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Industry Spotlight > Mergers and Acquisitions

Fluid Performance

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Ryan M. Connors Janney Capital Markets 215-665-1359 [email protected]

After issuing guidance on Jan. 24, [American Water Works (AWK)] management found no reason a month later to depart from its range of $2.15-2.25 earnings per share for 2013. Regulated operations will continue to drive earnings, although American’s new service line protection offerings in New York City have received positive feedback, with the company noting a 7% response rate.

Tuck-in acquisitions [and] rate cases remain the vehicles for growth in 2013. After 16 acquisitions in 2012 for a total of $44.6 million and the sale of its regulated operations in New Mexico, Arizona, and Ohio for $580 million, American Water has optimized its portfolio to the point where management remarked that its strategy going forward will be to focus more on “adjacent” opportunities rather than completely new ventures.

On the rate-making side, American was awarded 10 cases in 2012 and 2 in 2013 that our model suggests will provide approximately $56 million in incremental revenue in 2013 on top of a $24 million addition from infrastructure charges, enabling the company (in our view) to grow the top line by 3% in 2013 despite average annual usage rate declines of 2%.

[Its] geographic footprint remains compelling; [we] reiterate Buy. Striving to achieve operations in 39 states by the end of 2013, American Water is certainly hedged better than most (if not all) water utilities in terms of exposure to both regulatory systems and adverse weather conditions. 

More importantly, however, is that the company’s top two operating states, Pennsylvania and New Jersey (contributing over 50% of revenue), represent the highest-ranked and most-improved states in our Janney Regulatory Climate Index, respectively. In an industry where regulatory conditions are king, American’s exposure to progressive systems (six of its states have now adopted a distribution system investment charge, or DSIC) position it well for sector out performance. 

As management remains focused on operational improvement, we continue to recommend American Water as its shares trade at 18 times forward earnings compared to the industry average of 20 times.

Joel K. Havard J.J.B. Hilliard, W.L. Lyons 502-588-1833 [email protected]

Spencer E. Joyce J.J.B. Hilliard, W.L. Lyons 502-588-8402 [email protected]

American Water Works (AWK) revenues increased 6.4% and 7.9% year over year in Q4 and over the full year, respectively. Over 60% (about $129 million) of the increase in ’12 is attributable to rate increases and surcharges; weather (increased volumes) was also a material driver for the year.

We are holding stable our full-year 2013 EPS estimate at $2.24, which is within management’s reaffirmed guidance range of $2.15-$2.25. We are initiating a 2014 EPS estimate of $2.40.

We are reiterating our Buy rating and 12-month $45 price target, which we derive by applying a 20 times multiple to our 2013 EPS estimate. We believe this is appropriate given AWK’s growth prospects, financial position and broader industry valuations.

Aqua America Inc.’s (WTR) fourth quarter revealed few operational surprises, in our view, though a bottom line beat was delivered as the repair tax accounting change affected results for the first time. Operations and maintenance came in a bit above our expectation, though revenue did as well; netting out the noise, earnings before interest and taxes (EBIT) of $54.7 million was in line with our estimate. Our projection for just under $2 million in tax benefit proved to be too conservative, with actual benefit in the quarter of $10.4 million fueling the $0.06 of upside to our Q4 estimate.

Looking back over the totality of 2012, we believe it was an impressive year for the company. WTR divested operations in Maine and New York, while successfully integrating 18 acquisitions, including all of American Water Works’ former Ohio assets. Despite the acquisition activity and the legwork necessary for rolling out the repair tax accounting change, the company held expenses in check, with O&M growth of 5.9%, substantially lagging revenue growth of 10.3%. Also in 2012, the company completed Phases I and II of its initial three-phase joint venture pipeline to supply water to drillers in the Marcellus; despite being a start-up, the project is already having a positive impact on EPS (approximately $0.01).

Ryan M. Connors Janney Capital Markets 215-665-1359 [email protected]

Aqua America posted revenue of $187.4 million (+6% year-over-year) in 4Q2012, above both our estimate of $183.1 million and consensus of $182.4 million. A shift to repair tax accounting in the quarter resulted in EPS of $0.47 as the entire 2012 tax benefit was recognized in the quarter. Excluding this benefit, Aqua recorded EPS of $0.25, beating our estimate of $0.22 but falling below the Street at $0.27.

After a slowdown in 2009 through 2011, Aqua has renewed its focus on customer growth via acquisitions and portfolio restructuring (witnessed in its impending exit of Florida and acquisition of Ohio American properties in 2012), which has enabled it to reach its pre-recession customer growth rate of 1.9% in 2012.

A dividend hike [was] on the agenda at Board of Directors meeting. Aqua once again announced a dividend increase of 6% to $0.175 in December, though in light of the new tax method this puts the dividend payout ratio at 50%. 

Management notes that with Aqua’s target payout ratio normally at 60%, the rate of the quarterly dividend would likely be a source of discussion among the directors in the meeting scheduled to take place in the coming days.


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