Category Archives: water utilities

Review: California Water Service

Contributor C. Cheng asks:

“Interesting that you should mention scarcity of water creating an upside cap on the company’s profitability. Now that California is dealing with drought conditions, how do you think this will factor into CWT’s performance?”

Our response:

On January 3, 2010 (found here), we posted an Investment Observation on California Water Service (CWT).  At that time we said that CWT has a 6-year pattern of trading in a range before breaking out to the upside, price is driven by the dividend with an upside target of $24.145 ($48.29).

Regarding the 6-year cycle, we said the following:

“CWT has had a pattern of trading in a range for approximately 6 years at a time before breaking out to a new and higher trading level. The following are the range in years that CWT traded before obtaining a new high:

  • 1976 to 1982
  • 1985 to 1993
  • 1993 to 1997
  • 1997 to 2004
  • 2005 to 2011 ???”

Our expectation was that at some point in 2011, CWT would ideally be bought for the pending breakout of the stock price.

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The reality of the situation with CWT is that the stock finally broke out of the trading range in January 2013.  Again, the 6-year trading range was only the average.  However, while investors waited for the stock price to increase there was a sizable dividend being offered at the time.  Coincidentally, the price of CWT has peaked at $48.28 on a closing basis as recently as March 25, 2014.  This closing price is within $0.01 of our projected high set in 2010.

Our view is that only in hindsight will we know for sure the impact of water scarcity on CWT. However, below is the trend of quarterly earnings since our 2010 posting and it seems to reflect the fact that instead of being able to see higher earnings in the face of scarcity (the rational economic view) we’re seeing pre-drought earnings.

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What we do know is that the price performance of the CWT has a lot to do with the price paid. Given that CWT currently trades at 25.8x earnings and yields “only” 2.8% (low for a utility), the odds of the stock outperforming in the long-run are slim.

In addition, utility companies generally issue bonds to fund their operations. With interest rates on the rise, their cost of funding will put more pressure on the future earnings. As such, our view on the risk/reward isn’t as rosy for CWT.

Sell American States Water (AWR) at the Market

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).

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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).

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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.

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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.

The Time Has Come For California Water Services (CWT)

CaliforniaWater Services Group (CWT) has finally arrived at the point that we’veanticipated for the last 2 years.  OnJanuary 3, 2010, we submitted an investment observation that CWT would continueto trade in an established 6-year range that had been identified for at least4 other periods.  Just as a debrief, inthe 2010 piece (found here), we said the following periods traded in 6-year ranges afterbreaking out of the previous range:

  • 1976to 1982

  • 1985to 1993

  • 1993to 1997

  • 1997to 2004

  • 2005to 2011

In a January 1,2011 piece (found here), we reiterated our view on CWT by saying the following:
“…based oncycle analysis, the prospects of CWT making a substantial move above the priorhigh would be between 2011 and 2012.”
As we enter2012, we’re of the view that this is the year that California Water ServicesGroup will break above the 2006 and 2009 highs of $23.  Those interested in buying this stock shouldacquire large quantities and be prepared for the downside risk.  We are reiterating our downside targets at:
  • $17.28
  • $13.70
  • $10.52
Finally, a boilerplatedisclaimer that should be considered for any water utility stock.  Although water is critical to life, stock investorsneed to understand that companies in the water industry aren't a "surething." The biggest reason for this is that when and if water becomes “scarce,”government regulators will step in to take over (nationalize) what shouldotherwise be sold at the most profitable price (thereby curbing wastefulconsumption.) There is literally an upside cap on profitability to a companylike this due to the critical importance of the resource being sold.
Additionally,CWT should be considered a relatively risky stock because of its low dailytrading volume. With a 3-month average volume of 220,000 shares, this stock maynot be suitable for investors who are concerned about getting the "best" price.  However, collecting the current dividend yield of 3.40% should provide some consolation for the wait to rise above $23 in 2012.

