Summary
- The American States Water Company together with its subsidiaries provides water and electricity utility services.
- The company has outperformed both the Utilities sector and the S&P 500 in terms of total return over the last 5 years.
- Despite strong financial performance and an efficient business model, very high valuation metrics deem the stock a hold for now.
Thesis
The Utilities sector has gained in popularity and has gathered more attention from investors during the current, turbulent market environment. In this analysis, I explore the financial performance and investing potential of a smaller, yet stable and attractive company in the sector, American States Water Company ( AWR ), a water and electricity service utility firm.
Desirable Stock Returns
Despite its defensive, slow-growth nature, AWR has significantly outperformed both the S&P 500 Index ( SPY ) and the Utilities Sector ( XLU ) in terms of total return over the past five year period. The biggest difference in performance is noted from mid-2022 onwards, as AWR has quickly recovered from the year's lows. Currently, the stock trades at $89.97 ($3.38B market capitalization), -10% from 52-week highs and pays a 1.74% FWD dividend yield. Over the past decade AWR has recorded a total share price growth of 224%, while short-term performance, over the TTM stands at +6.9%.
Business Model
The American States Water Company together with its subsidiaries provides water and electricity utility services. AWR reports results in three business segments: Water, Electric and Contracted services that represent the company's principal business units. Some of its subsidiaries include the Golden State Water Company (GSWC) and Bear Valley Electric. GSWC serves approximately 262,770 water customers and 24,656 electric customers at the end of 2021, primarily in California. In addition, through the American States Utility Services, Inc. (ASUS) subsidiary the company provides water services for 11 military bases across the country. Residential and commercial customers account for the majority of the company's water and electric revenue, however.
Water services from GSWC account for the vast majority of AWR's revenues at 73%, with ASUS being the second larger revenue source. Contracts for servicing military installations under the ASUS subsidiary are long-term in duration and provide the company with stable revenue flows. Management highlights that significant water contracts are to be awarded over the coming 5 years.
Water and Electricity services are seasonal in nature and demand, especially in California, and usually higher during the third quarter, when the climate tends to be more dry and hot. Electricity demand in the areas that the company services also depends on snow fall. Ski resort operations increase demand during longer periods of snow. Conversely, unseasonably warm weather during skiing season negatively affects sales.
Financial Performance
AWR is characterized by revenue stability and moderate growth over the past 5 years, just like many well-performing utility companies. Sales have increased at a 1.6% per annum pace since 2017, reaching $499M in 2021. Analysts expect the growth rate to pick up over the next few years, with the revenue forecast for 2022 at $512M (2.7% growth) and $527M for 2023 (2.8%). Overall, the company's top line appears to be recording moderate increases despite operating in a slow-growth, defensive sector.
Operating income has also progressively, slowly increased over the past five years, reaching $145M in 2021. Operating margins have also expanded marginally from 27.3% in 2017 to 29.1% in 2021, indicating efficiency in operations. Net margins have increased from 15.7% in 2017 to 18.9% in 2021. Compared to average sector margins the company displays stronger profitability both in terms of operating and net margins. For 2022 and 2023 analysts expect EPS to reach $2.48 and $2.74, representing mid-single digit annualized growth.
Cash from operations stands a bit below net income over the last 3 years. For 2021 AWR generated $116M in cash from operations. However, the company tends to spend large amounts of cash for its investing activities. Spending has increased from $80M in 2017 to $145M in 2021. Given the capital-intensive nature of the utilities industry capital expenditures are expected to remain at relatively high levels.
When it comes to the company's balance sheet, a large, growing debt balance stands out. Net debt has increased from $380M in 2017 to $696M as of the last filing. Currently, net debt represents around 20% of market cap. While debt levels are not yet alarming (usually utilities companies carry significant debt amounts), it is something for investors to keep monitoring. Excessive leverage can adversely affect the risk profile of the business, while elevated interest payments can hurt bottom-line profitability.
Dividend King Status
American States Water Company has paid dividends to shareholders every year since 1931, almost a century ago, and has consecutive dividend increases for the last 68 years, claiming an elite status among dividend paying firms.
Currently, AWR's dividend yield stands relatively low compared to sector averages, at 1.74%, despite its strong growth record. Dividends have increased at a respectable 5-year 9.11% CAGR, while AWR earns an A- score from Seeking Alpha's quant ratings for dividend safety and an A score for consistency. Analysts expect dividend increases to continue uninterrupted, at least for the mid-term. Overall, AWR represents a solid choice for dividend growth investors looking into the Utilities sector.
AWR's Valuation is Hard to Embrace
AWR exhibits very high valuation multiples across the board and compared to historic, 5-year averages. While P/E ratios for AWR have historically stood high (above 25x), the current 41.6x multiple is near the 5-year high and is by all accounts expensive. The same goes for a 6.9x P/S multiple that also sits close to 5-year highs. P/CFO per share stands at 26.9x.
The P/E and P/S ratio compare to sector averages of 19x and 2.0x respectively, both indicating that the AWR is currently overvalued.
Final Thoughts
For an otherwise well-performing, 'safe' stock pick in the Utilities sector, appropriate for almost any investor looking for some more defensive exposure or dividend growth, the company's current market valuations hurts its investment appeal significantly. In my view, AWR is a company for an investor's watchlist, waiting for a potential decrease in stock price to initiate or add to a long-term, buy-and-hold long position. As a result, I would currently rate AWR as a hold.
For further details see:
American States Water Company: Buy When The Price Drops A Bit