Cashing in on Water

After a long series of posts on suppliers of water infrastructure, from fire hydrants to filters and from taps to treatments, it is now time to look at the companies selling water.  The majority of water utilities is owned by municipalities and is beyond the reach of investors.  However, there is a clutch of publicly traded companies that peddle water as a business. 

Which water utilities make sense to return hungry and risk wary investors?

A short list of publicly traded water utilities in the U.S. reveals a diverse group of large and small companies.  American Water (AWK:  NYSE) is by far the largest operation after reporting $3.2 billion in revenue in fiscal year 2015.  American Water serves 1,600 communities in 16 states in the U.S. and Canada with potable water delivery and waste water collection. The smallest company in terms of revenue is York Water Company (YORK:  Nasdaq), which delivered $47.0 million worth of water to customers in Pennsylvania last year.

Water Utility	Market	SYM	Sales Mill
American States Water	California	AWR	$458.6
American Water	1,600 communities in 16 states	AWK	$3,160.0
Aqua America	PA, OH, TX, IL, NC, NJ, IN and VA	WTR	$814.2
California Water Service	CA, WA, NM	CWT	$588.4
Connecticut Water Service	Connecticut, Maine	CTWS	$95.9
Middlesex Water Company	NJ, DE, PA	MSEX	$123.2
SJW Corporation	San Jose, California	SJW	$305.1
York Water Company	Pennsylvania	YORW	$47.0

After all the discussion of water system failure, water contamination and the need to treat water destined for our kitchen faucets, a review of water utilities must include a review of financial strength.  Some investors might scrutinize leverage ratios and profit margins.  I prefer to look at how good a company is at turning sales dollars into operating cash.  After all, it is operating cash that pays for capital investments.  The winner in my contest is Aqua America (WTR:  NSYE), which converted 45.5% of its $814.2 million in revenue in the last fiscal year to operating cash flow.  The least proficient cash builder in the group is American States Water (AWR:  NYSE), which only turned each sales dollar into 20.7 cents.  That is still an impressive cash conversation ratio and goes a long way toward supporting capital spending programs to maintain and improve water delivering infrastructure. 

SYM	Sales Mill	CFO Mill	CFO/Sales
AWR	$458.6	$95.1	20.7%
AWK	$3,160.0	$1,180.0	37.3%
WTR	$814.2	$370.8	45.5%
CWT	$588.4	$144.6	24.6%
CTWS	$95.9	$37.8	39.5%
MSEX	$123.2	$39.3	31.9%
SJW	$305.1	$97.3	31.9%
YORW	$47.0	$18.5	39.3%
Average			33.8%

Aqua American may be the strongest in the group in terms of generating operating cash flows, but it is also among the most expensive stocks.  Its shares trade at 6.9 times sales - well above the group average of 4.7 times trailing sales.  The story is the same in terms of earnings and cash flows.  The supplier of water to the San Jose, California community, SJW Corporation (SJW:  NYSE), is the only one in the group that trades below the average in terms of sales, earnings, cash flows and book value. 

SYM	P/S	P/E	P/CFO	P/BV
AWR	3.2	25.3	15.8	3.2
AWK	4.0	27.0	10.8	2.5
WTR	6.9	28.0	15.4	3.3
CWT	2.3	29.8	9.3	2.1
CTWS	5.4	22.4	13.9	2.3
MSEX	4.7	30.4	14.9	2.8
SJW	2.5	20.1	7.9	2.0
YORW	8.7	32.9	22.4	3.8
Average	4.7	27.0	13.8	2.8

The relative value of SJW is interesting, particularly given the apparent optimism that analysts have for the company’s future.  Analysts have projected slowing growth for water utilities over the next five years.  The average future growth rate for our group of eight companies is 6.6%, but SJW is at the top end of the range with a 14% projected growth rate. Middlesex Water brings up the rear with a 2.7% growth rate projection.

The ratio of Price/Earnings-to-Growth Rate provides a logic check for investors in comparing earnings multiples.  SJW wins this contest as well with a ‘PEG Ratio’ of 1.44 compared to the average of the group of 5.26.   Still the target PEG Ratio is 1.00 so it appears investors are paying a premium for the growth that SJW has to offer.

Earnings and growth are only part of the picture for water utilities.  All of them pay a dividend.  The forward dividend yield for our favorite SJW Corporation is 2.2%, which is exactly the group average.  So dividend yield should be considered right along with growth potential.  Utility stocks also typically offer shareholders lower risk than other sectors, justifying higher multiples relative to yield and growth.  The average beta for our group is a modest 0.42. 

SYM	Yield	Growth		Beta		PEG	PERG	PERGY
AWR	2.2%	3.9%		0.40		6.58	2.63	1.67
AWK	1.9%	7.6%		0.23		3.55	0.82	0.65
WTR	2.2%	5.9%		0.54		4.79	2.58	1.87
CWT	2.5%	9.1%		0.67		3.29	2.21	1.73
CTWS	2.3%	5.0%		0.16		4.49	0.72	0.49
MSEX	2.2%	2.7%		0.55		11.24	6.18	3.39
SJW	2.2%	14.0%		0.24		1.44	0.34	0.30
YORW	1.9%	4.9%		0.59		6.71	3.96	2.84
Average	2.2%	6.6%		0.42		5.26	2.43	1.62

Considering dividend yield as well as growth and adjusting each ratio for risk, our favorite SJW still dominates the group.  Its PERGY (Risk Adjusted Price/Earnings to Growth Plus Yield) ratio is 0.30  -  the lowest in the group.  The shares of SJW may be the best value in the group, but it is worthwhile to point out that Connecticut Water Service (CTWS:  Nasdaq) with its 2.3% dividend yield is in second place.   Connecticut Water also appears to be a strong operator with a 39.5% sales-to-cash conversion ratio in the last fiscal year.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.