SJW - SJW Group's Q2: A River Of Growth Or Just A Stream?

2023-08-01 09:02:44 ET

Summary

• SJW Group's Q2 2023 financial results showed a beat in GAAP EPS but missed revenue expectations.
• The company has strengthened its financial position through successful fundraising and strategic moves on the regulatory front.
• However, caution is warranted due to potential overvaluation, environmental challenges, escalating costs, and regulatory uncertainties.

Thesis

This article presents an examination of SJW Group's ( SJW ) Q2 2023 financial results that revealed GAAP EPS of $0.58 beating by $0.02, and revenue of $156.89M that missed by $3.61M. While the company has strengthened its financial position with successful fundraising, maintaining healthy cash reserves, and making strategic moves on the regulatory front, this analysis argues that some caution is warranted due to potential overvaluation, environmental challenges, escalating costs, and regulatory uncertainties.

Company Overview

SJW Group is a major US water utility service provider that operates through its subsidiaries in two key segments: Water Utility Services and Real Estate Services. The company's water utility activities encompass a wide range of functions, including water production, storage, purification, distribution, wholesale, and retail sales, along with non-tariffed services like water system operations and maintenance agreements. With a considerable service area covering portions of California, Connecticut, Maine, and Texas, SJW Group serves approximately one million people and demonstrates a diversified approach with real estate holdings in California and Tennessee.

SJW Group's Q2 Earnings Highlights

SJW Group recently unveiled its financial results for the second quarter of 2023. Overall, the results painted a picture of progressive growth and financial strengthening. The revenue benchmark was set at $156.9 million, translating to a 5% uptick from the second quarter of the previous year. In parallel, the net income experienced a noteworthy surge, skyrocketing by 58% to reach $18.3 million. This uptrend brought about a 53% elevation in the diluted earnings per share, now at $0.58.

These increases were largely fueled by two factors: the revenue derived from the general rate case in the fourth quarter of 2022 and the release of a portion of the income tax reserves and regulatory mechanisms.

When examining the broader annual financial canvas, the firm reported a first-half revenue of $294.2 million for 2023. This reflects an 8% climb compared to the corresponding period in 2022. Even more pronounced was the rise in net income, which soared by an impressive 95% to $29.8 million. The diluted earnings per share showed a similar growth trajectory, bolstering by a substantial 90% to $0.95.

Turning the lens towards SJW Group's financial moves, the company bolstered its financial fortitude by raising $65 million in the first half of 2023 through its 'at the market' program. This fundraise was bifurcated into $50 million allocated for general corporate exigencies and the residual for potential acquisitions. In addition to this, the company has a cash reserve of $267 million and has accessed $83 million from their banking credit lines, poised to address short-term financing needs for utility plant expansions and operational functions.

From a regulatory perspective, the company observed multiple affirmative developments. These included approved rate filings in two states - California and Maine, bolstering its regional financial solidity. Furthermore, the California Public Utilities Commission rendered a favorable decision to uphold the previously authorized Water Cost of Capital Mechanism (WCCM). This outcome is poised to create a conducive regulatory environment for the company.

SJW Group also issued confident guidance for 2023, anticipating earnings per diluted share between $2.40 to $2.50 and committing to long-term growth and value creation through five-year capital investments totaling $1.6 billion.

Performance

To begin with, with optics focused on the medium-term, the consistent increase in SJW's share price, from USD 29.65 in 2016 to USD 70.46 in 2023, signals a healthy appreciation of value. This uptrend represents a commendable annualized return on investment of 12.10%, which even outperforms the S&P 500 Index with an 11.26% rate.

Equally significant is SJW's dividend growth. Between 2016 and 2022, SJW posted a steady increase in its dividends per share, growing at an average rate of 9.41%. Also, the yield on cost - a metric measuring the income an investment produces relative to the initial outlay - steadily increased from 2.73% in 2016 to 4.86% in 2022. This indicates that the dividend income generated by an initial investment in SJW Group has been increasing over time, enhancing the total return for long-term shareholders.

Valuation

When analyzing the Blended P/E ratio of 28.75x, we're looking at a price that's above the company's normal P/E ratio of 28.01x. This, in my view, suggests that the market currently values the company at a higher earnings multiple than its historical average, signaling potential overvaluation. As a firm believer in reversion to the mean, this is something that could indicate a future price correction.

What's also caught my eye is the Adjusted Earnings Growth Rate, which stands at 4.79%. While not outstanding, it's nonetheless a steady sign of financial health. However, considering the relatively high P/E ratio, I would ideally like to see higher growth rates to justify this valuation.

Diving into the dividend details, the 2.16% dividend yield is a solid point to consider for income-focused investors.

Risks & Headwinds

Despite the overall rosy financial picture painted by SJW Group's recent results , there are some undercurrents of concern that warrant attention. For starters, the company's service territories in Texas are grappling with severe drought conditions - specifically, Stage 3 and Stage 4. These environmental challenges have led to a contraction in water usage within Texas and Maine, primarily attributed to weather changes. Adding to these operational hurdles, the termination of the declared drought emergency in California has left a mark on SJW's operational performance.

In terms of financial strains, SJW has been dealing with climbing costs. The average per unit costs for water supply have seen an uptick of $6.6 million, a rise which has been only partially cushioned by a reduction in production costs tied to the diminished customer usage. In the same vein, interest expenses have also experienced an uptick.

The company's borrowing climate also shows signs of strain. The average borrowing rate for SJW's line of credit advances during the first half of 2023 has reached approximately 5.96%. This is a stark contrast to the considerably more amenable rate during the same period in the previous year, which stood at approximately 1.44%.

Rounding off the potential hurdles, several factors could potentially influence SJW's 2023 outlook. One of the more prominent concerns is that there are no significant rate case decisions anticipated in 2023. In tandem with this, there are increasing costs associated with inflation, which could impact interest, labor, and other expenses. Additionally, according to management, shifts in the effective tax rate could have repercussions for the company's financial performance.

Final Takeaway

Based on this analysis, I would rate SJW Group stock as a "Hold." While the company has exhibited consistent growth, strong financial health, and a progressive dividend policy, there are elements of overvaluation as per the current P/E ratio compared to historical averages, and potential headwinds related to environmental challenges, rising costs, and regulatory uncertainties that temper my enthusiasm. Moreover, the increased borrowing rate coupled with an uncertain rate case outlook and inflationary pressures could place some strain on future earnings, justifying a more cautious stance.

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