“As relations between the U.S. and China deteriorated during the Trump administration, moving chip production to the U.S. and hindering sales of U.S.-made semiconductors to China became a strategic goal for American policymakers.
As the U.S. looks to fulfill its semiconductor needs on its own, Arizona is fast emerging as a base for the domestic industry’s revival. Already home to large Intel workforces, the state will soon add staff from Taiwan’s TSMC, supplier LCY Group, and potentially Samsung, as a slew of industry giants eye sites in the sun-beaten Southwestern state.”Fortune.com
Unbeknownst to most, semiconductor manufacturing requires tremendous amounts of water. This creates a major concern for Arizona, which is already facing the greatest water crisis since its inception.
For those unfamiliar with Vidler Water (VWTR), the company is the largest private owner of water rights in Arizona and Nevada. If that doesn’t sound exciting, you probably haven’t noticed that:
1) inflation is sending the price of commodities through the roof.
2) the southwest is in the midst of a decade-long drought, its worst drought in 1,200 years… and a situation that has been steadily worsening in recent years.
3) the region continues to attract a growing number of citizens and semiconductor companies, both of which require immense amounts of water.
Specific to semiconductor manufacturers, both Intel (INTC) and Taiwan Semi have already announced plans to establish / expand facilities in Arizona. Samsung is expected to follow suit. This promises to increase demand (and most likely, the price) of water in the region, as numerous media outlets have been reporting.
In light of the water shortage, Arizona’s semiconductor expansion might not make sense to many. However, despite the spiraling issues related to water, Arizona has overwhelmingly positive attributes, making it the ideal location for companies like Intel, Taiwan Semi, and Samsung to establish new operations.
With the expansion of semiconductor operations in the southwest (and resultant increase in employee population), demand for water is clearly set to continue (if not accelerate upon) its multi-year trajectory.
Meanwhile, the following chart shows how bad the drought is impacting water supply in the southwest. Last year, the water level at Lake Mead (which is a major source of water for the region) hit a multi-year low of 1,068 feet.
However, 2022 is proving far worse.
Lake Mead opened this year 15 feet lower than it typically does. If that’s not bad enough, its water level has started collapsing much earlier this year versus historical norms.
If it drops just 15 more feet, the state will move to Level 2 of their Water Shortage Contingency Plans (FYI, California just did). This scenario appears likely, because 1) we are just entering the 6 month stretch of the year where water levels constantly fall and 2) levels have been falling by nearly one foot every four days.
Such a move will further increase the demand and value for water rights. In fact, the region’s governments are now naming Vidler by name in their long-term water sourcing plans.
These are just a couple of examples of why water has effectively become gold in the regions where Vidler operates. Accordingly, VWTR has (IMHO) become among the safest, most attractive, and profitable investments for investors looking to 1) gain exposure to rising commodities and 2) hedge against inflation and the recent bear market in stocks.
FYI, a 2016 Seeking Alpha article provided a great review of VWTR’s business and assets. It also discussed the activist movement that led to a management shakeup at Vidler, resulting in a multi-year monetization of VWTR (which is ongoing, to the benefit of shareholders).
From what I’ve gathered, I believe the company will continue to shed assets and return capital to shareholders (via buybacks and special dividends) until all of the company’s assets are sold off.
That means that we can expect fair value to be achieved in relatively short order.
So, let’s discuss fair value.
The first thing that investors should notice is that the company has been selling off water rights with ever-higher profits, year after year. In 2016, gross margins were just 48.5%, indicating a nice 2x return on their investments. However, 2020 and 2021 showed gross profits of 80%, indicating a 5x profit versus the price they paid for the rights.
This has been an ongoing trend, with margins steadily rising from the 48.5% level to 51.7%, 63.4%, and 71.1% in 2017, 2018, and 2019 respectively, culminating in the more-recent 80% levels.
This has been fueling an already-massive buyback program (20% of the company’s shares have ) and/or special dividends (like the $5 per share they issued near the end of 2017). Since the 2017 dividend, management has opted for buybacks, with good reason…
Post-activist insurgence, the stock peaked at $20.20 per share. That was just prior to the 2017 dividend of $5. So, in current terms, the 2017 peak was actually $16.20. However, the increasing gross margins suggests that the value of their assets may have increased by about 2.5x over the past 4 years (equivalent to 25% per year).
That implies a current value of $40+ per share.
That’s not much of surprise, since the value of water rights have increased substantially since the release of a mid-2021 report that declared VWTR’s value to be $25+. I calculate that an updated report would re-value VWTR about 25% higher, or $31+ per share (in the same ballpark as the aforementioned $33).
The aforementioned Seeking Alpha article provided a valuation range of $16.08 – $21.32 in June of 2016. At the time, gross margins were just 42.4%, so VWTR was making 1.74x its money on their portfolio of rights. However, based on the latest market prices, VWTR is now reaping 5x, nearly triple the mid-2016 levels. Accounting for VWTR’s $5 special dividend in 2017, this implies a current fair valuation of $31.84 – $46.90.
