American Water Works: Down 18% In 2022, Yet Still Richly Valued
Summary
- Utilities generally outperformed during the 2022 bear-market, but American Water Works' stock was down 18%.
- Despite the drop, AWK still trades at a rather rich TTM P/E = 21x and a forward P/E = 34x.
- However, strong federal water infrastructure support, growth by acquisition, and expectations for margin expansion are positive tailwinds for the company going forward.
BlackJack3D/iStock via Getty Images
American Water Works (NYSE:AWK) provides water and wastewater services to approximately 1,700 communities across 14 states that serve approximately 3.4 million residential and commercial customers. The stock had a tough 2022 (see below), but while FY22 revenue is expected to dip slightly on a yoy basis (~4%), earnings per share are expected to show a nice increase for full-year FY22. And while its projected CAGR over the next five years (~8%) is generally above peers, and despite the big stock decline last year, AWK appears fully valued, in my opinion.
Investment Thesis
Like many utility companies, AWK has a relatively low-risk profile given the fact that it generates the majority of revenue and income from relatively stable and regulated water and wastewater services (see below). However, as you can see from the above graphic, the company's returns in 2022 trailed that of the SPDR Select Utilities ETF (XLU) by ~19%. Could the stock price drop be an opportunity for investors going forward? Let's take a closer look.
AWK
Source: September Investor Presentation
Earnings
AWK reported Q3 earnings at the end of October, and the results beat consensus estimates on both the top and bottom lines. Highlights from the report included:
- Q3 GAAP EPS of $1.63/share was an $0.11 beat, and $0.10/share better than Q3 of last year.
- Revenue of $1.08 billion (-0.9% yoy) beat by $10 million.
- FY2023 earnings guidance was for a range of $4.72-$4.82 per share.
- Guidance for long-term EPS CAGR, and dividend growth expectations, were both in the range of 7-9%.
Susan Hardwick, AWK President and CEO, commented on the quarter:
We made great progress in executing our regulatory and acquisition strategies these last few months. Achieving settlements in the rate cases in our two largest jurisdictions, New Jersey and Pennsylvania, is a constructive step forward for our customers and our operations in each state. We also announced a few weeks ago an agreement to acquire assets serving another nearly 15,000 wastewater customers in western Pennsylvania. We look forward to completing that transaction in 2023.
As you can see from the following graphic, YTD EPS performance over the first nine months of this year is up significantly over last year:
AWK
Source: AWK Q3 Presentation
In addition, AWK continues its strategy of growth through acquisitions. Through the first nine months of the year, AWK added 65,300 new customer connections via 15 closed acquisitions across 6 states (primarily Missouri and Illinois) for $308 million.
Going Forward
Earlier this month, AWK reached rate-case settlement with the state of Pennsylvania, as well as in Illinois. These settlements reduce uncertainty and, in general, are positive developments for AWK moving forward. Margin could rise up to 200 basis points next year as compared to FY22.
In addition, AWK has agreements in place to - once the deals are closed - add another 21,600 new customer connections via 29 acquisitions in nine states for an additional $118 million. The point being, AWK's capex growth pipeline is strong and relatively impressive.
Valuation
The midpoint of FY23 EPS ($4.77/share) compares to expected EPS of $4.44/share for this year, implying EPS yoy growth of 7.4%.
However, the midpoint of FY23 EPS equates to a forward P/E = 32x based on the closing price last week of $152.42. In my opinion, that's a relatively frothy P/E in comparison to the expected 7.4% EPS growth next year.
AWK's current $0.6550/share quarterly dividend equates to a yield of only 1.72%, which is significantly below the 2.92% investors can get from the XLU Utilities ETF (let alone around 4.5% from 18-24 month CDs). In comparison, direct peers like American States Water (AWR) and Essential Utilities (WTRG) currently sport yields of 1.72% and 2.41%, respectively.
Risks
American Water has some important differences from its electric and gas utility peers: Its capital projects, in general, are much smaller on average than those in the electric and natural gas industries. Another difference is that AWK's greenhouse gas emissions footprint is very small compared to most other publicly traded electric and gas utilities. In aggregate, both of these are relative risk migrators as compared to the utility industry as a whole.
Rising interest rates and increased chemicals costs could put pressure on margins going forward due to AWK's growth-by-acquisition strategy. In addition, as mentioned earlier, investors can currently get significantly higher income from relatively short-term CDs, or even the XLU ETF. This is likely to put a cap on the stock's appreciation potential in 2023 given that the Fed is still set to raise interest rates further.
Summary and Conclusion
While AWK's high-quality low-risk profile is relatively attractive given the current macro-economic challenges, the stock looks fully valued in my opinion. That being the case, I find it - and the yield - to be relatively uncompelling in comparison to alternatives, including plain old two-year CDs and/or the XLU ETF - which is obviously over-weighted in electric utilities and therefore not really a direct apples-to-apples comparison (see XLU: Suddenly, Utilities Rock!).
