example).

 

What has tended to work for us are situations with the following attributes:

1)a large discount to liquidation value (preferably a “fifty cent dollar”);

2)fair value (the “dollar”) is growing; and 

3)a catalyst to unlock value.

 

I believe Purce [sic] Cycle has all of these attributes.

 

[Gregmal]

Thanks for sharing that. Been a busy week for me, so I didnt catch that. All I'd add, is again that its interesting how many local guys are invested in Pure Cycle. A big part of that is likely seeing firsthand whats taking place there and how the Front Range is really the last developable location in that region.

[Castanza]

100% upside really isn’t much beyond what the price was in January, so I guess my concern is at this point what should we expect as shareholders? I hope a distribution would begin being paid out. Otherwise there isn’t much reason to stick around. But once you have that recurring revenue stream at scale I don’t see a reason why a divy wouldn’t be established.

[Gregmal]

I think it really depends on your interpretation and timelines. Harding has mentioned before the preference towards installing a dividend. You are going to have a good chunk of cash coming in, continuously, which bridges the gap to sustained recurring revenue. This Q alone we should see payments reflecting the final 115 lots delivered. You've also got, IIRC, maybe $15-20M more in reimbursables accruing 6-7% from the municipality. The tax base, despite covid, has nearly doubled this year. In 2018 Dan Kozlowski pitch this at one of the conferences and the internal research conducted(again, another Denver guy) indicated an undiscounted NAV of about $2B. So on the lower, short term end, yea there's maybe 50-100% upside which if I had to guess, is probably largely just taking a loose stab at what completion of phase 1 gets you. But at the same time, I see the company earning $1 per share or so(give a take a little for various reasons) from here on out...so depending upon what they do with that there could be more upside(or downside). From here, or even the low teens...to me this is a classic swing big setup, one of my favorites...as long term downside from these prices is pretty limited and upside is pretty significant.

[valueventures]

Very interesting and thanks for your detailed research here! How would you justify the 25% owner mentioned in Maran's letter and various funds liquidating their stakes? Seems like a bit of a red flag given that we're still quite early in monetization/realization mode here.

[Gregmal]

No problem. Even if talking to myself at times, its helpful putting things out there to get conversation going, especially on off the radar names.

 

On the large holder(s), as I touched on earlier, many have been in here for almost a decade from $3 or share or so. Different funds have different strategies and timelines but at the end of the day the truthful answer is "who knows". My personal touch would be "who cares". Having spent a few minutes in the biz, I can tell you, that with the exception of perhaps someone like Berkshire, people sell(and you'd be surprised to hear, buy too) all the time for many reasons and most of the time its not really all that important to get too caught up dissecting. I know Par firsthand and they are very detailed and value oriented. They've been a long time holder who has pared down significantly. The best guess probably relates to the transformation that has occurred during that timeframe. Pure Cycle in 2010-2014 was basically a perpetual money loser, with debt, who needed to raise expensive capital to make a measly $7M acquisition. Pretty yucky. Someone buying into that, and seeing it through to what it is today, is likely writing up a very different risk/reward/investment profile. Today you are buying much more certainty.

 

To boot, as some exit, you have Plaisance, who has been an aggressive buyer, backing up the truck. Their track record is nothing to sneeze at either. But overall, I'd say, its Wall Street. People pass around shit all the time for many reasons, and for few. Shares prices can be all over. Just focus on what you own and if you properly allocate with a bit of patience, things usually work themselves out.

 

Earnings are soon as well. I would think we get updates on phase two and also FY guidance perhaps for taps and lots. The biggest issue of late has been the 4-6 week backlog at muni wrt permits.

[Spekulatius]

No problem. Even if talking to myself at times, its helpful putting things out there to get conversation going, especially on off the radar names.

