A Review Of ESSENTIAL UTILITIES, INC. – Not A Pretty Story

Summary

• Since the March crash, ESSENTIAL UTILITIES, INC. (WTRG) has rebounded with a +32% return: a nice time for insiders to cash out?
• The company provides a steady dividend yield of 2%, but is it sustainable?
• Was the Peoples Natural Gas acquisition a strategic blunder?

Like many of you, I’m an ordinary investor just trying to figure out what the hell is going in the world? Stock fundamentals and real-world economic reality are lost upon the investing community. Ignoring such economic realities have created many stock anomalies where the company’s fundamentals don’t support its high stock valuation. One of those companies is ESSENTIAL UTILITIES, INC, a water utility becoming an even a larger multi-utility company. We will explore why its current stock price does not make sense on a fundamental basis.

What are insiders doing?

Before jumping into any fundamental analysis, I always like to see what are the insiders are doing with their own money. As an investor it helps me gain a small perspective of insiders’ sentiment. As of November, insiders has sold nearly $4M of shares with the Chairman, President and Chief Executive Officer (CEO), Chris Franklin leading the way ($2.6M). This is not a good sign.

Transaction	Sale
Position	Insider	Total
Chief Executive Officer	FRANKLIN CHRISTOPHER H	2,573,489
Chief Operating Officer	FOX RICHARD SCOTT	566,931
General Counsel	LUNING CHRISTOPHER PAUL	532,928
Officer	RHODES MATTHEW	136,650
Grand Total		3,809,998

Sure, the dollar amount sold represents only a small fraction of the company’s market cap, but optically it sends the wrong signal to investors. Since March’s crash, the company returned +32% since its lows and still below its pre-COVID-19 high of $54.43. Does this mean that the CEO and other insiders left money on the table or is there is something more that we don't know? For me, I want to see consistency in both management's messaging and their investment actions. This is not the case for ESSENTIAL UTILITIES, INC. Indicator: Negative.

Nice steady stream of dividends: is it sustainable?

The company boasts that it has paid dividends consecutively for 75 years. With a regulated water utilities business as its core helps deliver consistent dividends year over year, but recent trends shows a growing concern. Calculating the company’s dividend payout ratio, we see its ratio growing from 60% in 2015 to 94% in 2020 (9 – months).

	2015	2016	2017	2018	2019	9 - Months 2020
Dividend payout ratio	59.9%	56.0%	58.8%	78.6%	84.0%	93.9%

What’s more alarming is when comparing the company’s dividend payout to its Free Cash Flow (FCF) instead of net income, it shows that the company generates insufficient funds to cover its operations, capital expenditures, and dividends without borrowing.

	2015	2016	2017	2018	2019	9 - Months 2020
Dividend payout / FCF	2016.7%	1007.7%	-145.4%	-118.9%	-89.6%	-130.8%

This not an issue in the short term for regulated companies to borrow against future earnings as a majority of profits are guaranteed. But to do it over 5 years going on 6, reduces the company’s margin of safety to cover its increasing debt load in addition to its operation and dividend spend mentioned above. With economic damage due to COVID-19 and challenges of integrating Peoples Natural Gas puts the company’s long history of dividend payouts at higher risk. Indicator: Negative.

Was the Peoples Natural Gas acquisition a strategic blunder?

Folks, this one is a head scratcher for me. Reading the February 27 Investor Day Deck for its acquisition rationale, it says a lot of nice things about growth, benefits of increase scale, etc. etc., but I was couldn’t find how the merger will add value to its water business.

It was not until reading its 10-Q for Q3 to see how bad the story was as management is adding a 3% net income business to its 30% water business.

In order to get back to it 2019 (9-months) net income margin of 24%, the company must add $59M of net income to break-even. Instead of the acquisition being accretive and supporting its long-term dividend growth, it's potentially a drag on its future earnings and major distraction from its core water business. Indicator: Negative.

Conclusion: Sell

ESSENTIAL UTILITIES, INC. has benefited from a nice rebound from its March lows, but after diving deeper into its financials does not show a pretty picture on its future prospects. The company faces some major headwinds in maintaining their dividend levels and the potential shareholder value destruction by the acquisition of Peoples Natural Gas. Of course don’t take my recommendation only, but follow management’s lead as they exit the door and cash out before economic reality does shows up.