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Bonds Are a 'Safe' Investment: A Big Lie Gets Even BiggerWater utilities are hardly a high-flying investment, but some may be worth a second look. According to EPA estimates, American municipalities will need to spend $500 billion over the next 15 years to upgrade and expand their aging water infrastructure, money most municipalities do not have. Enter privately owned waterworks, including Aqua America (NYSE: WTR) and American Water, currently in the process of being sold by RWE AG in an IPO valued between $4-6 billion. Aqua America currently owns 10,000 miles of pipes in 13 states. The company has a market cap of $3 billion, and recently posted 1Q 2007 earnings of 13 cents per share, just shy of the estimated 14 cents per share. Revenues were up for the quarter 16.5% to $137.3 million. The company also announced a small increase in its quarterly dividend, to 11.5 cents per share.
Aqua America, like its closest competitor American Water, grows primarily through acquisition of smaller water works that can no longer compete on economy of scale. Aqua America has acquired 25 to 30 smaller water companies each year for the past five years. When American Water is finally spun off from its German owner, it will be flush with cash and ready to acquire. The company currently serves 18 million residents in 29 states, and will only get larger. 85% of Americans receive their water via municipal systems, many of which will be prime targets for acquisition.
Investing in waterworks requires an understanding of an unusual business model. Municipalities must agree to sell their waterworks. Scenarios in which municipalities continue to own but contract out waterworks operations are low profit margin deals. Given the impending large bills municipalities will face, they will be more inclined to outright sell to large private waterworks. Once a private waterworks acquires a municipal system, it must spend on upgrades first, then seek to recoup upgrade costs in addition to interest on debt. Much of the debt can be borrowed tax free or tax reduced through municipal borrowing authorities. Typically, a waterworks company spends $3.45 upfront for each $1 in revenue. This is more than twice the cost electrical utilities incur to generate revenue. Private waterworks are also guaranteed a "reasonable" rate of return on equity, generally 10-11%, as part of the acquisition deal.
Investors want waterworks stocks, particularly stock in those companies that can acquire adjoining operations to build large-scale distribution infrastructure. In late 2006, California Water Service Group (NYSE: CWT) filed to sell 1.8 million shares, not nearly enough to satisfy the demand. It ended up selling 2.3 million shares. California Water currently pays a dividend of $1.15 per share, a dividend it has increased for 39 straight years. The company offers a DRIP for individual investors. The stock recently traded at $38.69, up 0.32.
For the previous 20 years period, water utilities have outperformed Exxon, Wal-Mart, and Home Depot. With the changing business model, waterworks stocks could be a good long-term investment.
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Reader Comments (Page 1 of 1)
5-13-2007 @ 1:30PM
Michael Schneider said...
Water is a good investment area. International water stocks shouldn't be ignored though. Jim Cramer recently recommended Veolia Environment (VE) as a water play and a play on the French election in which conservative, pro-business Sarkozy won a handy victory over a left wing opponent. In The Barrel View newsletter- free weekly e-mailing for those who sign the Private Guestbook at http://www.Barrelomoney.com- we recently recommended Suez, also a water and energy company, as a great French election play in a good arena. It is on the list of Barrel View stocks which anyone can find at Barrelomoney. In any case, water is a good area for the long term and it is important to recognize that this is a long term play because the stocks have moved up but the needs and trends will continue for some time.
5-14-2007 @ 2:54AM
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5-14-2007 @ 7:35AM
Ed Limbach said...
I read with interest the remarks about water utilities getting a guaranteed rate of return.
In my 33 years working in the private sector I never saw a public service commission guarantee a water utility a rate of return. What the commissions did do is authorize a revenue requirement that gave the utility the opportunity to earn the reasonable return. There is risk in the business and one does not always meet the rate of return authorized.
5-16-2007 @ 12:58PM
Jen Mueller said...
American Water is being sold specifically because RWE didn't get a good enough return on its investment. See http://www.usnews.com/usnews/biztech/articles/070515/15water.htm
According to a leaked set of board minutes, the company also cited community opposition to private ownership of water, resistance to rate hikes, and aging infrastructure as reasons to get out of the private water business in the United States.
Experiences has shown that private water companies often do not solve community water woes. More at http://www.foodandwaterwatch.org/water
5-16-2007 @ 6:54PM
Adam Scow said...
I'd advise folks to think twice about investing in the American Water IPO. The company has been battling communities across the nation that want to kick them out and go public. I would expect them to have a tough time acquiring new systems, given their reputation. It's no wonder RWE wants to dump them, as revealed on the cover of the Wall Street Journal: www.feltonflow.org/wsj.html