Pico Holdings: An Undervalued Water Play Disguised As Real Estate

Jul.19.07 | About: PICO Holdings (PICO)

If you just look at the financial results from the first quarter, you might think I have water on the brain for recommending Pico Holdings Inc. (NASDAQ:PICO).

Revenues were less than half of the revenues from the first quarter of 2006, and income was $12 million lower. Obviously this was not a strong quarter, but before writing this one off, take another look -- and wait for the next two quarters of results.

Pico is a company with some pretty varied operations: A water holding division, a land and real estate division, and then some business operations involved in financing and insurance. It was the financing and acquisitions division that was responsible for most of the poor first-quarter results; revenues in that division were down $7.8 million, according to the company, because there were no gains taken.

But if you look beyond this division, you may be encouraged. The water division's revenues were three times as high as the first quarter of 2006, and the land division enjoyed revenues twice as high (and income to match).

Pico's land and water operations are mostly based in Nevada, where the company holds significant stores of water, as well as a great deal of land with potential for real estate and/or mineral development. The water division, in particular, looks set to grow in the future. The horrible weather and drought conditions this year should certainly create profits for a company sitting on a great deal of water, but water supplies are a major long-term issue for the region due to limited supplies and increasing demand, and Pico's water division will be making money for years to come.

Most importantly for Pico, it is more than halfway through building a pipeline to deliver water from its supplies to Reno. The project has been on time and on budget so far, and the company expects to start delivering water by late 2007 or early 2008. There had been objections from the Pyramid Lake Paiute tribe that lives in the area, but Pico settled with it in early June, freeing its way to complete the project. Pico claims the value of the water is much greater than the costs of the pipeline, and it expects to be making money from this project for a long time. The company is also delivering water to housing developments in other places in the area (such as Carson City), and will continue to expand its efforts.

With major assets in scarce resources, and its diversified insurance and business operations, I think Pico is a long-term play. So don't be scared by one bad quarter; keep your eye on this one, because it could make you some good money. Plus, with all the emphasis on the shortage of water out West, it is only a matter of time that investors start piling into Pico. Highly respected and widely-read by institutional investors, Barron's just listed Pico as one of its top five green picks.

Type of Stock: A water and mineral resources company with operations in financing and insurance. This is a stock I love because Pico has been misclassified (and, thus, the stock price is unnecessarily down) as a real estate play in the "overvalued" southwest. In reality, the value of the water operations and the premium pricing power represents immense upside.

Price Target: Pico is currently trading at $43, off its $49 peak in May. If you want to be careful, you can wait to see if it drops to $40 or below, but I think Pico is going to be a projectile upwards after results from the second and third quarters are released, and the new water pipeline will almost certainly drive Pico up in 2008.

PICO 1-yr chart: