WTRG - Essential Utilities Is Not Worth It In The Current Environment

2023-05-11 15:18:31 ET

Summary

• Operationally, Essential Utilities is performing as expected.
• Earnings and dividend are expected to grow 5-7% during the next few years.
• Relatively low growth coupled with a starting yield of 2.7% is not a very interesting investment opportunity for most investors at this time.

Introduction

Essential Utilities ( WTRG ) states that their mission is "To sustain life and improve economic prosperity by safely and reliably delivering Earth’s most essential resources to our customers and communities."

What this means in practice is that the company is focused on providing water, wastewater, and natural gas services to their approximately five million customers across 10 states.

Growth Through Acquisitions

Essential Utilities itself is the result of Aqua America acquiring the natural gas provider Peoples. This transaction, the largest single transaction in the company history, was announced in 2018 and completed in March 2020 . This was also the first move that the company made into the natural gas distribution sector, with the aim of both diversifying its assets as well as gaining exposure to slightly higher growth rates than what its water and wastewater operations can provide.

The company has been well known to make a significant number of smaller tuck-in acquisitions in order to increase their customer base, thus enabling steady growth in an industry that provides very little organic growth. As mentioned on the first page of its Q1 2023 results , Essential Utilities has eight signed purchase agreements for nine additional water and wastewater systems which are expected to bring in over 200 000 customers. It is worth mentioning that a large portion of those customers are part of the Delaware County Regional Water Quality Control Authority (DELCORA) acquisition which is facing legal scrutiny. Regardless of the outcome of the DELCORA acquisition, Essential Utilities is almost guaranteed to keep growing through acquisitions, something they have already done successfully for decades.

Through both rate increases as well as growth through acquisitions, Essential Utilities has a strong history of sustainably increasing both their revenue, operating income and net income, as can be seen from the chart below. These of course are the key factors in forming the foundations for steadily growing earnings per share.

Q1 2023 financial results

On the 8th of May, 2023, Essential Utilities released its Q1 2023 financial results. Revenues climbed 3.9% while operating income declined 0.9% and net income declined 4.0%. The main reason for the slightly lower earnings was the abnormally warm weather which led to decreased volume from the regulated natural gas segment. Additionally, interest expenses were up from $53.6 million in Q1 2022 to $72.7 million, an increase of 35.6%. On the positive side, the company managed to lower its operating expenses by 3.2%, from $142.6 million in Q1 2022 to $138.0 million.

The key takeaway from the financial results was that despite some headwinds, the management reaffirmed their guidance for earnings per share growth at a compounded annual growth rate of 5 to 7% through 2025. Their guidance also includes a mention of growing their regulated water customer base by 2% to 3% annually, through both acquisitions and organic growth.

This guidance is very much in-line with their historical performance. Steadily increasing earnings will also contribute to dividend growth, which we will discuss in more detail below.

Dividend

Utility companies in general often provide dividend focused investors with good opportunities due to their safety stemming from a relatively predictable business environment, an industry with large barriers to entry, and their operations in potentially monopolistic markets. (all of which are true in the case of Essential Utilities). Furthermore, utility companies have a reputation of paying a higher-than-average dividend to shareholders.

The company, originally as Aqua American and as Essential Utilities since the acquisition, has paid a consecutive quarterly cash dividend for over 78 years. The current quarterly cash dividend is $0.2870 per share, which leads to a dividend yield of approximately 2.7% at the time of writing.

For the past five years, the company has increased its dividend payout by 7% each year and this trend is likely to continue for the foreseeable future, supported by growth in operations as highlighted previously.

Historically Essential Utilities has made an increase to its dividend in the third quarter of each year. Taking into account all that was mentioned above, I believe it is safe to assume that they will continue with this same trend and announce an approximately 7% dividend increase with an ex-dividend date in the first half of August 2023.

Recent Price Developments

As we can see from the chart above, Essential Utilities' price has slightly declined during the past 12 months. In comparison the S&P500 index has increased roughly 3% during the same period.

Utilities, especially those as stable as Essential Utilities, are often regarded as a safe haven during turbulent times in the market as investors appreciate the predictability and the almost guaranteed dividend. However, the recent increases in interest rates have led to bond yields that far exceed the dividend income provided by most utility companies, including Essential Utilities. While we are currently in a relatively volatile market, I do not see investors flocking to the safety of Essential Utilities as long as the US treasuries are providing significantly higher yields.

Conclusion

There is absolutely nothing wrong with Essential Utilities, in fact it's quite the opposite. They are operating efficiently and predictably, and it is extremely likely that they will keep rewarding investors with steady growth and steadily rising dividends for years, and likely for decades, to come.

However, from a dividend investor's point of view, I do not think that a combination of 5-7% expected growth and a 2.7% starting yield is anything to be excited about right now. While there are few companies where the dividend payments and the dividend growth is as safe as with Essential Utilities, I still feel that there are plenty of better options out there right now for both those who seek higher growth and those who seek higher yields.

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