CWCO - Consolidated Water Co. Ltd.: Utilization Of Long-Term Contracts Fostering Growth

2023-05-26 03:31:17 ET

Summary

• Consolidated Water pays out a fair dividend yield which rewards shareholders with consistent income while also leaving ample FCF for growth.
• The company has outperformed the S&P 500 when adjusting for dividends over the past 10 years.
• Consolidated Water's use of long-term contracts allows the company to predict cash flows and thus better leverage themselves towards growth.
• Assuming my DCF figures, Consolidated Water is currently overvalued, resulting in a hold rating.

Consolidated Water Co. Ltd. ( CWCO ) has recently exemplified strong earnings resulting in large growth. I believe the stock is currently a hold due to its solid dividend, ability to lock in long-term contracts and overvaluation assuming my DCF figures.

Business Overview

Consolidated Water Co. Ltd. and its subsidiaries are engaged in the design, construction, management, and operation of water production and treatment plants primarily in the Cayman Islands, the Bahamas, and the United States. The company is divided into four segments: Retail, Bulk, Services, and Manufacturing. It utilizes reverse osmosis technology to convert seawater into potable water.

Consolidated Water supplies water to various end-users, including residential, commercial, and government customers, as well as government-owned distributors. The company also offers services such as design, engineering, construction, procurement, and management for desalination projects and water treatment plants. They provide management and engineering services for municipal water distribution and treatment.

Additionally, Consolidated Water manufactures and services various water-related products, including reverse osmosis desalination equipment, membrane separation equipment, filtration equipment, piping systems, vessels, and custom fabricated components.

They also provide design, engineering, consulting, management, inspection, training, and equipment maintenance services for commercial, municipal, and industrial water production, supply, treatment, desalination, and wastewater treatment.

With a market capitalization of $303.55 million, Consolidated Water demonstrates a decent return on invested capital of 8%. The stock's price of $19.92, close to its 52-week high of $20.58, indicates positive momentum. Additionally, the price-to-earnings ratio of 22.3 for Consolidated Water is slightly higher than the industry average, suggesting a premium valuation compared to its peers.

Consolidated Water offers its shareholders a fair dividend of 1.76% and maintains a safe payout ratio of 66.89%. This prudent payout ratio allows the company to retain sufficient free cash flow to allocate towards capital expenditures, enhancing its infrastructure and supporting future growth. Simultaneously, the dividend payments provide shareholders with consistent income, reflecting the company's commitment to delivering value to its investors.

Consolidated Water showcased impressive performance in Q1 2023 , surpassing both revenue and earnings expectations. The company reported earnings per share of $0.26, beating estimates by $0.10, and generated $32.87 million in revenue, exceeding expectations by $4.62 million. Notably, the revenue growth for the quarter reached an impressive 67.7% year-over-year.

These strong financial results are particularly notable given the prevailing moderate economic headwinds during the period. The outperformance of Consolidated Water in such conditions highlights the company's emphasis on growth and its ability to navigate challenging economic environments successfully.

Furthermore, this achievement underscores the significance of long-term contracts for Consolidated Water's business strategy. These contracts provide the company with stability and predictable cash flows, even during periods of economic uncertainty. The reliable revenue generated from long-term contracts ensures a solid foundation for Consolidated Water's financial position and allows it to sustain and expand its operations.

Outperforming the Broader Market

Over the past decade, Consolidated Water has demonstrated consistent growth and a commitment to reinvesting in its core business, resulting in the company's ability to outperform the S&P 500 when considering dividends. This impressive outperformance serves as a clear indication of Consolidated Water's adeptness in effectively leveraging its existing market while also venturing into new territories, thereby highlighting its ability to capitalize on opportunities and drive sustained success.

Utilization of Long-Term Contracts to Stabilize Cash Flows and Foster Growth

An essential part of Consolidated Water's business model, long-term contracts ensure stability and consistent revenue streams. The business actively seeks and negotiates long-term contracts with a range of organizations, including cities, resorts, businesses, and governments. These agreements, which frequently last for several years, offer a solid framework for the business's operations and expansion.

Consolidated Water's collaboration with the Water Authority of the Cayman Islands (WACI) is one notable illustration of its success in gaining long-term contracts. On the island of Grand Cayman, Consolidated Water manages the largest seawater desalination facility in the Caribbean. Consolidated Water is the only supplier of potable water to the island, providing both residential and business clients, according to a long-term contract with WACI.

Consolidated Water is in charge of producing and delivering potable water to the island under the terms of the contract with WACI, which is a build-own-operate model. Consolidated Water will have a consistent revenue stream for a considerable amount of time thanks to the 20-year contract's term.

Consolidated Water's long-term agreement with WACI not only ensures a steady customer base but also enables the business to plan and invest in infrastructure improvements and capacity increases to handle the island's rising water demand. It displays the business' capacity to forge long-lasting bonds with important constituencies and its dedication to offering reliable, high-quality water solutions.

I believe that these contracts provide Consolidated Water with the reduced risk associated with short-term variations in water demand and pricing by establishing comparable long-term contracts with respectable companies in diverse regions, ensuring a more stable and sustainable economic perspective. These agreements give the business a strong platform for expansion and enable it to concentrate on offering value-added services to clients and forging enduring relationships.

I firmly believe that even in difficult market conditions, Consolidated Water's long-term contracts are essential for projecting and upholding steady free cash flows. These contracts give the business a steady and dependable cash flow stream, enabling it to capitalize on its priceless assets and pursue expansion possibilities that have the potential to generate large profits.

Analyst Consensus

Consolidated Water receives a "buy" rating from analysts, with a consensus one-year price estimate of $21.50, suggesting a potential upside of 7.93%.

Valuation

Prior to formulating my assumptions and conducting my discounted cash flow analysis, I will determine the Cost of Equity and Weighted Average Cost of Capital for Consolidated Water using the Capital Asset Pricing Model. Considering a risk-free rate of 3.72% using the yield of the 10Y treasury rate , my calculations indicate that the Cost of Equity stands at 7.25% as demonstrated below.

Based on the aforementioned Cost of Equity value, I derived the Weighted Average Cost of Capital to be 7.25%, as illustrated below. This figure is lower than the industry average of 8.73%.

Utilizing an Equity Model DCF analysis based on net income, I have determined that Consolidated Water is currently overvalued by 12% compared to its fair value of approximately $17.44. This valuation was obtained by employing a discount rate of 7.25% over a 5-year period. Additionally, I anticipate that the company will continue to pursue long-term contracts, which will enable them to leverage predictable cash flows and further enhance their operational efficiency, resulting in improved margins and resource optimization.

Risks

Regulatory and Compliance Risks: Consolidated Water works in a highly regulated sector, and adjustments to water laws, licenses, or other compliance standards may have an effect on business operations and raise expenses.

Dependence on Long-Term Contracts: Consolidated Water is vulnerable to risks related to contract renewals, renegotiations, or early terminations even while long-term contracts offer consistent cash flow. The company's income streams may be impacted by alterations in the market environment or changes in the financial security of clients.

Conclusion

To summarize, I believe that Consolidated Water is a hold due to its solid dividend, ability to hold long-term contracts, and slight overvaluation assuming my DCF figures. Thus, Consolidated Water exemplifies great long-term prospects which require revisitation in the near future.

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