Comparing Aqua America To Its Peers And Other Utilities

Summary

• Aqua America is a growing utility company that has shown impressive dividend growth and consistently good revenue and net income performance.
• The company recently posted good third-quarter net income results, but missed on revenue.
• It appears the revenue miss was the result of short-term developments, while the longer term prospects still appear very positive.
• Overall, Aqua America tops its peers in a number of categories that are of interest to DG investors.

Aqua America (WTR) is a large U.S.-based water utility company, serving nearly 3 million people in Pennsylvania, Ohio, North Carolina, Illinois, Texas. It is considered a good dividend growth stock by many investors due to its consistent price and dividend growth over several decades. Specifically, Aqua America has increased its dividend for over 25 straight years, and its more recent five-year dividend growth rate tops 8.4%, which demonstrates the strong underlying financial condition of the company.

As an investor focused on long-term dividend growth, I have recently invested in WTR stock because of its track history, future prospects, and impressive financial metrics. You can see the metrics I use to analyze companies for my personal portfolio here.

For those who like a good long-term thesis before investing, the water utilities sector has a lot of potential in the coming decades, primarily because many geographic areas in the U.S. increasingly require more or better water infrastructure - as a result of droughts, water shortages, and/or the need for overall improvements to water infrastructure. Aqua America is thus in a great position to capitalize, primarily through increasing its customer base. In fact, WTR has substantially increased its customer base in the recent past, primarily through a number of acquisitions.

Aqua America's Consistent Net Income Gains

A quick look at WTR's net income growth over the past decade shows just how consistent the company has been in increasing its bottom line.

WTR Net Income (Annual) data by YCharts

While there is a slight dip around 2015, WTR's net income is increasing at a nice, steady pace, and has more than doubled over the past decade.

How Aqua America Has and Will Continue to Consistently Drive Growth

Aqua America's recent past shows us they are driving growth through acquisition, including recent acquisition of three public water utilities in Indiana and Pennsylvania for $5.8 million. Utility companies often rely on acquisitions in order to increase their customer base, and thus increase revenues. In line with this strategy, WTR is planning five additional acquisitions valued at a combined $150 million. According to the comany's recent 8-K, dated October 31, 2017:

We added a fifth municipal acquisition to the four we previously announced as being under contract. This municipal wastewater system has roughly 3,800 customers and is expected to close in 2018. Combined with Tobyhanna, a municipal wastewater system in Pennsylvania that closed earlier this year, these six municipal acquisitions represent a purchase price of approximately $150 million and nearly 15,700 customers that we will welcome into the Aqua family.

Clearly, Aqua America's management plans to continue aggressive acquisitions and believes utility acquisitions, expansions, and the resulting increase in customer base will continue to be a substantial source of growth.

The acquisition strategy has thus far paid off for Aqua America, giving confidence that future acquisitions may also prove fruitful. For example, through November of 2016 Aqua America grew its customer base by 1.3% through acquisitions and organic connection increases. And thus far in 2017, Aqua America added approximately 1,000 customer connections through acquisitions in Pennsylvania and Indiana. In total, acquisitions and organic customer growth have increased the company’s customer base by approximately 0.8 percent thus far in 2017.

Analyzing WTR's Recent Revenue Miss

While Aqua America showed consistent increase in net income as recently as the third quarter results posted at the end of October, 2017, revenues have shown a recent decline. Revenues for the quarter were $215 million, a decrease of 5.1 percent compared to $226.6 million in the third quarter of 2016.

Importantly, the revenue decreases appear to be related to short-term developments; specifically, lower overall water consumption by the company's customers due to wet weather experienced in more than half the company’s operating divisions. Some of these decreases were offset by an increase in water rates.

Overall, I believe this quarter's revenue miss is inconsequential when looking at Aqua America's overall earnings and future growth prospects. First, short-term decreases in water consumption will happen from time to time. Conversely, there are bound to be quarters where the opposite effect takes place - that is, where customers are using water at above average rates - due to dry weather conditions. Second, Aqua America shown an ability to offset lower customer consumption through increased rates. This is because water regulators often allow increased rates to customers after water utilities make investments in infrastructure, which Aqua America has done and will continue to do in the near future. Third, the recent and future increases to WTR's customer base will provide additional sources of revenue, further helping to offset revenue declines due to decreased water usage.

