American Water Works (NYSE:AWK) is an organization with good development prospects in my view, as a lot of the US ingesting water and wastewater programs are un-privatized. The corporate is the biggest in its area and due to this fact has the benefit of economies of scale for additional development. As well as, AWK is presently fairly fairly valued as its share worth has fallen considerably over the previous 2 years. AWK has efficiently carried out its development technique up to now. The corporate is properly managed. This enables for continued success to be anticipated.
The corporate operates in two enterprise segments, that are Regulated Companies and Others.
Regulated companies embrace numerous AWK subsidiaries that present water and wastewater providers in 14 states. The client base is broad. This consists of residential, business, industrial, authorities companies, and hearth departments. In whole, there are 3.4 million energetic prospects within the phase’s water and wastewater community. The Regulated Enterprise phase generated $3.505 million in gross sales in 2022, representing roughly 92% of the corporate’s whole income. AWK generates roughly half of its gross sales from two states, New Jersey and Pennsylvania. One other distinctive function of this enterprise phase is that the share of wastewater in comparison with water service is sort of small. For instance, the wastewater portion of the phase’s gross sales income in 2022 was $242 million. This can be a whole of solely 6.9% of the whole phase’s gross sales income. There’s appreciable room for development right here. A part of AWK’s development technique is to amass wastewater service suppliers in areas the place it has water prospects.
Non-public prospects make up the biggest a part of the client base. The remaining buyer varieties are proven within the diagram under.
The Firm’s second enterprise phase is the Navy Companies Group (MSG), the outcomes of that are reported underneath the title of the “Others” phase. The share of this phase is small, making up solely 8% of gross sales. MSG offers water and wastewater providers to 18 US navy bases underneath 50-year contracts. The typical remaining contract time period is 40 years. Most of those contracts are topic to annual settlement or early termination. MSG’s opponents in servicing navy bases are American States Water Firm (AWR) and Veolia Environnement S.A. (OTCPK:VEOEY).
The principle supply of water provide for AWK is floor water. In second place is groundwater. Floor water usually requires a good quantity of therapy earlier than use.
A Take a look at Lengthy-Time period Previous Efficiency
How profitable has AWK been up to now over an prolonged time period? Let’s take a look at some key indicators under. First, gross sales.
Gross sales have constantly elevated through the years. In 2001 it was $1.43 billion and in 2023 (TTM) $4.13 billion. This offers a median annual development price of 4.93%. Within the final decade, the CAGR has slowed down to three.21%. Within the final 5 years, its development has been solely 2.72% per yr. (2019 gross sales had been $3.61 billion). Thus, gross sales development has clearly slowed down through the years. However gross sales development is barely one of many metrics. Let’s check out the revenue.
As a way to get an extended overview, I’ll use the information from 2010 as a foundation right here.
From 2010 to this point, the CAGR of earnings has been 5.50%. The CAGR of earnings during the last decade has been 4.77%. Nevertheless, the CAGR of the final 5 years is barely increased: 6.05%.
The above exhibits that for a few years, AWK’s revenue development has been quicker than gross sales development. I feel that this type of revenue development can’t be sustainable for a really very long time. The corporate does have an bold long-term capital spending plan that might enhance capital spending for brand new acquisitions by a median of roughly 8% per yr. The implementation of this plan would most likely make it attainable to extend each gross sales and earnings sooner or later at a quicker tempo than earlier than. Nevertheless, what’s secret’s the value at which new corporations are acquired. If new acquisitions might be made correctly and economically, I feel it’s attainable that the corporate’s earnings will develop quicker.
American Water Works’ dividend development has been quicker than earnings development for a very long time. Over the previous 15 years, the corporate’s dividends have grown by a median of 8.47% per yr.
This raises questions in regards to the sustainability of dividend development on the identical tempo. For this function, firm earnings ought to develop at the least on the identical tempo as dividends sooner or later. For many buyers, nonetheless, AWK is primarily a dividend inventory. Present developments quite predict a lower within the dividend development price to 4-5%.
Variety of Shares and Change in Internet Margin
AWK has not been very energetic in share buybacks. Moderately, the variety of shares within the firm has elevated through the years. This has particularly occurred within the final yr. If on the finish of 2022, AWK had 182 million shares, by now there are already 195 million of them. For the investor, this implies revenue dilution. This additional reduces the comparatively sluggish development in earnings per share.
American Water Works has been working increasingly more effectively yearly. That is proven by the change within the firm’s internet margin over an extended interval.
