Pure Cycle Corp Q2 FY2024 Earnings Call

Good morning, everyone, and welcome to the Pure Cycle Corporation’s Q2 2024 Earnings Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for questions after the presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Mark Harding, President and CEO of Pure Cycle.

Thank you, Jenny. Good morning, everyone, and welcome to our earnings call for the six months ended February 29, 2024. We do have a deck available for this presentation. You can visit our website at purecyclewater.com, click on the Investor tab, and find the link to the deck. I can walk through this, and I'll try to note the transition of slides as we move through the presentation. Let me start out with our first slide, our forward-looking statement, which indicates that many of you are familiar with, that statements are not historical facts contained or incorporated by reference in this presentation are forward-looking statements. I want to spend a little time discussing various segments of the business, looking at our performance through the first six months of this year, some of the investments that we've made into our assets, their trajectory, together with their capacities, and the opportunities to continue to monetize those assets. I also want to mention the important updates coming up. None of this is possible without having a great team to rely on, not only our management team but all of our line operators who work diligently every day to ensure we’re performing strongly in each of our individual segments. We have a tremendous Board of Directors that keeps us accountable and offers their wisdom and advice. We’re benefiting from that strong team both at the company level and the Board level. The company operates in three different business segments that are vertically integrated. These segments inform and improve the value of each other. Fundamentally, we're a Water/Wastewater provider, holding a significant portfolio of valuable assets in an area where water is a scarce commodity. We've been developing these assets over a very long period, more than 30 years. These investments have appreciated significantly. We provide water and wastewater service to approximately 60,000 single-family connections, and we’re just getting started. Currently, we have over 1,300 connections. The Water segment helps us create value in our Land Development segment, where we develop land as master-planned communities. We make significant investments in both water/wastewater and land development, providing single-family lots and multifamily as well as commercial lots to national homebuilders and local businesses. Our third segment allows us to retain some of those lots for our use. We keep the equity value of the lot, together with the water service connections, and work with our homebuilder partners to build single-family homes on those lots, renting them out for the single-family rental market. Each of these segments complements the other and provides value in our asset chain. We have about $120 million in assets. One unique aspect of the company is the extremely low basis we have in these assets. The fair market value compared to our cost basis is significantly favorable. Our capital accounts in just the water rights portfolio is slightly less than $15 million, generating over $2.5 billion worth of revenue and annual revenues greater than $100 million. This emphasizes the opportunity that the company has from just that asset. On the land assets, we were fortunate in acquiring our Sky Ranch property, back when land assets had little demand during the Great Recession in 2010. We secured a low basis of less than $5 million on the Land Development side and about $10 million in assets there. This asset can generate significant opportunities for the company exceeding $600 million as we continue to build that out. Our newest segment, Single Family Rentals, provides a tax-advantaged way of adding recurring cash flows to the company while retaining some equity value in both land and water. Each home we bring online carries with it up to 30% equity value, and we can rent them out at fair market value. This vertical integration allows us to monetize each of those segments effectively. Let's talk about our financial performance. In Q2, we had about $8.5 million in revenue, aligning with our expectations based on ramping up operations since 2021. In '23, we experienced a minor pause due to aggressive interest rate increases toward the end of 2022, which influenced our homebuilder partners’ inventory strategy and velocity of homes being sought. We experienced about a 90-day gap in the start of our Q2, Phase 2b operations. However, there’s been stabilization in the interest rate market, which is settling in within normal expectations for mortgage rates. There's a nationwide lack of inventory for sale, driven by homeowners locking in low mortgage rates. Our margins continue to be strong, exceeding 50% across all three business segments. We reported net income of a little over $2 million and earnings per share of about $0.09. This performance keeps us stable through slower business periods, as we do face seasonality within the company due to Denver's climate and construction activities. We expect to see significant acceleration in Q3 and Q4. In terms of revenue and gross margins for each segment, the results are impressive—55% gross margins in our water utilities and high margins in land development. We're working to gain traction in the Single Family Rentals, with 14 units fully leased, and renters are enthusiastic about the product and services provided. Our renewal rate has been quite high. As for where our Water and Wastewater segment revenues originate, we provide water to the oil and gas sector, which is a high component of our business. This helps us develop our water system with current user demand, providing the company additional capital to expand before residential demand sets in. The second quarter was close to a record for oil and gas water deliveries, with a positive trend anticipated. Our field is the Southern Niobrara field in Colorado, covering about 200 square miles, where we're delivering water to operators. We have several operators, including one large operator, Civitas. However, there was a slight dip in Q2's tap fees, which typically sees more activity in Q3 and Q4 as builders pull permits. Land Development continues to see settling interest rates, and we currently have three phases under construction. Phase 2a is about 96% complete, and our activity there is nearing completion. Phase 2b is approximately 52% complete, and we’re prepping for further construction. Phase 2c includes another 220 lots, with grading work already underway. Our development rates indicate high demand, particularly for entry-level products in the Denver market.

