Essential Utilities: A Buy Below $40/Share

Summary

• Essential Utilities delivered a solid 7% dividend increase in August, which along with the payout ratio indicates the sustainability of the dividend going forward.
• Despite a challenging operating environment, Essential Utilities experienced a mere 0.9% YTD YoY decline in adjusted income/share.
• Unfortunately, shares of Essential Utilities are trading at a 16% premium to fair value.
• Between its 2.2% yield, 6.0-7.0% annual earnings growth potential, and 1.5% annual valuation multiple contraction, shares of Essential Utilities aren't quite attractive enough to warrant a buy rating.
• With a 2.5% yield and the same 6.0-7.0% annual earnings growth potential, I would rate shares of Essential Utilities as a buy given the steady nature of the utility.

As I have repeatedly emphasized in my (nearly) 2 years as a Seeking Alpha contributor, it is of utmost importance that dividend growth investors choose to invest in high-quality stocks within durable industries.

Given that abundant access to water and natural gas services is necessary regardless of economic conditions, it should be no surprise that the utility industry is holding up well despite COVID-19.

With that in mind, I will be revisiting Essential Utilities (NYSE:WTRG) for the first time since December 2019 to reexamine Essential Utilities' dividend safety and growth potential, discuss recent operating results and Essential Utilities' risk profile, as well as Essential Utilities' stock price with relation to my estimated fair value using a couple valuation metrics and a valuation model, which led me to reiterate my hold rating on shares of Essential Utilities.

Essential Utilities' Dividend Remains Safe While Mid-Single Digit Annual Growth Potential Is Intact

Even though Essential Utilities' yield of 2.19% itself is barely above the S&P 500's 1.62% yield, suggesting that the dividend is rather safe for the foreseeable future, I will be measuring the YTD adjusted income/share against the YTD dividends/share to assess the safety of the dividend and the growth potential going forward.

While I usually like to examine a stock's non-GAAP earnings and FCF payout ratios to determine the sustainability of its dividend, I am refraining from doing so in the case of Essential Utilities, and utilities in general.

As I have noted in my previous two articles on American Electric Power and WEC Energy Group, and as I will reiterate again in the case of Essential Utilities, utilities are consistently investing capital to expand their rate base (and in turn, to grow their revenue and earnings), causing FCF to often be negative.

Provided that a utility is able to secure

Analyst’s Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.