 

On the large holder(s), as I touched on earlier, many have been in here for almost a decade from $3 or share or so. Different funds have different strategies and timelines but at the end of the day the truthful answer is "who knows". My personal touch would be "who cares". Having spent a few minutes in the biz, I can tell you, that with the exception of perhaps someone like Berkshire, people sell(and you'd be surprised to hear, buy too) all the time for many reasons and most of the time its not really all that important to get too caught up dissecting. I know Par firsthand and they are very detailed and value oriented. They've been a long time holder who has pared down significantly. The best guess probably relates to the transformation that has occurred during that timeframe. Pure Cycle in 2010-2014 was basically a perpetual money loser, with debt, who needed to raise expensive capital to make a measly $7M acquisition. Pretty yucky. Someone buying into that, and seeing it through to what it is today, is likely writing up a very different risk/reward/investment profile. Today you are buying much more certainty.

 

To boot, as some exit, you have Plaisance, who has been an aggressive buyer, backing up the truck. Their track record is nothing to sneeze at either. But overall, I'd say, its Wall Street. People pass around shit all the time for many reasons, and for few. Shares prices can be all over. Just focus on what you own and if you properly allocate with a bit of patience, things usually work themselves out.

 

Earnings are soon as well. I would think we get updates on phase two and also FY guidance perhaps for taps and lots. The biggest issue of late has been the 4-6 week backlog at muni wrt permits.

 

Plaisance is an odd one too, it’s a small fund, and PCYC is their largest holding, by a factor of 5x. the next largest is STJ. One just hopes that their capital is permanent because selling out this position the open market would take a while

https://app.tikr.com/investor?id=5001442431

[Gregmal]

The Plaisance Pure Cycle stake is largely held in a single asset SPV which has defined terms and a clearly outlined purpose for the capital. It will likely sell at some point, but not anytime soon given the fund was established barely a year ago, was purchasing stock earlier in the quarter, and at minimum, has a multi year lockup.

[valueventures]

That's helpful, thanks! Gregmal, you mentioned Plaisance's track record is nothing to sneeze at. Any idea where I could find this?

 

It's definitely comforting to see Plaisance take a sizable position given this is right in their backyard.

[Gregmal]

You can find Dan's background through the firm site and other places like LinkedIn(or doing more extensive work calling around and seeking out those that know him) but I think what I find most impressive was the well roundedness if you will, of his abilities. The quick loop is that he was a part of several very successful funds at Janus, left, had them beg him to come back, and then after knocking the cover off the ball, started back off on his own, with Janus then becoming a Plaisance investor. When people talk "track records" or "resume" in this line of work, the first level thought is always "whats the 1/3/5 yr performance". But if you've developed a deeper understanding of what makes things work, you will look at a multitude of factors, well before the 1/3/5 etc. Especially important is the understanding required to navigate a long/short fund. One of my favorite VIC posters is Bluewater12. There is an inherent beauty to the fluidity and ability to pivot as information comes ones way. Most investors get way too hung up on stale narratives. Successful long/short guys get this. As an example I'd look at something like BAM as its the easiest example. A few years ago it had gimmicky accounting, and aggressive exposure to some troubled areas but otherwise a great and undervalued business. A year ago it had the same, but the valuation was much greater with few opportunities in a richly valued market. Today, its cheaper than a year ago, with more capital than ever, and many current and future opportunities in areas they possess expertise. Meanwhile there are still many people and funds/institutions sharing the same trite narrative they have for years. Their narrative hasn't changed but the real time situation is always evolving. This was one of the main allures to Pure Cycle was the narrative shift from a turd to a very high quality growth business.

 

I'd also again point to Mark Harding...a stud of a CEO who has taken on every role imaginable here from IR to CFO in order to keep the company lean. One of the more amazing facets here is G&A and how low its managed to be over the years.

[valueventures]

Thanks Gregmal, very insightful! Hopefully last question for now and then I can give you a break :)

 

I couldn't help but notice that you just doubled your position in JBGS. I've been thinking about initiating a position too, but still just concerned about recovery for office RE. How do you weigh risk/return dynamics of something like JBGS against this? Obviously both DC and Denver are strong markets, but I feel there's an added element of de-risking with PCYO given better tailwinds for residential RE.

[Gregmal]

I think PCYO is unique and to itself sort of an insulated special situation. Denver area is special and in addition to having unique and key assets they have very understated local influence and relationships that could eventually be beneficial. It hasn't really been impacted by the stuff plaguing most reits and residential is in a great place. You also have big call option with the 1M sq/ft potential commercial development here. Favorably expected to come into light in several years, rather than right now.