In 2010, AWK’s internet margin was 10%. Steadily enhancing, it has reached 22% immediately. This exhibits efficient administration and value effectivity. Margin enchancment additionally explains, in my view, why the corporate’s earnings have grown quicker than gross sales over an extended interval. Might AWK’s internet margin enhance additional sooner or later? That is attainable if price effectivity improves. Competing corporations embrace corporations with even increased internet margins. For instance, York Water (YORW), whose internet margin has been over 30% for a number of years. I feel the continued enchancment in margins will play an vital function in AWK’s continued earnings development. As a result of pretty massive debt load of this firm, it’s not attainable to make new acquisitions by additional rising the debt load. Whereas there are various alternatives for acquisitions within the US water and wastewater sector, AWK wants to take action well and cost-effectively. In my view, a big enhance within the debt burden won’t have a big impact right here.
Monetary Well being
The debt/fairness ratio of American Water Works within the third quarter was 1.24. In the meantime, Quick-Time period Debt & Capital Lease Obligation was $492 million, Lengthy-Time period Debt & Capital Lease Obligation $11,772 million, and Complete Stockholders Fairness $9,897 million. Is the debt/fairness ratio of 1.24 excessive or low? AWK’s median debt/fairness ratio over the previous 10 years is 1.43 From that perspective, the present price is maybe a bit low. However let’s examine AWK’s debt/fairness ratio with different water infrastructure corporations.
Of the ten corporations within the desk above, AWK’s debt/fairness ratio ranks third. Based on this, it may be stated that it has a quite excessive debt load amongst related corporations. Wanting extra broadly, the Utilities-Regulated business has a debt/fairness median of 0.86. American Water Works’ 1.24 considerably exceeds it. Additionally in absolute phrases, AWK’s long-term debt has elevated considerably over the previous decade. Whereas the debt has grown at a barely quicker tempo than the corporate’s fairness. The typical annual development price of fairness since 2013 has been 6.94% The typical annual development of long-term debt in the identical interval has been 7.59%.
|Lengthy-Time period Debt
|Complete Widespread Fairness
|Lengthy-Time period Debt
|Complete Widespread Fairness
AWK-s Lengthy-Time period Debt and Complete Widespread Fairness 2013-2023 In Hundreds of thousands of USD supply: In search of Alpha
Contemplating the above, I feel that AWK’s debt load is a bit excessive in the mean time, particularly in comparison with the opponents. Due to this fact, it’s most likely not cheap to extend it considerably in an effort to purchase new corporations quicker.
The outcomes for the third quarter of 2023 considerably exceeded expectations. Gross sales had been $1.17 billion vs. forecast $1.14 billion. EPS was $1.66. It beat the forecast by $ 0.01.
The third quarter of the yr is historically influenced by weather conditions. Water consumption normally will increase through the summer time interval, which is useful for AWK gross sales. This yr, quarterly earnings per share had been $0.11 increased resulting from favorable climate situations. However, there are additionally years with a whole lot of precipitation, when the necessity for water consumption within the exterior setting decreases. For instance, in Q2 2022, EPS decreased by $0.06 resulting from local weather causes. In the long term, nonetheless, this won’t considerably change the corporate’s earnings, as some states have carried out compensation agreements to compensate for local weather situations.
Future Steering and 2023 Acquisitions
Within the presentation of the third quarter Earnings Name, the corporate additionally provides a number of attention-grabbing future forecasts. A protracted-term common annual revenue development of 7-9% is obtainable. Towards the backdrop of previous EPS CAGR of 4-6%, this appears quite too optimistic. Nevertheless, if revenue margins can proceed to enhance, EPS CAGR may also enhance considerably.
Price Base ought to develop by 8-9% yearly. It additionally consists of the contribution of the acquired corporations.
Is it sensible to anticipate an 8-9% annual development within the base price? Let’s check out the corresponding price for the interval 2017-2023. The CAGR for the stated interval is 7.30%. I feel that if acquisitions are included, an 8-9% CAGR might be fairly sensible.
One of many firm’s targets is to develop its buyer base by 2% per yr within the following years. As well as, a long-term annual dividend development of 7-9% is foreseen. At roughly the identical tempo, AWK’s dividends have grown over the previous 15 years as properly. Thus, such dividend development might be thought of sensible. The desk under exhibits the extent to which the change in base charges impacts AWK gross sales.
As might be seen, AWK gross sales in 2023 have elevated by $359 million because of the change in water service worth base charges. The corporate’s TTM gross sales had been $4.133 billion. $359 million is 8.68% of it. That is on the identical price because the projected enhance in base charges over an extended interval.
