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Dividend King in Focus: SJW Group

Published by Nicholas McCullum on June 8th, 2017

Dividend history is one of the most straightforward and useful ways to determine whether a company has shareholder-friendly management.

There is remarkable consistency among companies with long histories of steadily rising dividends – meaning that a long dividend increase suggests more increases are yet to come.

That’s why the Dividend Aristocrats are one of the best places to find high-quality dividend growth stocks. To be a Dividend Aristocrat, a company must be in the S&P 500 and increase its dividend for 25 consecutive years.

You can see the full list of all 51 Dividend Aristocrats here. 

The Dividend Aristocrats have meaningfully outperformed the S&P 500 over long periods of time. Dividend history matters.

Thus, when a company announces its 50th consecutive annual dividend increase, investors ought to take notice.

SJW Group (SJW) recently did just that. The company’s dividend increase last January qualified it to be a member of the Dividend Kings – an elite group of stocks with 50+ years of consecutive dividend increases.

You can see the full list of all 20 Dividend Kings analyzed in detail here.

SJW’s long streak of dividend increases indicates that it has a defensible competitive advantage and that it is a very shareholder-friendly company.

This article will analyze the investment prospects of the SJW Group in detail.

Business Overview

The SJW Group is a water utility company based in San Jose, California. SJW was founded in 1866 and has a remarkably long corporate history of 151 years. The company has a current market capitalization of $1.0 billion.

More details about SJW’s investment highlights can be seen below.

SJW Group Investment Highlights

Source: SJW Group Investor Presentation, slide 3

The SJW Group acts as a holding company for its four operating subsidiaries:

Both the San Jose Water Company and SJWTX Inc. are water utilities in the traditional sense and deliver water to more than 1 million customers in aggregate. The other subsidiaries operate in unrelated (but complimentary) industries.

The SJW Land Company owns and operates commercial real estate investments. Conversely, the Texas Water Alliance is an entity dedicating to pursuing the development of a regional water supply project in central Texas.

Two of these subsidiaries – the San Jose Water Company and SJWTX – are regulated utilities, while the other two are non-regulated.

SJW Group Structure and Platforms

Source: SJW Group Investor Presentation, slide 5

Moving on, the next section will discuss SJW’s growth prospects in detail.

Growth Prospects

The SJW Group’s biggest growth factor is the long-term de-privatization of water infrastructure assets.

Water utilities have traditionally been owned by governmental entities, preventing public investors from participating in the upside of this growing industry.

However, government balance sheets are highly leveraged right now and these entities are looking for ways to shed assets and pay down debt. This often occurs by selling private assets to publicly-traded companies.

Cue the SJW Group. This company has a tremendous opportunity to acquire high-quality assets as governments work to de-privatize their water utility assets.

More details about the water sector investment thesis can be seen below.

SJW Group Water Sector Investment Thesis

Source: SJW Group Investor Presentation, slide 4

SJW is working aggressively to take advantage of this trend.

Financially, this can be seen in the company’s capital expenditures. The company has grown its capex by an annual rate of 16.9% over the past 5 years, indicating that it is well-positioned to take advantage of the de-privatization of the water infrastructure industry.

SJW Group CAPEX Growth

Source: SJW Group Investor Presentation, slide 19

Competitive Advantage & Recession Resilience

The main competitive advantage of the SJW Group is the company’s ownership of high-quality water infrastructure assets.

This can be seen mostly in its two water utility subsidiaries, the San Jose Water Company and SJWTX.

Looking at the first subsidiary, it operates 111 production wells, 97 storage facilities, 2,400 miles of mains, and more than 6,000 acres of watershed property.

The subsidiary also has a diverse customer base, with 229,000 connections divided into 90% residential and 10% commercial customers.

SJW Group San Joe Water Company Key System Assets

Source: SJW Group Investor Presentation, slide 22

The company’s SJWTX subsidiary is smaller but has an equally impressive asset base: 42 wells, 61 storage facilities, and 599 miles of mains.

In addition, SJWTX operates 13,000 water connections, 50 wastewater connections and is responsible for a 240 square mile service area.

SJW group SJWTX Key System Assets

Source: SJW Group Investor Presentation, slide 23

As a water utility, the SJW Group delivers a product that is critical for human life. This suggests that the company’s performance would be relatively stable in most economic environments.

We can test this theory by examining the company’s performance during the last recession.

The company’s adjusted earnings-per-share history during the global financial crisis of 2007-2009 can be seen below:

SJW saw a peak-to-trough earnings-per-share decline of 25% during the last recession. The company managed to remain profitable during the recession but is not as recession resistant as some other health care or consumer staples stocks.

Valuation, Dividends, & Expected Total Returns

Expected total returns for shareholders of the SJW Group will come from valuation changes, earnings-per-share growth, and the company’s current dividend yield.

Related: How to Calculate the Expected Total Return of Any Stock

After reporting a total shareholder return of 91.5% in 2016 and nearly doubling its stock price, investors are right to worry about the current valuation of the SJW Group.

Fortunately, the company’s earnings grew significantly during fiscal 2016. While valuation expansion certainly played a large role in the company’s returns last year, its current price-to-earnings ratio is actually quite reasonable thanks to its proportionate earnings growth.

SJW Group Net Income

Source: SJW Group Investor Presentation, slide 16

The SJW Group reported adjusted earnings-per-share of $2.57 in fiscal 2016. The company’s current stock price of $51.40 is trading at a price-to-earnings ratio of 20.

For context, the S&P 500 is trading at a price-to-earnings ratio of 25.7 right now. SJW Group is trading at a discount to the rest of the stock market (as measured by the S&P 500 Index). But how does it compare to the typical valuation of this stock?

SJW’s current valuation is compared to its long-term historical averages below.

SJW Group Valuation Analysis

Source: Value Line

SJW’s current valuation is slightly lower than its long-term historical average. The company appears to be slightly undervalued, especially considering that low interest rates are inflating valuation across the broader stock market.

Thus, valuation expansion will likely have a positive effect on the future returns of SJW shareholders.

Turning to earnings-per-share growth, SJW has compounded its adjusted earnings-per-share at an annual rate of ~8% since 2001. The company’s long-term earnings-per-share trend can be seen below.

SJW Group Earnings-Per-Share Trend

Source: Value Line

However, 8% annual earnings-per-share growth for a water utility seems a bit high. This number is likely inflated by the strong earnings generated by the company in 2016 (2017’s number is expected to be slightly lower).

I believe a long-term expectation of 4%-6% earnings-per-share growth is reasonable for this company.

The remainder of SJW’s future shareholder returns will come from its current dividend payments.

The SJW group currently pays a quarterly dividend of $0.2175 which yields 1.7% on the company’s current stock price of $51.40.

SJW’s dividend yield is below the S&P 500’s average dividend yield of 1.9%, but will still have a modest positive effect on this stock’s long-term total returns.

Also, the company’s shareholders are all but assured that it will continue raising dividends for many years to come. The Lindy Effect suggests that the SJW Group is likely to continue raising its dividend for about another 50 years.

To sum up, SJW’s total returns will be composed of:

For expected total returns of 5.7%-7.7% before the (likely positive) effect of valuation expansion.

Final Thoughts

The SJW Group has many of the characteristics of an appealing dividend invest: shareholder-friendly management, a low-risk business model, and a very long history of steadily increasing dividend payments.

And, this stock is trading below its long-term average price-to-earnings ratio. This is rare in today’s market.

The SJW Group merits investment for those looking to secure low-risk dividend income from a stock that is unlikely to deliver double-digit total returns.

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