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Summary

  • There is a growing water shortage in the American Southwest.
  • Globally we are facing severe water issues in many parts of the globe. .
  • American Water Works should benefit from this crisis.

Water, water everywhere and nor any drop to drink. -Samuel Taylor Coleridge, The Rime of the Ancient Mariner

Truer words were never spoken, particularly here in California where we are in the middle of a five-year drought, which is threatening agriculture and recreational activities throughout the state and has led to some of the worst wildfires we've ever seen. If this continues, there will be profound effects on virtually every aspect of our lives here and elsewhere in the Southwest. This got me thinking about what companies will benefit and could play a part in helping to solve what is a global problem and a significant threat to our national well-being.

The idea of water being the new oil is not new. Water-related investments, broadly speaking, have mostly just tracked the S&P 500 for the past few years, but going forward, this looks like a mega trend that's not going away.

The U.S. water utility business is a $130 billion industry that is growing at 4% per year. The capital demands are high, so there are relatively few players that can afford to be in this sector on a large-scale basis. There has been massive consolidation in the industry over the last number of years, further reducing the number of companies who can serve this important segment.

We have recommended Flowserve in the past (NYSE:FLS) and did very well with it. I still like it, although it seems fully-priced for now. Another way to get exposure to this sector is by using the PowerShares Water Resources Portfolio ETF (NYSEARCA:PHO) that contains Flowserve and American Water Works (NYSE:AWK), which I am recommending in this column.

AWK is also a significant component of the Canadian-based iShares Global Water Index ETF (TSX: CWW), which was recommended by my colleague Gavin Graham in our companion Income Investor newsletter in July 2013 at $19.65. It was trading at $24.71 at the time of writing.

So let's take a closer look at AWK. The company was founded in 1886, is based in New Jersey and has 6,600 employees. It is essentially a U.S.-based utility, which serves 14 million people in 40 American states and parts of Canada. In 16 states, the company is a regulated business similar to an electric or gas utility. This status subjects the company to oversight that includes how much it can charge for water and wastewater services. The regulated part of the business is asset based and offers water and wastewater services to approximately 1,500 communities in 16 states. It operates approximately 80 surface water treatment plants, 500 groundwater treatment plants, 1,000 groundwater wells, 100 wastewater treatment facilities, 1,200 treated water storage facilities, 1,300 pumping stations, 87 dams, and 47,000 miles of mains and collection pipes.

However, the company also has a significant market-based business that can charge whatever the traffic will bear. The non-regulated part of the business is essentially service based, with the company operating and providing maintenance, financing, and waste disposal services to municipalities, armed services, and private homeowners.

In total, American Water Works serves approximately 14 million people with drinking water, wastewater, and other water-related services

Recently the company announced first-quarter earnings that grew by 25% with net operating cash flow increasing by 63.65%, driven by revenue increases of 7.2%. This resulted in an increase in earnings to $68.1 million ($0.38 per share, fully diluted, figures in U.S. dollars). That compared to $57.6 million ($0.32 per share) for an increase of about 19% over the prior year on a per share basis. The company also recently announced an 11% increase in its dividend to $0.31 per quarter ($1.24 annually) and is now yielding 2.57% based on its Friday closing price of $48.16. It marked the seventh straight year since 2008 that the company has increased its payout.

I like the fact that this a relatively unexciting company with solid earnings, a decent dividend, and a customer base of Canadians and Americans, which reduces the risk of global craziness such as we are seeing now in Ukraine, Iraq, etc. When rates begin to rise, we will have to have another look, but for now, AWK offers growth and stability.

If you want more reassurance, take a look at the stock's five-year chart. No scary peaks and valleys here - just a nice steady upward climb.

Action now: Buy with a target of $55. The shares closed on Friday at $48.16.

Disclosure: The author is long AWK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Source: American Water Works Provides Stable Earnings In An Frothy Market.