James O. Lykins
J.J.B. Hilliard, W.L. Lyons, LLC
American Water Works (AWK) reported ongoing Q2’11 EPS of $0.46 versus $0.42, compared to our estimate of $0.41 and the consensus of $0.46. GAAP results for the quarter were $0.48, which includes approximately $0.02 related to cessation of depreciation from the sale of assets. During the quarter, the company received rate awards totaling $10.7 million, and after quarter’s end received an additional $4.8 million for a Virginia rate case. Pending rate cases total $314.6 million.
While the Market-Based Operations segment has more of a nice complement versus a significant EPS driver, there are two things we believe have the potential to be more meaningful: The first is the company expanding with service warranties on the commercial side, while it is also looking to do the same with gas and electric. The second is opportunities in the Marcellus Shale related to hydraulic fracturing, and whether the company would clean up water, supply it to producers, or both.
This past June AWK announced a 5 percent dividend increase, raising the quarterly payment from $0.22 to $0.23 per share. Management reiterated FY’11 EPS guidance of $1.65-$1.75 (exclusive of the $0.09 related to cessation of depreciation) with an emphasis on the upper end of the range.
We are increasing our FY’11 EPS estimate by $0.12 to $1.81 and our FY’12 EPS estimate by $0.08 to $1.93. The stock is trading at what we consider a very compelling 15.2x and 14.3x our FY’11 and FY’12 EPS estimates, respectively. We are also raising our price target by $4 to $35, and note that our price target implies a multiple of just 18.1x our FY’12 EPS estimate.
Janney Capital Markets
As macro storm clouds gather, American Water represents a compelling way for investors to play “offense” and “defense” simultaneously by owning a company that possesses a defensive business model, but also boasts a growth story largely decoupled from the major issues driving concerns about U.S. and global economic growth. Water is the ultimate non-discretionary item, and cyclical oscillations in GDP have little impact on volume sales for American Water, the nation’s largest private water provider. Meanwhile, American Water continues to work its way out from “under-earning” status under its prior owner RWE, providing the opportunity for above-trend growth. In addition, the company continues to optimize its portfolio via asset sales and “swaps” with peers, setting the stage for further profitability improvement. Overall, we view American Water as a quality, top-tier player in the water utility space whose discount valuation creates an attractive entry point.
AWK posted adjusted 2Q earnings of $0.46/share, in-line with consensus. Though in-line, we view the results favorably, as wet weather in many parts of the company’s territory negatively impacted volumes (notably the Midwest, where flooding not only impacted irrigation demand, but also took industrial facilities off-line altogether).
American Water’s trailing four-quarter return on equity now stands at 7.3 percent, the highest level since the company re-entered the public markets in 2008. The ROE improvement is driven by a combination of rate catch-up and internal improvements, and while “parent debt” (payments on which regulators do not allow the company to pass through to ratepayers) will preclude AWK from reaching industry averages in the near term, we believe there is at least another 100 basis points of upside to ROE.
Showing steady growth, consistently increasing the dividend, and offering the opportunity for modest multiple expansion (something that cannot be said for all peers in the space), AWK offers investors a compelling risk-adjusted total return opportunity This is particularly the case in these uncertain markets, where the company’s defensive business model provides a safe haven. We reiterate our Buy rating.
J.J.B. Hilliard, W.L. Lyons, LLC
Aqua America (WTR) reported GAAP Q2’11 EPS of $0.27 versus $0.22 in the year ago period. However, after stripping out the benefit from bonus depreciation, EPS for the quarter were $0.25, compared to our $0.23 estimate and the $0.24 consensus. Revenue rose 5.5 percent to $188.2 million, due largely to favorable weather.
O&M (Operations & Maintenance) expenses rose just 1.6 percent to $70.4 million and as a percentage of revenue improved 140 basis points to 37.4 percent. For the full year, management believes it may be able to keep O&M below 38 percent, and possibly even get into the 36-37 percent range beyond 2011. Depreciation increased 2.9 percent to $27.6 million and operating income was up 13.3 percent to $74.8 million.
Long-term debt decreased 4.0 percent from the sequential quarter to $1.5 billion, and as a percentage of total capitalization decreased 140 bps to 55.8 percent. The company’s target equity ratio is approximately 45 percent, and there are no debt borrowings or equity raises planned over the near-term.
Moreover, this may be the first year for the company to have cash flows in excess of capital expenditures. During the quarter WTR invested over $74 million in infrastructure improvements, and expects to invest over $325 million (up from $300 million) for the full year.
On August, 2 WTR announced a 6.5 percent dividend increase, the 21st time the company has raised its dividend over the past 20 years.
We derive our $25 price target using a multiple of 24x to our 2012 earnings estimate, which is at the low end of multiples where the company typically trades. The stock is currently trading at 20.8x and 20.4x our 2010 and 2011 EPS estimates, respectively.
Janney Capital Markets
Aqua America’s (WTR) business [has been] impacted little by recessions, even “The Big One.” In 2008, as earnings for the S&P 500 declined 40 percent, Aqua America grew earning by a 2.2 percent, not mind-blowing in absolute terms but a dramatic relative outperformance that underscored the defensive nature of the water utility business model.
The reason is simple, as water is the ultimate non-discretionary item, and residential consumption declines little in recessions. We expect the same will be true this time around if the economy double-dips.
[The] 2Q earnings report shows [the] company [is] executing well. Evidencing Aqua’s status as a top-notch operator in the space, the company’s second-quarter earnings were well above expectations, impressive during an earnings season where unfavorable weather has been a headwind for many peers. Overall, Aqua continues to execute well, and we expect further earnings strength going forward. n