UCP Inc - Worthwhile on its Own?

This will be the last post on the PICO/UCP story for a while, but I haven't had much time to dig into new situations and there just seem to be fewer interesting investing ideas with the markets drifting higher and remaining relatively calm.  As I've covered recently, UCP is the home builder/land developer unit of PICO Holdings that recently completed its initial public offering.  While I consider the transaction a positive for PICO, given PICO's complexity and management compensation structure, UCP might be the better investment for the near term as its a purer play on the continued housing recovery.

To summarize, UCP Inc (the publicly traded entity) owns 42.3% of the operating company UCP LLC, while PICO owns the other 57.7% and will remain the controlling shareholder.  UCP is primarily a California home builder and land developer with some additional exposure to the Puget Sound Area in Washington state.  Below is a snapshot of the current owned and controlled lots in UCP's inventory:

Since UCP essentially didn't get started until after PICO bought it in 2008, UCP has no legacy or problem assets on its balance sheet, the majority of their lots were purchased opportunistically in the 2008-2011 period and are carried on the balance sheet at historical cost.

What have real estate prices done in the areas where UCP operates?

Fresno: http://www.zillow.com/local-info/CA-Fresno-home-value/r_18203/

Monterey: http://www.zillow.com/local-info/CA-Monterey-County-home-value/r_2444/

Santa Clara: http://www.zillow.com/local-info/CA-Santa-Clara-County-home-value/r_3136/

Seattle: http://www.zillow.com/local-info/WA-Seattle-home-value/r_16037/

While Zillow isn't the perfect data source, their estimates all show year over year price increases in UCP's markets of anywhere between 12-22%.  So if anything, the real estate on the balance sheet is likely understated, but for the sake of being conservative I won't make any adjustments.

Below is the pro forma balance sheet after the offering:

Based on the current market price of $14.23, UCP has a market capitalization of $261 million, and a price-to-book ratio of about 1.2x.  Other home builders trade for a multiple of book value, but a good recent comparable seems to be TRI Point Homes (TPH) as its almost exclusively based in California, was formed by a private equity investor during the crisis and as a result of its January IPO, has plenty of cash.   TPH trades for 1.6x book value, a 33% premium to UCP, maybe some of that is justified by more desirable community locations, but given the similarities, I think its a good comparable.  UCP also compares favorably on the home building margins and it has the optionality of being a developer and selling their lots to other builders.

So why is UCP cheap?  Besides its small size and geographic concentration, there was very little hype leading up to the offering, little coverage since,  and it hit the market as home builders have been tumbling with the rise in mortgage interest rates (the home builder index is only up marginally on the year, but was up significantly in 2012).  It just seems to be overlooked here, UCP debuted at $15, the low end of its range, and has traded lower ever since.  Some of that discount is probably a result of the organizational structure, as PICO will continue to hold 57% of the economic interest and control the board, making an acquisition or other transaction unlikely.  Additionally on the negative side management is getting a nice raise, and doesn't own any shares outside of the initial options they were granted in the offering, plus there will be extra expenses UCP will incur as a stand alone public company.  

But I think the positives and the valuation outweigh the negatives.  I'm generally positive on real estate still, there will be pauses as interest rates rise to a more natural level, but with pent up demand from years of low household formation and long term demographic shifts away from the midwest and to places like California, UCP could be a good short-to-medium term investment.

Disclosure: No current position in UCP, I own shares of PICO