Finally, it is important to note that, while Aqua America posted a third quarter decline in revenue, net income was still on the rise. At times, such a result can be problematic, particularly if the company is using accounting gimmicks or short-term solutions to bolster net income numbers. Here, however, net income continued to increase in large part due to Aqua America's ability to lower operations and maintenance expenses. In other words, the company became more efficient. By way of example, Aqua America's operations and maintenance expenses decreased $11.8 million or 14.8 percent to $68 million for the third quarter of 2017 compared to $79.8 million in the third quarter of 2016. Divestitures in market-based activities, lower production expenses and employee-related expenses collectively reduced operating expenses by $11.4 million in the quarter.

According to Aqua America President and CEO Christopher Franklin, “We continue to prudently invest in infrastructure, while maintaining our position as one of the most efficient utilities in the nation, which ultimately benefits the customers and communities we are privileged to serve.”

As a result, I am fairly confident that Aqua America will continue growing net income on a regular basis, and expect revenues to trend consistently upward as well, primarily due to the companies continued commitment to increasing its customer base. Of course, it is natural to expect that there will be times where the company misses on revenue due to particularly wet weather conditions. This can be devastating for short term investors. However, for long term DGI, such occasional phenomena are insignificant.

Comparing Aqua America To Peers and "Big Name" Utility Stocks

One way I like to evaluate stocks is to compare their metrics and performance to other companies in the same industry. For Aqua America, the other bigger name competitors in the water utility space include American Water Works (AWK) and American States Water Co. (AWR).

Additionally, since water is just one small segment of the general utility industry, I also compare some of the metrics of WTR to some of the larger electrical utilities, including the following DGI electric utility stocks: Southern Company (SO), Dominion Resources (D), WEC Energy (WEC), and Duke Energy (DUK).The purpose of this exercise is to try and do an apples to apples comparison (or as close as can be possible given the different industries) and therefore see if my utility-sector money may best be invested elsewhere. Also, I have found this is a good method to identify additional stocks that I may look to add to my portfolio at a later time. Of course, if you are looking to add another stock in the same industry, it is important to ensure your stocks will not be overly concentrated in any particular area.

Below is a table showing some of the metrics I like to see out of DG stocks. Aqua America can be compared to its largest water utility peers AWK and AWR, as well as other popular utility stocks, using the criteria below.

Comparison Table

Criteria	WTR	AWK	AWR	SO	D	WEC	DUK
ROE	12.62%	9.12%	13.73%	2.77%	14.84%	10.67	6.80%
ROIC	6.45%	3.9%	8.44%	5.60%	6.36%	6.26%	3.99%
D/E	.96	1.05	.63	1.88	2.01	0.96	1.12
Payout Ratio	55.95%	57.37%	56.41%	86.97%	81.39%	66.89%	87.07%
3 Year Dividend Growth Rate	7.83%	9.30%	6.13%	3.65%	8.7%	10.24%	3.29%
5 Year Dividend Growth Rate	8.07%	9.80%	10.42%	3.62%	7.9%	12.38%	2.76%
P/E	27.19	33.08	29.59	80.14	23.27	22.32	26.06
Yield	2.31%	1.89%	1.86%	4.45%	3.75%	3.07%	4.05%
Years of Consecutive Dividend Increases	25	8	62	15	8	13	10

Click to enlarge

Source: Information comes from Morningstar and Seeking Alpha; author created table.

Right off the bat, as shown in the table above, WTR performs extremely well in the categories above, with 3 and 5 year dividend growth rates around 8% per year. These numbers are far more impressive, for instance, than the dividend growth rates of either SO or DUK, which have increased their dividends at a pace far less than 4% per year. When comparing Aqua America to the electrical utilites, WTR appears to have the edge in most of the metrics listed above. Specifically, WTR has far superior debt to equity levels when compared to all the electrical utilities--other than WEC, which has the same ratio at .96. Because of this, WTR is better able to focus its earnings on driving further growth, as opposed to debt service payments.

Water Utilities Are Competitively Matched- But WTR Comes Out on Top

As also shown in the table above, the metrics of the three water utilities (WTR, AWK, and AWR) show similarities across the board. However, for my personal investment criteria, WTR is outperforming in most categories. First, the stock's yield of 2.3% is more favorable than the yields for either AWR or AWK. Better still, WTR actually has the lowest dividend payout ratio among its peers, meaning the company's earnings are covering its dividend payments to shareholders at the greatest rate. Finally, WTR has the most attractive valuation of the "big 3" water utilities, as the company is trading at just over 27 times earnings.

