- Being in the utility industry, AWK was not an exception from the challenging 2022 FY.
- AWK faces sequential dilutions until 2027, which I believe will affect the company's share prices.
- In light of the unattractive fundamentals, it is preferable to cash out gains and hold off on reinvesting until conditions are more favorable.
Through its subsidiaries, American Water Works Company, Inc. (NYSE:AWK) provides water and waste water services in the United States. Being in the utility industry, AWK was not an exception from the challenging 2022 FY. The utility industry was generally awful regarding shareholder returns due to a harsh macroeconomic environment. Although the entire sector performed poorly, it is worth noting that AWK underperformed both the US water utility industry and the entire US market. AWK had a shareholder return of -10.6% compared to -8.2% and -8.8% of the US water utility industry and the US market, respectively.
The performance of the company's shares over the previous year was generally dismal. Its shares fell by roughly 11%, which the company attributes to the challenging macroeconomic environment, particularly the high inflation. I agree that this was a significant element, but the company's share dilution over the previous year played a role.
After this kind of result, the future matters in terms of investment. The stock price has leveled out after a relatively strong upward trajectory over the past five years, suggesting that the market has already overvalued the company. With its year-to-date price performance and forward price-to-earnings ratio of 28.61X, down from 30.27X, I think AWK is headed in the wrong direction. Considering the company's continual share dilutions and weak balance sheet, this PE shrinkage suggests an impending bear trend. In addition, the company is expensive according to relative valuation criteria, and its fundamentals are unappealing; thus, I expect it to continue on a downward trend.
Dilution can be detrimental to shareholders because it dilutes their ownership stake and diminishes their say in business affairs. Shareholders may find it more challenging to sell their shares at a price that reflects the company's true value if dilution has occurred. With this context in mind, AWK has diluted its shareholders' ownership during the past year. It plans to raise more capital through stock offerings, which will continue impacting current shareholders and eventually affect the company's share prices.
Over the last year, total shares outstanding have increased by 7.1%, diluting the holdings of existing shareholders. During the company's Q4 2022 call transcript, the CFO said that the company's plan for financing included issuing about $2 billion more equity between 2023 and 2027. This shows that investors should be ready for their shares to be diluted over time.
John Griffith," Moving on to our financing plan. We expect to issue an estimated $2 billion of equity from 2023 through 2027. Consistent with our prior messaging, subject to market conditions, we plan to raise a significant portion of the total planned equity in 2023. The remaining portion of the $2 billion of planned equity not completed in 2023 is expected to be issued near the end of the current five-year plan."
In what appears to be part of this strategic plan's execution, the company raised $1.4905 billion through a Follow-on Stock Offering earlier this month. The price range offered was $135.50, which represented a reduction of $2.0325 per share off the security's $2.0325 per share security price. It is apparent from this offering that the company is issuing its stock at a discount, which adds to the predicaments faced by existing shareholders who may want to sell their current holdings. Additionally, this discount supports my claim that the company's shares are overvalued, and this action will cause the share price of this company to trend downward.
Weak Balance Sheet
With $12.38B in debt and $7.69B in equity, AWK has a debt-to-equity ratio of 161%, which is pretty high. In addition to this balance sheet's precarious state, its liquidity is also low, with $85M in cash and cash equivalents.
The most current annual balance sheet for American Water Works Corporation shows that the company has $2.81b in short-term and $17.28b in long-term obligations. In contrast, it had $85 million in cash and $723.5 million in receivables with a maturity date within the next 12 months. Hence, its liabilities exceed its cash and short-term receivables.
Given that this deficit is large compared to American Water Works Company's sizable market capitalization of US$26.54 billion, shareholders may want to pay close attention to how the company uses debt. Shareholders would undoubtedly see significant dilution if its lenders demanded that it strengthen the balance sheet. It is no surprise that the current share dilution is in play.
The company's debt to EBITDA ratio is fairly high-5.6-and points to a substantial debt load. Interestingly, it has a 3.5 times interest cover, which is reassuring because it suggests it can responsibly fulfill its debt obligation. Accounting earnings aren't enough for a corporation to pay off debt; it needs free cash flow. So, it is vital that we need to check to see if the EBIT is producing the expected free cash flow. The American Water Works Corporation spent a lot of money over the past three years. Although investors are undoubtedly anticipating a change in that circumstance in due time, it is apparent that this makes its use of debt riskier.
The company's high net debt prompted my hesitation about buying AWK stock to the EBITDA ratio. The firm's subsequent EBIT did not allay my skepticism about free cash flow conversion. Yet, concerns about its ability to increase EBIT are overstated. It is also important to remember that organizations in the Water Utilities market, such as American Water Works Company, regularly employ debt without experiencing any difficulties. When we consider the big picture, it is evident that American Water Works Company's debt levels pose concerns for the company. It could increase profits if things go well, but it also means taking on more debt, which increases the chance of a devastating loss of capital.
AWK's valuation metrics are much higher than the industry median; hence the firm is overvalued relative to the industry and receives a grade of F in valuation.
Since the company's fundamentals aren't very appealing, I think this is the best time to sell and wait for a cheaper entry point, around $66 per share, which is what Wall Street estimates as the fair value.
Over the past five years, AWK has seen tremendous growth, leading to an increase in its stock price and an overvaluation of the company. However, the company's growth has stalled, with an 11% drop in value over the past year. The company's fundamentals aren't compelling; therefore, I recommend selling at the current premium price and waiting for a cheaper entry opportunity when the fundamentals turn optimistic.
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