PICO Holdings Inc fka PICO

[frenchee]

Drink Up!
By Chris Mayer

In the rising tide of market volatility, the sinking level of worldwide water supply provides a fundamentally sound investment theme. Simply put, water is precious, especially when you don't have it.

The water theme has many facets. There are water pipe makers and filtration companies, irrigation equipment, water pumps and more. The facet I want to focus on here is just the basic resource itself - owning actual water - because the investment backdrop for a rising water price looks pretty good from here.

The Financial Times recently highlighted the salient population-based facts. Take a look at this chart:



The chart shows how water use has grown faster than population growth. In fact, annual world water use rose sixfold - more than double the rate of population growth. What does it mean? The FT opines, "One unavoidable consequence will be that the price of water will rise substantially."

I would agree. When you study where population growth is greatest, you come to find out that it is in areas where water is most scarce. Look at the U.S., for example. The two fastest-growing populations in the country are those of Nevada and Arizona. Projections from the U.S. Census Bureau show that shouldn't change anytime soon.

The American West is already a dry and arid place. This past spring was the sixth driest on record. In some states - such as Georgia, Alabama, Tennessee and Mississippi - it was the driest spring in 113 years. Drought conditions persist into summer in many parts of the country. About two-thirds of the Southwest is in some form of drought.

Wildfires have devoured hundreds of thousands of acres of valuable timberland. (A recent fire in the Lake Tahoe basin was the worst in half a century.) Crop losses start to add up. And now drought threatens the Midwest, the heart of the ethanol boom and home to record levels of corn acreage.It should only get drier as the years roll by. No matter what you believe about what's causing this pretty little blue and green planet of ours to warm, it is warming. And everyone seems to agree that certain places will get drier and hotter.

As the Financial Times noted: "By the year 2070, Stockholm and Oslo will have 'moved' in terms of weather to central Spain, while Mediterranean resorts will suffer conditions comparable to Saharan Africa today." Likewise, the already arid American West will get even drier and hotter. The year 2070 is a long way off, of course. I like to think of myself as a long-term investor, but I ain't that long term! Still, these trends provide a powerful backdrop for rising water prices.

Right now, there are some absurd anomalies in water markets around the world, because governments provide, or heavily regulate, most of the water consumers use. So you have situations in which water costs 90% more in Barcelona than in Valencia (which is farther down the Spanish coast), even though water is far scarcer in Valencia than Barcelona.And you have absurdities such as those that occur in California. Farmers consume 80% of California's water.

California's infamous alfalfa growers drink up 25% of the state's water. However, because of government subsidies, they pay between $2-20 per acre-foot for water - that's only about 10% of the water's full economic cost. There is little incentive to cut water use when rates are this low. [An acre-foot is basically what it takes to flood a plain of one acre to a depth of one foot. One acre-foot can supply enough water for one family of four for a whole year.]

In Europe, the government still provides two-thirds of the water supply. In America, it's 85%. In Asia, it's 95%. Water has been too cheap for too long. And years of government ownership have, not surprisingly, led to neglect of these systems.

In the U.K., "where the water sector is mainly privately owned," the FT says, "and prices probably reflect costs more accurately, prices are the third highest in the world - 66% above those in the U.S." We'll pay more for our water one way or another, or we won't have it.

In certain Western states, you can see how much people pay for water by looking at contracts between the owner of water rights and utilities (and other end-users). The price per acre-foot is tens of thousands of dollars in some places.

The price of water has nowhere to go but up, in my view - especially in those water-scarce regions. Somewhere, cash registers will ring.

You'll want to own one of those cash registers - such as PICO Holdings (PICO: Nasdaq). PICO owns Vidler Water, which owns a portfolio of some 65,000 acre-feet of water rights, mainly in Nevada and Arizona. The company has carefully selected these water rights over the years. According to management: "The water rights owned by Vidler are typically the most economical supplies of new water in areas experiencing rapid growth."

PICO recently began to build a pipeline to provide the fast-growing north valleys of Reno with about 8,000 acre-feet of water annually. So far, it's made deals to sell 117 acre-feet of water for $45,000 per acre-foot. "Despite the well-publicized decline in the housing market,"management continues, "demand for water to support growth and development in the north valleys of Reno continues to exceed the available supply for water."

I estimate Vidler's water rights portfolio is worth around $550 million. That's conservative. PICO also owns the Nevada Land and Resource Co., which is the largest private andholder in the state of Nevada. It has undeveloped land and water rights (about 35,000 acre-feet) I estimate are worth around $250 million. In addition to its water and land assets, PICO owns a sizable investment portfolio of cash, bonds and European equities. All told, these assets come to around $340 million.

That's a total of $1.14 billion, or $60 per share. I believe that is a good conservative net asset value. It could be worth much more. And it's not a static number. I'd expect the net asset value of PICO Holdings to grow over the years at a market-beating clip as water becomes more valuable.

Drink up!