Aqua America's Dividend - Past Results and Future Expectations

As shown in the table above, Aqua America currently has the most favorable current yield when compared to its competitors in the water utility space, at 2.3%. For those DGI interested in higher yield, however, it appears that the electrical utility stocks listed in the above table all have greater yields, generally ranging from 3-4.5%. However, while such yields are currently more favorable, Aqua America's dividend may provide for better and safer future prospects for several reasons. First, WTR's payout ratio of less than 56% gives the company ample room to grow the dividend without paying out too much of the company's earnings. Personally, I prefer companies that can consistently post payout ratios below 60%, as such numbers generally signify dividend safety. As you can glean from the table above, the electrical utility stocks all post payout ratios above 60%. Further, Aqua America is growing its dividend at a pace of around 8% per year. At these rates, it is reasonable to expect that the company's dividend may provide better total returns to investors in the coming decades than either Southern Company or Duke Energy, which are growing their dividends at less than half the rate of Aqua America. On the other hand, both WEC Energy and Dominion Resources have outpaced Aqua America in terms of recent dividend growth.

Overall, Aqua America's low payout ratio and solid dividend growth rate bode extremely well for anticipated future performance. However, it would be reasonable for many DGI to prefer adding an electrical utility such as WEC Energy because of its relatively more impressive yield and dividend growth. Personally, I chose to invest in Aqua America for its dividend safety and steady dividend growth, and because I believe in the long-term growth prospects for the water utility space. In my opinion, going with a higher-yielding electrical utility is still reasonable if that would be the investor's preference.

Additional Considerations and Risks When Investing in Aqua America

It is important to remember that Aqua America, as well as most other water utilities, are "slow a steady" dividend growers. This is primarily because water utilities are heavily regulated (i.e, they are often limited in how much they can charge customers, and how much and how often they can increase rates to customers). As an example, here is a brief explanation of some of the regulations applicable to Aqua America, according to the companies most recent 10-k.

The rates we charge our customers are subject to approval by utility commissions in the states in which we operate. We file rate increase requests, from time to time, to recover our investments in utility plant and expenses. Our ability to maintain and meet our financial objectives is dependent upon the recovery of, and return on, our capital investments and expenses through the rates we charge our customers. Once a rate increase petition is filed with a utility commission, the ensuing administrative and hearing process may be lengthy and costly, and our costs may not always be fully recoverable. The timing of our rate increase requests are therefore partially dependent upon the estimated cost of the administrative process in relation to the investments and expenses that we hope to recover through the rate increase. In addition, the amount or frequency of rate increases may be decreased or lengthened as a result of many factors including changes in regulatory oversight in the states in which we operate water and wastewater utilities and income tax laws , including regulations regarding tax-basis depreciation as it applies to our capital expenditures or qualifying utility asset improvements. We can provide no assurances that any future rate increase request will be approved by the appropriate utility commission; and, if approved, we cannot guarantee that these rate increases will be granted in a timely or sufficient manner.

Therefore, don't expect WTR to show growth numbers like Apple (AAPL). For those interested in a utility that also operates as a growth stock play, the international utility Brookfield Infrastructure Partners (BIP) may be a better fit.

Moreover, it is important to note that in a rising interest rate environment like we have right now, money tends to slowly move out of the more stable, slow growing stocks and into bonds or other alternatives. This could lead to a number of selloffs in WTR (as well as many other utilities) as investors head for the bond market.

Conclusion

Aqua America is in a strong position to add value to its shareholders, through both price and dividend growth. The recent revenue miss appears to be due to short term setbacks, while the long term revenue and net income prospects remain solid, particularly considering Aqua America's ability to increase its customer base, make prudent acquisitions, and decrease operational costs. I am currently long the stock, and plan to add more in the future.

FOLLOW ME: If you found this article helpful in any way, or would like to continue to receive updates on this portfolio, please click the "Follow" button.

I look forward to hearing your comments on this article, and would welcome any comments. Thanks for reading!

Analyst’s Disclosure: I am/we are long WTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.