This triangulates well with the data contained in a separate & comprehensive 100-page report from last year, which derived a replacement value of $40 for VWTR’s portfolio of infrastructure and water assets. Of course, the pricing on water rights have continued upward since then (by about 20-25%), which suggests a much higher total replacement value for the company’s assets.
Further validating the $40 thesis was a report entitled, “Is The Drought In Water Stocks About To End?? which stated, “Getting to $30+, especially considering this water crisis is more likely to get worse than better, is not a hard task.” Like the previously highlighted report, this one was written last year, when prevailing prices were lower.
With the recent addition of $19M to the balance sheet, I believe that the buybacks have accelerated, jump-starting the stock’s move toward the fair value figures cited above. In turn, this has pushed the stock into position to be added to the Russell 2000, which would require institutions (specifically, Russell 2000 ETFs) to purchase over $20M worth of VWTR shares for their portfolios.
Last but not least, there is a subset of investors (of which I am a part) who like to buy stocks that are poised to be admitted into the Russell 2000 (because of the forced buying that ensues). So, we now have management, institutions, and investors all buying/HODLing shares.
Ultimately, all this buying should intuitively (though doesn’t guarantee) erase the massive discount on VWTR shares, pushing the stock toward its true fair value.
Helping the cause, investors can expect the aforementioned “massive buyback” to continue. VWTR’s playbook has been clear ever since the activists took control of the board. Following the $5 Special Dividend in 2017, anytime VWTR has had more than $10M on the balance sheet, they have spent it on buybacks.
To date, the company has already bought back about 20% of VWTR’s outstanding shares. Given the nature of activists, investors can assume management will continue buying back shares until the shares are fully valued (or they run out of cash, above the $10M level mentioned above).
Just follow the trail.
In 2019, the company earned $15M in cash flow from operations. In 2020, they bought back $10M of stock. In the COVID-impacted 2020, the company was only able to earn $2M… and in 2021, they bought back $3M worth of stock.
See the pattern here?
Well, keep that in mind when I say that they earned more than $21M in 2021.
FYI, their buyback activity always seems to start after the company’s annual report (10-K) is released. This makes sense because companies and execs are often “blacked out” — not allowed to buy shares ahead of major reports. So, it should come as no surprise that VWTR’s stock experienced sharp rebounds starting on March 23 of 2020, March 23 of 2021, and March 15 of 2022… each time, just a few days after the release of the company’s 10-K.
The difference this year, is that the company is starting its annual buyback surge with a lot more money. Additionally, management is well-aware that the stock is less than one month away from qualifying to be added to the Russell 2000 (on May 6). Post-qualification, institutions would have just 7 additional weeks (until June 24) to accumulate all needed shares.
It doesn’t take a Finance degree to understand that $40M+ worth of buying ($20M from management and $20M from ETFs) creates a unique and powerful low-risk / high-reward situation for shareholders through the June 24 deadline.
FYI, despite the small buyback in 2021, the shares managed to rise 83% between March and July. A mere repeat of that action would take the stock to $21 per share. But this year has significantly greater catalysts in play. Thus, the question is, “where will the stock go with 10x more buying pressure than management was able to exert in 2021?”.
Assuming the stock achieves fair value before VWTR runs out of buyback cash, it would be logical to expect another Special Dividend. The great news here is that the tax treatment is likely to be favorable for shareholder for multiple reasons. Among them, the company has a net operating loss carryforward. This is a hidden asset on their balance sheet, enabling the company to generate massive profits without paying taxes (due to past losses).
This is outlined in the company’s recent annual report:
“As of December 31, 2021, we had federal and state net operating loss carryforwards of approximately $139.7 million and $125.9 million”
Later in the document, they state…
“We have determined that it is more likely than not that sufficient taxable income will be generated in the future to realize certain of our deferred tax assets. We maintain valuation allowances of $36.4 million as of December 31, 2021 for deferred tax assets not expected to be realized in the future. In 2021, the Company added $18.2 million to the deferred tax asset, due to the valuation allowance release of $21.7 million offset by a reduction of $3.7 million due to the Company’s taxable income for 2021.”
THE BOTTOM LINE
The factors listed above (and in my previous articles / YouTube videos) validate VWTR’s inclusion among my “Starting 5”, which represents nearly 90% of my personal portfolio of long positions… a portfolio that has returned over 40% annually since 1996 (and nearly 80% annually since 2017, as documented in my real-time tracking sheet.
If all goes according to plan, investors with a HODL mindset can expect a continuation of the recent rally in VWTR shares, at least through the June 24 Russell reconstitution date.
For more on this subject, check out my previous blog post and YouTube videos. Also, here’s some of the latest news and information related to the ongoing rise in shares of Vidler Water (VWTR). Cheers!
- Severe drought and mandatory water cuts are pitting communities against each other in Arizona
- As Western Drought Worsens, Governor Newsom Moves to Bolster Regional Conservation Efforts
- Critical water shortage, wells running dry in Arizona community of Pine-Strawberry
- Experts say the term ‘drought’ may be insufficient to capture what is happening in the West
- California, Nevada and Arizona to cut Colorado River water use — Utah says it’s about time
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