Best stock to invest in – Water Utilities Keeping The Flow In Cash Flow

Best stock to invest in

Water Utilities Keeping The Flow In Cash Flow

by Debra Fiakas CFA

After a long series of posts on suppliers of water
, from fire hydrants to filters
and from taps
to treatments,
it is now time to look at the companies selling water.  The majority
of water utilities is owned by municipalities and is beyond the
reach of investors.  However,

there is a clutch of publicly traded companies that peddle water as
a business.

Which water utilities make sense to return hungry and risk wary

A short list of publicly traded water utilities in the U.S.
reveals a diverse group of large and small companies.  American Water (AWK:  NYSE) is by far the largest
operation after reporting $3.2 billion in revenue in fiscal year
2015. American Water serves 1,600 communities in
16 states in the U.S. and Canada with potable water delivery and
waste water collection. The smallest company in terms of revenue
is York
Water Company (YORK:  Nasdaq)
, which delivered
$47.0 million worth of water to customers in Pennsylvania last

Water Utility Market SYM Sales Mill
American States Water California  AWR $458.6
American Water 1,600 communities in 16
AWK $3,160.0
Aqua America PA, OH, TX, IL, NC, NJ, IN
and VA
WTR $814.2
California Water Service CA, WA, NM CWT $588.4
Connecticut Water Service Connecticut, Maine CTWS $95.9
Middlesex Water Company NJ, DE, PA MSEX $123.2
SJW Corporation San Jose, California SJW $305.1
York Water Company Pennsylvania YORW $47.0

After all the discussion of water system failure, water
contamination and the need to treat water destined for our kitchen
faucets, a review of water utilities must include a review of
financial strength.  Some

investors might scrutinize leverage ratios and profit margins.  I prefer to
look at how good a company is at turning sales dollars into
operating cash.  After

all, it is operating cash that pays for capital investments.  The winner
in my contest is Aqua
America (WTR:  NSYE)
, which converted 45.5% of its
$814.2 million in revenue in the last fiscal year to operating
cash flow.  The least proficient cash builder in the
group is American
States Water (AWR:  NYSE)
, which only turned each
sales dollar into 20.7 cents.  That is
still an impressive cash conversation ratio and goes a long way
toward supporting capital spending programs to maintain and
improve water delivering infrastructure. 

SYM Sales Mill CFO Mill CFO/Sales
AWR $458.6 $95.1 20.7%
AWK $3,160.0 $1,180.0 37.3%
WTR $814.2 $370.8 45.5%
CWT $588.4 $144.6 24.6%
CTWS $95.9 $37.8 39.5%
MSEX $123.2 $39.3 31.9%
SJW $305.1 $97.3 31.9%
YORW $47.0 $18.5 39.3%
Average 33.8%

Aqua American may be the strongest in the group in terms of
generating operating cash flows, but it is also among the most
expensive stocks.  Its

shares trade at 6.9 times sales – well above the group average of
4.7 times trailing sales.  The story is
the same in terms of earnings and cash flows.  The supplier
of water to the San Jose, California community, SJW Corporation (SJW:  NYSE),
is the only one in the group that trades below the average in
terms of sales, earnings, cash flows and book value. 

AWR 3.2 25.3 15.8 3.2
AWK 4.0 27.0 10.8 2.5
WTR 6.9 28.0 15.4 3.3
CWT 2.3 29.8 9.3 2.1
CTWS 5.4 22.4 13.9 2.3
MSEX 4.7 30.4 14.9 2.8
SJW 2.5 20.1 7.9 2.0
YORW 8.7 32.9 22.4 3.8
Average 4.7 27.0 13.8 2.8

The relative value of SJW is interesting, particularly given the
apparent optimism that analysts have for the company’s future.  Analysts have
projected slowing growth for water utilities over the next five
years.  The

average future growth rate for our group of eight companies is 6.6%,
but SJW is at the top end of the range with a 14% projected growth
rate. Middlesex Water brings up the rear with a 2.7% growth rate

The ratio of Price/Earnings-to-Growth Rate provides a logic check
for investors in comparing earnings multiples.  SJW wins
this contest as well with a ‘PEG Ratio’ of 1.44 compared to the
average of the group of 5.26.   Still

the target PEG Ratio is 1.00 so it appears investors are paying a
premium for the growth that SJW has to offer.

Earnings and growth are only part of the picture for water
utilities.  All
of them pay a dividend.  The forward
dividend yield for our favorite SJW Corporation is 2.2%, which is
exactly the group average.  So dividend
yield should be considered right along with growth potential.  Utility
stocks also typically offer shareholders lower risk than other
sectors, justifying higher multiples relative to yield and growth.  The average
beta for our group is a modest 0.42. 

SYM Yield Growth Beta PEG PERG PERGY
AWR 2.2% 3.9% 0.40 6.58 2.63 1.67
AWK 1.9% 7.6% 0.23 3.55 0.82 0.65
WTR 2.2% 5.9% 0.54 4.79 2.58 1.87
CWT 2.5% 9.1% 0.67 3.29 2.21 1.73
CTWS 2.3% 5.0% 0.16 4.49 0.72 0.49
MSEX 2.2% 2.7% 0.55 11.24 6.18 3.39
SJW 2.2% 14.0% 0.24 1.44 0.34 0.30
YORW 1.9% 4.9% 0.59 6.71 3.96 2.84
Average 2.2% 6.6% 0.42 5.26 2.43 1.62

Considering dividend yield as well as growth and adjusting each
ratio for risk, our favorite SJW still dominates the group.  Its PERGY
(Risk Adjusted Price/Earnings to Growth Plus Yield) ratio is 0.30    the lowest
in the group. The shares of SJW may be the best
value in the group, but it is worthwhile to point out that Connecticut Water Service (CTWS:  Nasdaq) with
its 2.3% dividend yield is in second place.   Connecticut
Water also appears to be a strong operator with a 39.5%
sales-to-cash conversion ratio in the last fiscal year.

Debra Fiakas is the Managing
Director of
Crystal Equity
, an alternative
research resource on small capitalization companies in selected

Neither the author of the Small Cap
web log,
Crystal Equity Research nor its affiliates have a beneficial
interest in the companies mentioned herein.

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