3 Water Utilities Thriving in the Drought

by Susan J. Aluise | August 21, 2012 6:30 am

If you’re looking for a defensive play in this roller-coaster economy, forget oil. Gold likewise has lost a lot of glitter. With the U.S. suffering the worst drought in more than half a century[1], one of the best bets anywhere is water. And when you’re betting on H2O, it’s hard to beat these three dividend-rich water utility stocks.

The value of water, like all commodities, comes down to the issue of supply and demand — and current demand is at the flood stage. Many regions in the U.S. already were feeling the pinch before this summer’s drought.

Over the past five years, nearly every section of the country has had to contend with water shortages, according to the Environmental Protection Agency. Even without the current drought, the agency estimates at least 36 states will experience local, regional or statewide water shortages by next year.

These three utilities also provide wastewater services, and many benefit from increased hydraulic fracturing, or “fracking” technologies, which use vast amounts of water to extract natural gas and oil from shale deposits.

The current severe drought has further tightened supply, and utilities have responded by pumping more water, which translates into higher earnings. Combine higher earnings with the traditional benefits associated with utility stocks — low beta, a stable ratepayer base and healthy dividends — and water utilities provide a refreshing opportunity for income investors now.

Here are three water utilities to play the drought:

American Water Works (NYSE:AWK[2]). AWK is the largest publicly traded U.S. water utility. It provides a wide range of consumer, business and industrial services in 35 states and in parts of Canada. Earlier this month, American Water reported an 11% rise in second-quarter revenue and record pumping volume. It also raised its outlook for the rest of 2012.

With a market cap of nearly $6.7 billion, AWK is trading around $37.50, only 4% below the new 52-week high it hit on Aug. 3. AWK has a tiny beta of 0.3, with 1 representing average volatility. Most utilities have a fairly high price-to-earnings growth (PEG) ratio, and AWK’s is 2.1, with a PEG ratio of 1 representing a fair valuation.

American Water also has a fairly high forward P/E of nearly 18, although that’s about average for the sector. AWK has a current dividend yield of nearly 2.7% and a whopping one-year return of 41%.

Aqua America (NYSE:WTR[3]). WTR provides water and wastewater services in 13 states in the Northeast and Southeast U.S., as well as Texas. Last month, the company announced record earnings for its fiscal second quarter. Aqua America stands to gain from the acquisition of AWK’s regulated utility in Ohio. It also sold its New York operations to AWK.

Acquisitions are an important part of Aqua America’s strategy. It recently acquired two water systems in Virginia[4] and announced plans in May to focus more on fracking sales.

With a market cap of $3.5 billion, WTR is trading around $25, about 6% below the new 52-week high it set in July. WTR also has very low volatility, with a beta of 0.4.

On the downside, Aqua America has a high PEG ratio of nearly 3.3 and a forward P/E of 23 — both indicators that it’s pretty expensive. That said, it boasts a current dividend yield of nearly 2.8% and a one-year return of nearly 24%.

American States Water (NYSE:AWR[5]). The California utility provides water, wastewater, electric and contract services to more than 250,000 customers and some military installations in that state. Earlier this month, American States beat the Street with a 16% increase in second-quarter earnings[6] per share. AWR also increased its dividend by 27% this month. The company has experienced strong growth in its contracted business, but it hadn’t paid dividends on earnings from its 50-year military privatization contracts until now.

Considerably smaller than the other two utilities with a market cap of $843 million, AWR is trading around $44.50. It set a new 52-week high last Friday. WTR has a beta of 0.5. It has the highest PEG ratio in the group at 3.6 and a forward P/E of 18.

But the current dividend yield after the increase is 3.2%, and it looks sustainable. Its one-year return isn’t too shabby at nearly 37%.

As of this writing, Susan J. Aluise did not hold a position in any stocks mentioned here.

  1. worst drought in more than half a century: http://www.cpc.ncep.noaa.gov/products/analysis_monitoring/regional_monitoring/palmer.gif
  2. AWK: http://studio-5.financialcontent.com/investplace/quote?Symbol=AWK
  3. WTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=WTR
  4. two water systems in Virginia: http://www.bloomberg.com/news/2012-08-10/aqua-america-unit-acquires-water-systems-to-expand-in-virginia.html
  5. AWR: http://studio-5.financialcontent.com/investplace/quote?Symbol=AWR
  6. second-quarter earnings: http://www.bloomberg.com/article/2012-08-06/anKI6GTDgVGI.html

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