Water Utilities Look Affordable

As we have indicated in our February 26th posting, “as a sector, the water utilities are the most undervalued in our Dividend Achiever Watch List." After the rumblings in the water utility sector this week with the announced acquisition of Southwest Water Company (SWWC) by Water Asset Management LLC, we have decided to outline the potential price and percentage change that the stocks would go to if they only went to the 10-year average for the respective fundamental valuation metric. However, as has been pointed out by Warren Buffett in his 2009 annual report, “Even evaluations covering as long as a decade can be greatly distorted by foolishly high or low prices at the beginning or end of the measurement period.”
Company
Price Valuation Target % Up
American States Water (AWR) $34.62 P/Earnings $37.27 7.88%
P/Book $36.12 4.55%
P/Sales $38.80 12.30%
P/Cashflow $40.29 16.61%
San Jose Water (SJW) $23.56 P/E $22.28 -4.74%
P/B $27.89 19.25%
P/S $30.94 32.27%
P/C $32.61 39.43%
California Water (CWT) $36.90 P/E $46.02 25.09%
P/B $42.36 15.15%
P/S $40.53 10.16%
P/C $38.61 4.94%
AquaAmerica (WTR) $16.75 P/E $20.93 25.00%
P/B $23.70 41.56%
P/S $23.95 43.05%
P/C $24.76 47.92%
Data Source: Morningstar.com

Again, the target prices are based on the 10-year average for the given valuation metric. Of the water companies above, AquaAmerica (WTR) has the highest average upside potential of 39% for all four valuation categories. Although San Jose Water (SJW) is not currently on our Watch List, but it has the second highest average upside potential of 21%. California Water (CWT) and American States Water (AWR) followed closely behind with an average upside potential of 13% and 10% respectively.

The biggest risk factor for water utilities is interest rates. If, for some reason, there is a spike in interest rates, then all utilities will suffer tremendously. As we are at historical lows in the cycle for interest rates, we can only expect that there is greater risk of rates rising than falling. Even if rates were to fall, there is little to fall from, whereas, there is tremendous upside.Despite our seemingly aggressive investment strategy, we only consider the mean as the best guess of the potential for where these water stocks might go. In addition, we enter into every transaction accepting the possibility that any investment might fall at least 50% as outlined in our article titled “A Simple Way to Avoid Losing Money in Stocks.”-Touc

Email our team here.

Water Utilities on the Move

Yesterday, water utilities were on the move because Los Angeles-based, Dividend Achiever Southwest Water Company (SWWC) announced that it was being bought by Water Asset Management, LLC in a deal valued at $427 million. The stock of Southwest Water Company (SWWC) jumped 46% during market hours.  On the news, almost all other water utility companies moved higher as seen in the table below.
It should be noted that of the eight companies listed above, San Jose Water (SJW), American States Water (AWR), California Water Service (CWT), AquaAmerica (WTR), American Water Works (AWK) and Consolidated Water (CWCO) are Dividend Achievers.  In the last month, San Jose Water (SJW), California Water (CWT), AquaAmerica (WTR) and American States Water (AWR) have been on our Dividend Achiever Watch List at the same time.  The New Low Observer had issued Investment Observations on AquaAmerica (WTR) on October 31, 2009 and the other on California Water Service (CWT) on January 3rd.
As a general observation of our Dividend Acheiver Watch List and our Nasdaq 100 Watch List, when companies from an industry start to cluster on the list we know that whatever cyclical forces are at play require us to look closely at that industry and those companies.  Although we have sold our initial investment in AquaAmerica (WTR), we subsequently acquired a "substantial" position in California Water Service (CWT). 
Anyone interested in the qualitative elements of water utilities should be mindful of our boiler plate warning on investments in the industry:
"Although 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, municipalities 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 companies like these due to the critical importance of the resource being sold."
Despite my personal concerns on the water utility industry, I encourage readers to follow our Watch Lists closely for potential signs of other exceptional investment opportunities.
-Touc
Email our team here.