 

In regards to JBGS, I think its hard to compare to PCYO, but on a larger scale on the safer and higher quality end of the REIT/RE recovery play. Just using ones that stick out to me, I'll create the spectrum. Its ARE/JBS/VNO. So at the top, you have something(ARE) insulated by an in favor theme, geographically diverse, and something that will subsequently provide an adequate result for your capital, consistently. Then you have JBGS which is dealing will short term "issues" but otherwise favorable conditions and regionally favorable tailwinds that just need to be shaken out and time will cure this. Lastly, you have VNO which is hated, in a terrible short term place, and has every narrative going against it. But it also has the greatest room for recovery and if you believe the "when not if" theory for NYC you cant really go wrong here but you also have to give up the expectation that you are going to be seeing green(or green shoots for that matter) anytime soon. Most people, are simply too short sighted and incapable of buying something mentally if there is a high likelihood it will be lower tomorrow; let alone a month of few from now. Its one of the harder things to do but a massive advantage to real investors. It also helps if you are capable of viewing you shares as ownership in a business and subsequent addition of shares as great if they come cheaper than the last. Buffett often talks about getting excited when stocks go down. The average person shits their pants. Even the above average, as we saw here in March, shits their pants at the thought of 30-60 days of pain(let alone more). I generally ask myself, "do you need the capital tomorrow?" and if not, then "why does it matter?". So all of this really just comes down to you mindset and tolerance for dealing with businesses/assets vs paper valuations and short term losses. Summarily, JBGS is kind of the pussy way to capture the real estate recovery. Significantly higher quality and better located than the NYC/SF stuff but also better positioned for upside than the stuff that has held up well. I would refer to pupils work on JBGS for the nitty gritty, but its hard to argue against here, or hopefully, a bit lower. Great assets. Great area. Huge spread to 10yr vs the historical norms.

[Gregmal]

https://seekingalpha.com/pr/18069932-pure-cycle-corporation-announces-contracts-for-sale-of-lots-in-2nd-development-filing-sky

 

Christmas comes early. All around excellent.

[Williams406]

Do I have this roughly right?: Cost to develop each lot is estimated to be about $70k, of which $50k/lot may ultimately be reimbursable. 50' lot equivalent pricing is $102k/lot for phase 2. Assuming reimbursement, it looks like profit per lot exceeds $100k when including tap fees for phase 2. Economics seem quite...adequate. Please correct me if I've botched any of the above figures.

[kab60]

Do I have this roughly right?: Cost to develop each lot is estimated to be about $70k, of which $50k/lot may ultimately be reimbursable. 50' lot equivalent pricing is $102k/lot for phase 2. Assuming reimbursement, it looks like profit per lot exceeds $100k when including tap fees for phase 2. Economics seem quite...adequate. Please correct me if I've botched any of the above figures.

That's basically what I gathered as well. But it'll take up to four years, even though it sounds like it'll be quiet a bit less than that, and then there's ongoing SG&A on top I suppose? Anyway, what'll recurring water fees be like? Is that like 3k per house on what'll now be almost 2k house?

[Gregmal]

Do I have this roughly right?: Cost to develop each lot is estimated to be about $70k, of which $50k/lot may ultimately be reimbursable. 50' lot equivalent pricing is $102k/lot for phase 2. Assuming reimbursement, it looks like profit per lot exceeds $100k when including tap fees for phase 2. Economics seem quite...adequate. Please correct me if I've botched any of the above figures.

 

Yes sir. So this is part of why this can screen like shit. You had phase 1 for example showing roughly a mid single digit margin on the lot sales but the unaccounted for figure is the reimbursement which has a kicker in that it accrues interest at 6.5% IIRC. Add in the tap fee, currently a hair under $32k a home but subject to increases and theres a lot more profit than first glance. Ballpark on the recurring revenue from water fee is $1500 per home. As a landlord, I can tell you this fluctuates quite a bit. I have units that are the same where a water bill may be $300 per quarter, and another may be $600. Mark's estimates have typically been on the conservative side, which is why I would expect the phase to be completed sooner than the mentioned 4 years.