Comparability With Rivals
Over the previous yr, most water infrastructure corporations have proven adverse whole returns. AWK is the second finest out of the 6-member group into consideration. The chart under additionally considers company dividends for returns.
|1 Yr Return
supply: In search of Alpha
The one firm with a constructive return was Companhia de Saneamento Básico do Estado de São Paulo – SABESP (SBS). It’s a water infrastructure firm working in Brazil.
When it comes to valuation, AWK is the most costly firm within the comparability group if we take the P/E (FWD) ratio as the idea.
|P/E GAAP (FWD)
supply: In search of Alpha
Subsequent, let’s examine the web margins of the businesses.
|Internet Revenue Margin TTM
supply: In search of Alpha
AWK has the very best internet margin of the group underneath evaluation, which testifies to the effectivity of this firm.
Inventory merchants could also be within the American Water Works seasonality map. The chart under offers an summary of which calendar months and days could be optimum to purchase and promote AWK shares.
As might be seen from this map, the interval from March 23 to April 25 has been some of the productive durations for AWK inventory over the previous 10 years. By shopping for the corporate’s inventory on March 23 and promoting it on April 25, the annualized return on the transaction could be 111.57%. There could be 90% profitable trades, or 9 out of 10. The typical return on one commerce was 7.05%.
One other interval with good returns for AWK inventory was between Might 19 to August 14. By shopping for this inventory on Might 19 and promoting on August 14, the annualized return over the previous decade would have been 43.23%. In all 10 years, you’d have made worthwhile trades. The typical yield of the commerce would have been 8.95%.
Let’s first decide AWK’s valuation utilizing the discounted money stream technique.
I used a conservative 5% because the anticipated development price since American Water Works’ long-term EPS CAGR has been 5.50%. The corporate itself forecasts a future EPS CAGR of 7-9% in the long run. I used 10% because the low cost price, given the comparatively excessive present rates of interest. The next knowledge are used within the calculation: Preliminary Money Stream of $1.691 billion, Complete Money of $700 million, Complete Debt of $12.270 billion, Shares Excellent of 194.7 million and Present Share Worth of $131.99. Based on this estimate, the honest worth of AWK inventory is $172.1 and which means it’s undervalued by 26.38%.
Let’s check out relative valuation metrics subsequent. As talked about above, AWK is likely one of the corporations with the next P/E ratio amongst its opponents.
AWK-s P/E ratio 2010-2023 supply: roic.ai
American Water Works’ 2010-2023 common P/E ratio is 26.73. The corporate’s FWD P/E ratio is 27.37. In gentle of this, AWK is a bit overvalued. Nevertheless, the typical P/E ratio of the final decade is 30.09. In comparison with the final decade, the present worth is a bit low-cost.
Primarily based on the discounted money stream technique, AWK is sort of considerably undervalued. I contemplate the discounted money stream technique to be a bit extra goal, supplied in fact that sensible development and low cost charges are used within the knowledge.
Offering water and wastewater providers is likely one of the most secure companies as a result of whatever the normal state of the economic system, individuals nonetheless want these providers. Nevertheless, there are some dangers on this space as properly.
Generally an organization is unable to acquire the mandatory water service worth enhance from regulators, despite the fact that it has met the situations needed to use for it. It could additionally occur that the selections of the regulators come solely after a protracted delay. On this case, the capital expenditures won’t pay for themselves and the corporate won’t obtain the specified revenue development.
One other threat issue is the standard of the provided water. If it doesn’t meet the necessities, massive fines can observe and the corporate will undergo a lack of status.
Because of drought or different pure situations, the corporate could not have the ability to guarantee enough water provide in some areas. This will end in diminished gross sales or fines.
Wastewater is a separate area. Though presently, the share of wastewater in AWK’s enterprise is small, it might enhance sooner or later. Tightening the laws associated to the gathering and therapy of wastewater can result in important further prices for the corporate. This in flip can cut back AWK’s earnings.
The Backside Line
American Water Works is, for my part, fairly valued at this level. Though the corporate’s long-term revenue development knowledge has been modest, the revenue development of latest years and the speed of development of water service base charges enable us to contemplate a median revenue development per share of 7-9% within the following years as sensible. Certainly one of AWK’s benefits is economies of scale, as it’s the largest firm in its area within the US market. This enables it to function effectively and additional enhance revenue margins over time. Since this firm’s debt load is excessive in comparison with its opponents, a big enhance in debt might, in my view, worsen its monetary well being. Nevertheless, I’m bullish on AWK and price it a Purchase.
Editor’s Word: This text discusses a number of securities that don’t commerce on a serious U.S. alternate. Please pay attention to the dangers related to these shares.