Every day I drive into an adjoining town that is rationing water. This made me think about whether there are companies that make money off the vital liquid. A leader among such companies is water-utility Aqua America (NYSE:WTR).

Slightly more than half of Aqua America’s revenue comes from its Pennsylvania, unit however it also owns water utilities in a dozen other states. And it makes acquisitions — 19 in 2010 alone — including one last month of a water utility in Texas.

There is one good reason to consider owning shares of Aqua America — its rising dividend. Aqua America has had 65 years of consecutive dividends with 20 cash increases in the last 19 years. And it has been raising its dividend 4 cents every year since 2006 — resulting in a 7% increase in 2010 to a dividend yield of 2.8%.

But there are four causes for concern:

• Long-term growth with shakier balance sheet. Aqua America has grown steadily. Its revenue has increased at an average rate of 8% over the last five years and its net income has risen at a 7.7% annual rate over that period. However, its cash has been falling while its debt has risen. Specifically, Aqua America’s cash fell at a 39% annual rate between 2006 ($44 million) and 2010 ($6 million) while its debt rose at a 12% annual rate between 2006 ($952 million) and 2010 ($1.5 billion).
• First-quarter earnings that beat expectations with disappointing revenue. Aqua America’s adjusted income was $26 million, or 19 cents a share — a penny ahead of analysts polled by Thomson Reuters; however, revenue for the quarter grew 6.7% to $171 million — 1.4% below analysts’ consensus revenue estimate.
• Under-earning its capital cost. Aqua America earned less operating profit than its cost of capital, however it’s improving. Aqua America’s EVA momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was 1%, based on EVA that improved from -$70 million in 2009 to -$66 million in 2010, using a 6% weighted average cost of capital.
• Expensive stock. Aqua America’s price-to-earnings-to-growth ratio of 3.2 makes it very overvalued (a PEG of 1.0 is considered fairly priced).
  Aqua America’s price-to-earnings ratio is 23.3 and its earnings are expected to grow 7.4% to $1.06 a share in 2012.

People need water, and Aqua America supplies lots of it. But to get more, the company is larding up its balance sheet with debt and isn’t able to achieve sufficient cost savings from its acquisitions to out-earn the cost of the capital it’s using to finance them.

I don’t see a compelling reason to buy this stock.

Peter Cohan has no financial interest in the securities mentioned.