Dividend Kings In Focus: American States Water - Sure Dividend

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Dividend Kings In Focus: American States Water


Updated on December 2nd, 2021 by Bob Ciura

American States Water (AWR) has an amazing track record when it comes to paying dividends to shareholders.

AWR is part of the Dividend Kings, a group of stocks that have raised their payouts for at least 50 consecutive years. You can see all 35 Dividend Kings here.

And, yYou can download the full list of Dividend Kings, plus important financial metrics such as dividend yields and price-to-earnings ratios, by clicking on the link below:

 

Click here to download my Dividend Kings Excel Spreadsheet now. Keep reading this article to learn more.

Dividend Kings are the “best of the best” when it comes to rewarding shareholders with cash and this article will discuss AWR’s dividend, as well as its valuation and outlook.

AWR has raised its dividend for 67 consecutive years, giving it one of the longest dividend growth streaks in the stock market. There are only three companies that have longer dividend growth streaks than AWR.

This article will discuss the reasons why American States Water has maintained such a long history of steady dividend increases.

Business Overview

AWR is primarily a regulated water utility business, which serves ~262,000 customers in California. It also has a regulated electric utility business in California and a non-regulated business in which it provides services for water distribution and wastewater collection in eleven military bases in the U.S.

Related: The 7 Best Water Stocks To Buy Now

The regulated water utility business is by far the most important division, as it generates ~67% of the total revenues of the company.

Source: Investor Presentation

While the regulated water business generates most of the revenues of AWR, the non-regulated business that provides services to water and wastewater systems in military bases is significant as well. AWR has signed 50-year contracts with the military bases and thus it has secured a reliable and recurring stream of revenues.

Utility stocks are slow-growth companies. They spend enormous amounts on the expansion and maintenance of their infrastructure and thus they accumulate high debt loads.

As a result, they rely on the regulatory authorities to approve of rate hikes every year. These rate hikes aim to help utilities service their debt but they usually result in modest growth of revenue and earnings.

Authorities have incentive to offer attractive rate hikes to utilities in order to encourage them to continue to invest heavily in infrastructure. On the other hand, authorities try to keep consumers satisfied and hence they usually offer limited rate hikes.

AWR is a bright exception to the rule of slow growth in the utility sector. The company has grown its earnings per share at an 11% average annual rate in the past decade.

AWR has achieved a superior growth pace primarily thanks to the material rate hikes it has received from regulatory authorities and its growth in its non-regulated business. Overall, it has a less “boring” business model than a typical utility company.

Growth Prospects

American States Water reported its thirdquarter earnings results on November 1st, 2021. Fully diluted earningspershare decreased from $0.76 in Q3 2020 to $0.72 in Q3 2021, while Q3 revenue grew by 2.3% to $136.76 million yearoveryear.

Adjusted diluted earnings per share increased by 8.6% per share, compared to last year’s same period.

As already mentioned, utilities are slow-growth stocks in general due to the lackluster rate hikes they receive from regulatory authorities in exchange for their hefty capital expenses. AWR is superior to most utilities in this aspect, as it has enjoyed an exceptional 9.2% average annual rate hike in its regulated water business in recent years.

Source: Investor Presentation

This has helped the company grow its earnings per share at an 11% average annual rate over the last decade, which is one of the highest growth rates in the utility sector.

Moreover, thanks to its positive performance, its resilience to the coronavirus crisis and its bright outlook, AWR raised its dividend by 9% this year. This is above the typical dividend growth rate of utility stocks.

AWR has now grown its dividend for 67 consecutive years.

Source: Investor Presentation

It is also remarkable that management has set a goal of raising the dividend by more than 7% per year on average over the long term.

Such a high dividend growth rate is rare in the slow-growth utility sector and renders the 1.5% dividend yield of the stock somewhat more attractive.

Moreover, AWR has a markedly strong balance sheet, with an A+ credit rating, one of the highest in the utility industry.

Thanks to its healthy payout ratio of ~60%, its strong balance sheet and its sustained growth, AWR has good chances of delivering its ambitious goal of more than 7% annual dividend growth to its shareholders.

Going forward, AWR is likely to continue growing at a meaningful pace thanks to rate hikes in its water utility business. In addition, thanks to the highly fragmented status of the water utility business, AWR can also grow by acquiring small companies.

Competitive Advantages & Recession Performance

Utilities invest excessive amounts on the maintenance and expansion of their network. These amounts result in high amounts of debt but they also form impenetrable barriers to entry to potential competitors.

It is essentially impossible for new competitors to enter the utility markets in which AWR operates.

Even in its non-regulated business, AWR enjoys weak competition thanks to the 50-year duration of its contracts.

In addition, while most companies suffer during recessions, utilities are among the most resilient companies during such periods, as economic downturns do not affect the consumption of water and electricity.

The resilience of AWR was prominent in the Great Recession. Its earnings-per-share during the Great Recession are as follows:

Therefore, AWR remained resilient during the Great Recession, managing to grow its earnings per share 6% between 2007 and 2010.

The resilience of AWR was also evident in 2020, as the company still managed to grow earnings-per-share, despite the deep economic downturn caused by the coronavirus pandemic.

Overall, AWR is one of the most resilient companies during recessions and bear markets. This resilience is very important, as it supports the long-term returns of the stock and makes it easier for the shareholders to retain the stock during broad market sell-offs.

Valuation & Expected Returns

We expect AWR to generate earnings-per-share of $2.43 this year. As a result, the stock is currently trading at a price-to-earnings ratio of 39.5. We consider 25.0 to be a fair earnings multiple for this stock.

The extremely high price-to-earnings ratio can be attributed, at least in part, to the depressed interest rates over the past decade.

When interest rates are low, income-oriented investors have a problem identifying attractive yields in the market and thus they view the dividend yields of utilities as more attractive. As a result, utility stock prices benefit from suppressed interest rates.

On the other hand, the market has already priced the benefit from low interest rates in the stock of AWR. Moreover, investors should pay special attention on the valuation of slow-growth stocks, such as utilities. If they overpay for a utility, it may take several years only to breakeven.

The downside risk of AWR will be significant whenever the company faces an unforeseen headwind, such as poor rate hikes or a period of rising interest rates. Therefore, we see potential for contraction of the P/E multiple moving forward.

If AWR reaches our assumed fair price-to-earnings ratio of 25.0 over the next five years, it will incur a -8.7% reduction in annual returns, due to the contraction of its earnings multiple.

Moreover, AWR is currently offering a 1.5% dividend yield. We also expect the company to grow its earnings per share at a 1.5% average annual rate over the next five years.

Putting it all together, AWR is likely to offer a negative annual return of -5.7% over the next five years.

It appears that the market has fully appreciated (and then some) the reliable earnings growth and the defensive characteristics of the stock.

Final Thoughts

AWR is much more interesting than the average utility stock, as it has some exceptional characteristics.

It has grown its earnings per share at a high single-digit annual rate over the last decade. This is much better than the low growth rates of most utilities.

In addition, the business of AWR includes a non-regulated segment, which provides recurring revenues for 50 years and offers significant growth potential.

However, investors should realize that the market has fully appreciated all the virtues of AWR.

With a negative expected five-year return, AWR stock receives a “sell” rating.

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