Thank you, Mark, and good morning, everyone. We're excited about the Single Family Rental segment and the continued success it's bringing. In Q2, we achieved 100% occupancy, with increased revenue and asset valuation as additional units come online. Each completed unit adds an average of $150,000 in equity as we capitalize on our water availability and competitive housing market. We completed four units in Phase 1 and ten units in Phase 2a. Construction on the 17 units in Phase 2b will begin this summer, doubling our rental capacity. We’re expanding the types of units offered, and being vertically integrated allows us to control building costs and operating expenses.

To provide an overview of our segments, we've made significant investments and have robust capacities. Our Water segment has the capacity to serve 60,000 connections, with currently about 1,300 in use. On the Land Development side, we have a 930-acre community capable of serving thousands of residential lots, and we're efficiently managing water usage and expansion. The single-family rental segment represents a substantial opportunity, and we are focused on maximizing these assets. We believe that there's a disconnect between company value and market trading. Our Board has authorized a share repurchase program, and we are in the market each month, focusing on liquidity and profitability to benefit our shareholders. Our gross margins and overall performance remain strong, and we continue to execute on our business model while looking for ways to engage with investors better.

At this time, we will be conducting a question-and-answer session. Your first question is coming from Bill Miller, a Private Investor.

Thank you. Good morning. Wonderful quarter. My questions are: One, you’ve often mentioned acquisitions. I didn’t hear it in this call, but maybe I missed it. Secondly, what do you think are the highest return on investment opportunities that you can control? And thirdly, when do you think you will get into the large-scale commercial development along I-70?

Three good questions. The highest margin business is utilizing our water for oil and gas. The oil and gas companies benefit from our capacity without paying tap fees, improving our margins. We continue to invest in this area. Our land development revenues also generate high margins since we acquired the land wisely, and we are willing partners with homebuilders. Regarding potential acquisitions, we are actively seeking land where we can provide utility services from our existing infrastructure. While the timing is uncertain, we see more activity on that front than in the past, though no opportunities have been lost. As for commercial development, we think it might be a year or more out, reliant on residential rooftops since commercial businesses want high-volume stores. We’re making progress in understanding demand.

Okay, Mark, you left out the rental area.

Regarding Single Family Rentals, we are seeing strong demand. Interestingly, many renters qualify to buy homes, yet still prefer renting due to maintenance costs and uncertainties about their long-term plans. Our occupancy rate has been around 90%, and we focus on cost-effectively delivering homes while partnering with builders. We are pleased with the performance in this segment.

Since we're sensitive to inflation, what kind of price increases have you been able to implement?

On the rental rates, they’re competitive, but modest increases of about 1% or 2% occur during renewals. We tend to raise rates more upon tenant turnover to align with market rates. Regarding oil and gas, we have multiyear contracts with our operators that include annual pricing increases, ensuring steady revenue without jeopardizing our valuable partnerships.

What about the impact of inflation on your business?

We haven't seen strong inflationary pressures recently. Some building materials costs have declined and trades have become less constrained. Thus, we've experienced some relief from inflationary impacts, though labor costs remain competitive.

Thank you very much.

Thanks for your continued support.

Your next question is coming from Greg Malachowski, a Private Investor.

Hey, Mark. How are you?

Good. How are you?

Good. So I got two questions. The first one relates to your receivables. Any color on the timeline for the next bond issuance?

The last bond issuance was in 2022 at the start of Phase 2. We bond based on phase commencement. As we begin Phase 3, likely by year’s end, we will enter discussions for a new bond issue. The ongoing Phase 2 process is likely to accelerate our financing need. Towards the end of this year or early next year for the next bond issuance and rolling into '25 and '26 for additional projects.

Okay. Thanks. Is there a point where we look at our market valuation and conclude that whatever you're doing isn't translating into value for shareholders?

You’ve touched on a concern shared by the management and Board. Despite continued high performance, market perception has not aligned with our results. The only stock issuance we have are incentives. Our buyback program aims to be antidilutive. We recognize the need for a strategic review since our market cap has not reflected our success. We are assessing our messaging and visibility in the market to attract more attention from analysts and investors.

I think the company could benefit from a strategic review. You're working with assets that are hard to value. There's not much reason you can't have a $10 million share repurchase program where you're buying $0.5 million a month.

You've made excellent points, and we will consider them carefully. We need to clarify our objectives regarding asset monetization and effective capital allocation. Having a strategic review could indeed guide us toward better valuation of our offerings in the market.

I appreciate your time, and I look forward to the next few quarters.

Thank you, and we value your input. We’ll announce our Investor Day this summer to showcase our progress.

This concludes today's conference call. You may disconnect your lines and have a wonderful day.