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Living in the mountains of Southern New Mexico and surrounded by a cactus-filled desert while enduring a terrible multi-year drought, I'm beginning to understand the importance of water and farming and the growing necessity to carefully handle available, but scarce resources. It was just last week that I heard farmers on or near the Rio Grande River, close to Las Cruces, state that the river has now completely dried up for the first time in many years. The state of Texas and New Mexico are embroiled in heated litigation over water rights concerning the Pecos River. The fights for water in the Southwest and many other places are beginning to take center stage.

Since water and agriculture are so important to a growing population, I thought I'd take a basic look at several companies in this space and what I found valuation wise was startling and obviously there are far more people paying attention to this seemingly boring sector than I ever imagined and thus, what people might initially and wrongfully perceive as boring could in fact turn out to be the next hot thing in the market.

Two Rivers Water & Farming Company (OTCQB:TURV) has a current market cap of $28.7 million and has developed and operates a revolutionary new water business model suitable for arid regions in the Southwestern U.S. in which the company synergistically integrates farming and wholesale water distribution into one company, utilizing a practice of what's known as rotational farm fallowing. Two Rivers uses what they consider a best-methods farm practice whereby portions of farm acreage are temporarily fallowed in cyclic rotation to give soil an opportunity to reconstitute itself. They're able to produce and market high value vegetable and fodder crops on irrigated farmland and provide wholesale water distribution through farm fallowing agreements in initial areas of focus on the Arkansas River and its tributaries along the Southern Front Range of Colorado.

What's interesting is that Two Rivers was formed in 2006 with initial financing of $10 million as a result of a spin-off from the once very successful BPZ Resources, Inc. (NYSE:BPZ) and a total of $40 million has been raised since inception. Revenues for 2012 rose to slightly over $1 million from just $105K in the prior year, as the company is on the verge of completion of its many projects and thus awaits an entirely different financial picture going forward.

This coming Tuesday, May 14th, Two Rivers goes before the Colorado Water Conservation Board in seeking a staff pre-recommended 1.25% (per annum) $10 million loan for engineering and construction costs related to the $12.4 million Arkansas Storage Facility Project. This is a big deal and approval certainly validates the business model and demonstrates how effectively Two Rivers has integrated itself in the Colorado farming and water communities. The company has achieved prior success in obtaining project loans from the Colorado Water Conservation Board, so obviously management appears to know their stuff and the stock should be followed closely in my opinion for when all of these projects reach fruition and begin to pay off.

PICO Holdings Inc. (NASDAQ:PICO) has a market cap of $483 million and operates in three diversified segments - water resource and storage, real estate and agribusiness. PICO's three businesses are Vidler Water Company, Union Community Partners and Northstar Agri Industries, a canola processing plant that just commenced operations in Q3 of last year, yet had already seen sales of $85.3 million by the end of the year, consisting of canola oil and canola meal. Even though demand has exceeded supply, margins aren't yet up to par due to two below-forecast crops and a robust soy crop, an alternative to canola. A second canola processing plant is being considered by PICO, but I suspect they'll want the first to turn a profit before taking on any more debt. Margins were pressured once again in Q1 of this year and the company says it will be several months away from determining the degree of improvement in margins.

In 2012, PICO lost $29.1 million, but that was much improved from 2011's loss of $54.5 million and while the company nurtures the agri side of the business out of its infancy, they're most certainly counting on exciting things to further develop from UCP's development of acquired properties in California and Washington, as the company strategically started to scoop up these properties at bargain basement prices beginning back in 2008 at the start of the financial crisis while others were running for the hills. UCP is planning to raise $125 million from an IPO and plans to use the funds for acquisition of land.

PICO's Vidler Water Company is currently in an option agreement with the Lincoln County Water District (Nevada) to sell 7,240 acre-feet of water rights to be utilized by a planned power generation plant at $12K per acre-foot and the option must be exercised by November 30th of next year, so obviously this is a dangling carrot while investors wait. In the meantime, Vidler is also a private sector owner of water resources and water storage in Nevada, Idaho, New Mexico, Colorado and Arizona. Development of water resources for end-users such as municipalities, developers, water utilities and industrial users is what Vidler is banking on and while investors will have to wait for projects to come to fruition, the lofty valuation of PICO tells me investors see the light at the end of the tunnel.

Pure Cycle Corporation (NASDAQ:PCYO) has a market cap of $163 million and owns water assets in several river basins in the state of Colorado as well as certain aquifers in the Denver metropolitan area. They provide water and wastewater services, including water for use to drill and frack oil and gas wells.

In the last six months, the company's EPS loss has shrunk from (.11) to (.08) year over year and revenues have increased 640%. Besides increased revenue generally derived from water supplied for drilling and fracking, Pure Cycle also owns 16,000 acres of irrigated farm land in Southeastern Colorado, which it now manages and leases to farmers. The company also owns 930 acres of land known as Sky Ranch along Denver's primary east/west corridor Interstate 70, about 16 miles east of downtown. The property includes water, oil and gas rights and is fully entitled for master planned community development. With housing starts up 55% in the Denver area year over year, Pure Cycle is hoping that there will be interest shown by developers to build out and thus the company can profit from lots sales, water and waste water services.

I think what's keeping investors around is the fact that Pure Cycle has identified three potential well sites near Sky Ranch for drilling and its 20% future royalty from Conoco could really give the company a much needed financial boost. Their current $4 million cash position has led to a definite tightening of the belt.

Conclusion:

I find the water and farming sector to be somewhat fascinating, mainly due to the high expectations of investors and the fact that these companies are valued on a much different scale in comparison with most other sectors in the market today. Obviously investors can see a light at the end of the tunnel for each of the companies mentioned above and as far as short interest is concerned, there are virtually no short positions in these stocks like you might think there would be. I think the trick here is to closely follow the above companies, learn how the stock trades, study the management teams behind each company and monitor their progress and abilities to complete various stages of development and ultimately determine who will continue to grow and be successful. There's no doubt in my mind that interest will rapidly rise in this sector, as most all of us are aware of today's growing concern surrounding the need for water and successful farming. This will be my first article of several that will explore an area that in my mind has been neglected and most certainly underappreciated.

Source: Combining Water With Farming Equates To Soaring Valuations