Richard A. Verdi
Solid second-quarter 2016 (Q2’16) results are reported as American States Water beats estimates: Sales of $112.0 million surpassed our $109.0 million estimate for AWR, driven mainly by American States Utility Services’ (ASUS) revenue outperformance.
American States Utility Services delivered Q2 sales of $23.2 million, outperforming our estimate by $5.4 million. This was counterbalanced by a top-line shortfall in Golden State Water Co.’s (GSWC) sales relative to our forecast as revenue for both the water and electric units declined year over year. Contrarily, consolidated cost of goods and services was beneath our estimate, permitting consolidated gross profit of $90.3 million to surpass our forecast by $7.1 million. Golden States Water operating expense matched our estimate, offset by American States Utility Services’ operating expense missing our estimate; as a result, consolidated operating expense of $58.6 million missed our $54.2 million projection.
Despite the total operating expense miss, we view the outcome positively since it suggests the additional expense was incurred to support future American States Utility Services growth, while also implying to us AWR is properly managing expenses of the regulated business. With items below the line broadly meeting our expectations, AWR beat our $0.39 diluted EPS forecast by $0.06.
Daniel Ford, CFA
The rate-case resolution is getting closer, American States Utility Services gets a new contract, and American States Water reports solid earnings: AWR is still awaiting a final rate order in California for its general rate case covering 2016 through 2018. To that end, the company has settled with the California Public Utilities Commission’s Office of Ratepayer Advocates on nearly all operating expenses and consumption levels.
The adopted revenues for 2016 are expected to be lower than in 2015 based on lower supply costs (consumption driven), lower depreciation and amortization from an updated depreciation study, and lower other-operating expenses resulting from cost management. The expectation is that the final rate order will occur this year and will be retroactive to January 1, 2016.
American States Utility Services was awarded a 50-year contract with Eglin Air Force Base to operate, maintain, and provide construction services for the water and wastewater systems. The estimated contract value is $510 million over the 50-year period. The expectation is for a 10-month transition period.
The company expects that this contract could add 2-3 cents in EPS on an annualized basis, with upside for additional capital work. This contract award shows the continued competitiveness of American States Utility Services. The company is actively engaged in bidding on new bases along with developing opportunities for new construction work on currently contracted bases. ASUS has two price redeterminations expected in the third quarter, which should provide enhanced cost recovery.
AWR reported Q2 EPS of $0.45 vs consensus expectations of $0.44. By segment, Water was up 3 cents as compared to Q2’15, American States Utility Services was up 1 cent, and Electric and Parent were both flat to Q2’15.
For Water, the main drivers were recognition of the 2015 Water Revenue Adjustment Mechanism [in California], lower operating expenses, lower interest expense and a lower income tax rate partially offset by higher legal and outside services.
For American States Utility Services, the main drivers were higher construction activity (consistent with expectations from the Q1 call), partially offset by operating expense and a higher effective income tax rate. The expectation remains for ASUS’ EPS to be in the range of $0.28-$0.32 for 2016.
American States Water reports solid results for Q2’16: AWR EPS of $0.45 for the quarter was just above consensus estimates of $0.44. For the Water segment, reported EPS of $0.36 compared favorably to Q2’15 EPS of $0.33.
The increase was primarily attributed to the recognition of parts of the previously deferred 2015 Water Revenue Adjustment Mechanism revenues coupled with lowered operation costs. EPS from Contracted Services for the quarter was $0.07, which was up $0.01 year over year. Higher construction activity more than offset higher operating expenses and taxes.
Also during the quarter, AWR announced it had received a 50-year contract by the U.S. government to operate and maintain the wastewater system at Eglin Air Force Base in Florida. The electric segment results were flat at $0.01 of EPS, as was the parent-level contribution.
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Aqua America’s Q2’16 results were a touch above forecasts: WTR’s Q2’Q16 results slightly exceeded our expectations, with revenues of $204 million and EPS of $0.33. Recent strategic actions reduced operating expenses materially, offsetting lower consumption. Looking forward, we’ve introduced (and moved to) 2018 estimates for valuation purposes, which increases our Fair Value assumption on WTR shares to $39 from $35. We continue to recommend accumulation at current price levels.
On the top line, revenues of $204 million were actually below our $208 million forecast, before adjusting for divestitures in market-based activities. Making that adjustment, Aqua America came within $1 million of our estimate. More interesting though was the operating-expense improvement, which decreased by 7.2% year over year. The aforementioned sales of market-based activities appear to have had a noticeable impact. Otherwise, most other income statement line items were within normal statistical bounds of what we were expecting. EPS of $0.33 was $0.01 ahead of our $0.32 estimate, which was also consensus.
Dividend increase announced: The company boosted its dividend [increase of] 7.5%, to $0.1913 per share, payable to shareholders of record on Aug. 18. This marks the 26th dividend increase in 25 years.
Guidance reaffirmed: Aqua America reaffirmed its 2016 EPS guidance of $1.30 to $1.35. The company also expects in excess of $350 million of capital expenditures to be deployed during the year, and customer growth of 1.5% to 2.0%. Thus far, WTR has invested $168.8 million and increased its customer count by 1.1%.
Summary and valuation: The move to 2018 forecasts for valuation purposes allows us to increase our Fair Value target for Aqua America shares from $35 to $39, based on a 26 price-to-earnings multiple. What we saw in the Q2’16 results was a widening focus on improving operational margins, in addition to solid execution against the guidance parameters laid out for 2016.
We’ve also noted from recent activity that Aqua America is not content to just “work around the edges” to improve its performance; if it sees large scale opportunities to grow the business, it steps right up to the plate and takes its swings.
We differ with those that believe multiple contraction would occur should WTR move outside water/wastewater utilities; we believe most analysts would simply incorporate a “sum-of-the parts” methodology to the various earnings streams generated, much like we do in our electric & gas utility universe. That said, we continue to recommend accumulation at current share price levels.