 

G&A as Ive mentioned, is about $3.5m, which is great with me given some of the other companies of similar size/market cap Ive been involved with.

[BG2008]

So what is this bullshit.  I present a warehouse company with $21mm of NOI and you guys shit all over me for the $8mm of G&A.  Gregmal is pitching you guys stuff based on revenue and you are eating it out of his hands like little puppy dogs.  This is white privilege and it needs to stop.  Put your critical thinking hat on and put down your "Greg For Prez" hat.  Think about this, GRIF was trading at about 67% of PCYO.  We really are in the "dreams and stories" phases of the market.  Don't deliver cashflow, once you do, people know how to value it.  Take that $3.5mm of cost and apply a 4% cap rate on it because 10 year is at 70bps.  That's a $87.5mm liability you need to subtract out. 

 

Just kidding (but telling a 1% truth as well).  I bought a few shares this morning.  Small position. 

[Williams406]

BG2008, Gregmal's sweet talkin' about Pure Cycle's revenue didn't sway me, this picture did:

https://www.purecyclewater.com/skyranch-development/

 

I think that is the Sky Ranch community swimming pool. That "go big or go home" attitude appeals to me. I may buy more shares after I get around to reading the financials...

 

FWIW I own a lot more GRIF, but they don't have a pool at all from what I can tell.

[BG2008]

BG2008, Gregmal's sweet talkin' about Pure Cycle's revenue didn't sway me, this picture did:

https://www.purecyclewater.com/skyranch-development/

 

I think that is the Sky Ranch community swimming pool. That "go big or go home" attitude appeals to me. I may buy more shares after I get around to reading the financials...

 

FWIW I own a lot more GRIF, but they don't have a pool at all from what I can tell.

 

Hey, we all know that warehouses and e-commerce are the cool kids at the party for the moment!

[Gregmal]

I will totally be the guy jumping in that thing when they finally hold another investor day again, something they did annually up until covid...

[Gregmal]

YE call today with Harding was excellent and definitely worth a listen if you are interested in this.

 

Few key highlights

 

Very conscious about how capital is deployed, now up to $22M or 10% of MC. Also have another $18M of reimbursements from phase 1. Almost certainly going to pull the trigger on another land acquisition IMO. Made a tremendous point about the instant value add that happens here when you buy land that is not already in a municipality with a water servicing contract, which is much of the area they are operating in. Instantly, the land + water combination creates value. Commercial planning should start towards end of 2021. Expect about $140M from phase 2 and conservatively ball parking $300M+ for phase 3 which should start getting some legs in about 2 years. Been getting a lot of interest and offers for the commercial space, but mainly its developers looking to be the middle man and snag much of the value. Mark is not having it and seems to prefer doing direct deals in the form of ground leases with companies like Home Depot, Walmart, Kroger, etc. Lot of different value levers and avenues here.

[Gregmal]

https://seekingalpha.com/pr/18138539-pure-cycle-reports-first-quarter-results

 

One of my favorite things about Pure Cycle is the no nonsense approach to releasing numbers. Quarter over, boom, here's the numbers.

[Castanza]

https://seekingalpha.com/pr/18138539-pure-cycle-reports-first-quarter-results

 

One of my favorite things about Pure Cycle is the no nonsense approach to releasing numbers. Quarter over, boom, here's the numbers.

 

Love the execution and discretion of management. Looks like another solid quarter. I hope the drop in permitting spooks some (insignificant imo). I’d like to buy more at sub $10.

[Gregmal]

Yea the permitting has been explained and Im sure it will come up on the call tomorrow. Good to see some uptick in fracking revenue too.

[gfp]

https://seekingalpha.com/pr/18138539-pure-cycle-reports-first-quarter-results

 

One of my favorite things about Pure Cycle is the no nonsense approach to releasing numbers. Quarter over, boom, here's the numbers.

 

Well I agree I like it when companies put the numbers out fast but also Pure Cycle's year ends on November 30th right?