We believe that now is the time to consider selling American States Water (AWR) at the market based on a few indications in the water utility industry.
First, the price of American States Water (AWR) at point 2 has achieved the prior high that was set in 2007, at point 1, in the chart below. Even the most minor downturn from the all-time high suggests that there is considerable downside risk, especially if the stock was bought at or near our March 7, 2010 recommendation of water utilities (found here).
Another factor being considered as part of our sell recommendation of AWR is that the water utility sector has experienced a triple top as indicated by the best performing industry ETF, First Trust ISE Water Index (FIW), since our March 7, 2010 recommendation of water utilities in the chart below (FIW is the blue line).
We have to hold our nose to the idea that First Trust ISE Water Index is the best representation of water utilities since its composition is hardly a pure play on the sector. We’ve included the comparison of other water ETFs including the Guggenheim S&P Global Water Index (CGW), PowerShares Water Resources (PHO), and PowerShares Global Water (PIO) to demonstrate the relative weakness of the sector overall.
Finally, the recent run-up in AWR has helped the stock to achieve gains that have exceeded the returns of the Dow Jones Industrial Average (^DJI) from the March 8, 2010 to the present.
The overall under-performance of AWR as compared to the Dow Industrials in prior periods suggests that the stock should be sold to take advantage of the exceptional gains since April 2012.
Some will likely argue that there is more upside potential based on the recent move in AWR. A favorite argument for water utilities is that water is fast becoming “scarce.” However, our prior disclaimer on the issue of water scarcity, from our October 31, 2009 recommendation of AquaAmerica (found here), encapsulates the problems faced by the industry:
“Although this is a water utility [AquaAmerica (WTR)] and water is critical to life, investors need to understand that companies in this industry aren’t a ‘sure thing.’ The biggest reason for this is that when, and if, water becomes scarce, government regulators will step in to take over (nationalize) what should otherwise be sold at the most profitable price (thereby curbing wasteful consumption.) There is literally an upside cap on profitability to a company like this [AquaAmerica (WTR)] due to the critical importance of the resource being sold.”
The lows experienced after the 2009 bottom and the nearly 3 1/2 year stock market rally indicates that certain positions need to be pared down. Recommendation to buy American States Water (AWR) based on their fundamentals are likely reflections of past performance being projected too far into the future and would not necessarily hold up in the short to medium-term. We believe that American Water Works can be acquired at more favorable prices going forward.