Bloggers Say UCP Goes Defensive

As originally appeared in the Troubled Company Reporter.

PICO Holdings, Inc. (Nasdaq:PICO), based in La Jolla, Calif., is a diversified holding company reporting recurring losses since 2008. PICO owns 57% of UCP, Inc. (NYSE:UCP), 100% of Vidler Water Company, Inc., a securities portfolio and various interests in small businesses. PICO has $662 million in assets and $426 million in shareholder equity. Central Square Management LLC and River Road Asset Management LLC collectively own more than 14% of PICO. Other activists at http://ReformPICONow.com/ have taken to the Internet to advance the shareholder cause.

The bloggers, after analyzing UCP’s latest financial statements, believe that UCP has gone defensive. The bloggers note that UCP recently sold an underperforming community. “In Q2 2016, UCP entered into a contract to sell its unfinished lots at the Sundance community in Bakersfield, California. The 65 lots were written down by $2.1 million ($32,307 per lot), while the completed and partially completed homes were written down by $300,000. Total impairment: $2.4 million. The sale of the 65 unfinished lots is expected to close by the end of 2016.”

The bloggers observe that UCP is not replenishing its lot inventory. “Page 26 of the UCP 10-Q contains the following disclosure under ‘Purchase Commitments’:

‘As of June 30, 2016, we had outstanding $3.0 million of cash deposits pertaining to purchase or option contracts for 628 optioned lots with an aggregate remaining purchase price of approximately $27.6 million. As of December 31, 2015, we had outstanding $3.8 million of cash deposits pertaining to purchase or option contracts for 1,127 lots with an aggregate remaining purchase price of approximately $80.1 million.’

UCP’s cash deposits for lots went from $3.8 million to $3 million (down $800K). Optioned lots went from 1,127 to 628 (down 500 lots). Aggregate remaining purchase price went from $80.1 million to $27.6 million (down $52.5 million).

A decline in real estate purchase commitments is not normal in today’s homebuilding industry. Yes, the reduction is due to UCP exercising the options and building the homes. But the purchase commitments are not being replaced. In other words, UCP is selling inventory, but not replenishing inventory.

Today, pretty much all homebuilder executives wax positive about industry conditions. And most homebuilders are growing their real estate inventory balances, including lots under contract. That UCP”s optioned lot count is shrinking runs directly contrary to its competitors and the current momentum in the industry. This is especially true given that UCP operates in some of the best markets in the country.

There are only two other publicly traded homebuilders that are shrinking their land position and both are financially distressed: Hovnanian Enterprises (Moody’s CFR Caa2) and Beazer Homes (Moody’s CFR B3).

Lots owned and controlled is an important figure for homebuilders — it is forward-looking. It takes about 2 years for a homebuilder to go from unfinished lot to home sale. Where is UCP going to be in 2 years, given its declining land inventory position?”

The bloggers continue by doing some lot inventory math. “UCP delivered 364 homes during the first six months of 2016. But at the expense of being repetitive, that UCP has not replaced these delivered lots and then some, is unusual. It is even more abnormal considering that UCP tells investors it has a 40% net debt to capital ratio – which if true, would put UCP at the conservative end of the homebuilder industry. If UCP is so financially strong, why isn’t it laying the groundwork for growth? And if it’s not planning to grow, why isn’t capital being returned to shareholders?”

The bloggers cite the “years supply” metric to buttress their argument. “Check out this disclosure from the UCP 2015 10-K:

‘As of December 31, 2015, we had an 8.4 year supply of owned or controlled lots based on 2015 deliveries.’

And here is the Q2 disclosure from the latest 10-Q:

‘As of June 30, 2016, we owned or controlled a total of 5,547 residential lots, a 7.0 year supply based on the last twelve month’s deliveries of 789 homes.’

Lot supply has declined from 8.4 years to 7 years in just 6 months.

Seven years of supply is not abnormal for today’s homebuilders. And the decline is partly due to UCP’s rapid revenue growth during the measurement period. But again, the sharp decline is unusual. Given UCP’s profile, one would expect supply to be increasing, or at least flat.

UCP is growing revenue rapidly. UCP is selling inventory quickly. UCP is not replacing the inventory it sells.

This is highly unusual given favorable homebuilder industry conditions, UCP’s rapid sales momentum, its high growth markets and the behavior of UCP’s competitors — almost all of whom are growing real estate inventory.

We don’t know what UCP executives told the PICO Directors when they met last month. But these measures are enormously important and need some explaining. The future course of UCP depends on them.”