I rate AWK a HOLD and suggest investors wait for a significantly lower entry point in the coming year before dipping their toes in the "water." I would get interested if the yield rose to, say, 2% - at which point the total returns potential of the stock would be more compelling.
I'll end with a five-year total returns comparison between AWK and the XLU ETF and note that AWK has outperformed the XLU ETF by ~24.5%:
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of XLU either through stock ownership, options, or other derivatives. 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.
I am an electronics engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.
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Comments (25)
17-Jul-2012 84.0000 $2,983.75 $35.52000 basis
3-Dec-2012 0.5520 $21.00 $38.04000 div
28-Dec-2012 0.5720 $21.14 $36.96000 div
3-Jun-2013 0.5900 $23.83 $40.39000 div
3-Sep-2013 0.5900 $24.00 $40.68000 div
2-Dec-2013 0.5750 $24.17 $42.03000 div
3-Mar-2014 0.5480 $24.33 $44.40000 div
2-Jun-2014 0.5600 $27.10 $48.34000 div
2-Sep-2014 0.5440 $27.28 $50.13000 div
1-Dec-2014 0.5250 $27.44 $52.27000 div
2-Mar-2015 0.5040 $27.61 $54.77600 div
1-Jun-2015 0.5730 $30.45 $53.17310 div
1-Sep-2015 0.5820 $30.65 $52.65500 div
1-Dec-2015 0.5410 $30.84 $56.97020 div
1-Mar-2016 0.4590 $31.03 $67.54290 div
1-Jun-2016 0.4660 $34.39 $73.81250 div
1-Sep-2016 0.4590 $34.57 $75.38560 div
1-Dec-2016 0.4620 $34.74 $75.12620 div
1-Mar-2017 0.4580 $34.91 $76.28440 div
1-Jun-2017 0.5000 $38.83 $77.59900 div
1-Sep-2017 0.4780 $39.03 $81.73440 div
1-Dec-2017 0.4360 $39.23 $90.04220 div
1-Mar-2018 0.4890 $39.41 $80.57180 div
1-Jun-2018 0.5150 $43.44 $84.28890 div
4-Sep-2018 0.4980 $43.67 $87.69600 div
4-Dec-2018 0.4680 $43.90 $93.80320 div
1-Mar-2019 0.4360 $44.11 $101.07590 div
4-Jun-2019 0.4320 $48.69 $112.64880 div
4-Sep-2019 0.3840 $48.91 $127.28400 div
1-Dec-2019 0.4070 $49.10 $120.55600 div
4-Mar-2020 0.3840 $49.30 $128.24730 div
1-Sep-2020 0.3828 $54.44 $142.21000 div
3-Dec-2020 0.3564 $54.65 $153.33110 div
3-Mar-2021 0.4013 $54.85 $136.67195 div
2-Jun-2021 0.3915 $60.33 $154.09990 div
2-Sep-2021 0.3270 $60.56 $185.20058 div
2-Dec-2021 0.3560 $60.76 $170.69500 div
2-Mar-2022 0.4028 $60.97 $151.37562 div
2-Jun-2022 0.4414 $66.55 $150.77779 div
2-Sep-2022 0.4408 $66.84 $151.63000 div
2-Dec-2022 0.4409 $67.13 $152.26280 div
2-Mar-2023 0.4890 $67.42 $137.88000 divA $2,983.75 basis is currently worth $14,447.34. A 384.20% gain on 15.99% CAGR. Beating the S&P500 256.099% gain on 12.750% CAGR.I'm in AWK on the blue gold thesis. Admittedly I am fortune with this performance, on sustained overvaluation. But I wonder if things are changing. Revenue and margins are down, contrasting to growth from 2012 when I bought in. Like you noted, inflation and rising interest rates make things uncertain. But growth by acquisition might still provide a means of revenue growth. Water services will continue to be important amid global warming and environmental concerns. You can't overcharge I guess, but some charges are necessary to avoid scarcity.BTW, here is my SA blog entry on AWK: seekingalpha.com/...SA doesn't allow new blogs unless one is an approved author. I tried getting published, but was told my submission didn't have enough length and depth...which was dead wrong compared to what they accept. I wish SA allowed for blogs, as this was a key feature.
I note that every time AWK announces the purchase of a communities' water/wastewater facilities, planned system upgrades, subsequent applications to State regulators for increased revenue based on those capital improvements, no one ever comments. I read and take note of them. This is how the company grows revenues and why dividends are not that important- what other utilities have a service area that is basically unlimited nationwide? Then throw in all of the US Military bases it services....
