US water utilities underperform in 2009
- From: Vol 11, Issue 1 (January 2010)
- Category: General
- Region: Americas
- Related Companies: (RWE) Rhein Ruhr Partners , American States Water, American Water, Aqua America, Artesian Water, Boenning & Scattergood, Cadiz Inc, California Public Utilities Commission (CPUC), California Water Service Co (Cal Water), Cascal, Connecticut Water, Consolidated Water, Janney Montgomery Scott, Middlesex Water, Pennichuck Water, Pico Holdings, San Jose Water, Southwest Water and York Water
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Quoted US water utility stocks put on a somewhat lacklustre show last year, after 2008’s stellar outperformance. Analysts are predicting great things for 2010.
It is the fate of water utility stocks to be among the most resilient sectors when it comes to an economic downturn. That same resilience, however, means that they are always less likely to resurge as dramatically as equipment suppliers when the economy picks up again. While the S&P 500 index increased by 23.5% in 2009, the GWI index of US water utility stocks – weighted by market cap and water exposure – was essentially flat on the year. Ryan Connors, an analyst with Boenning & Scattergood, explained that the relatively underwhelming performance came as a correcting response to the relatively high level of interest these stocks had received in 2008 as a result of the economic crisis.
“When the market rallies, they are probably going to underperform,” said Connors, noting that those who had invested in the sector to defend against free-falling stock prices elsewhere had likely ventured back into investments with higher growth potential. Indeed, the 2008 performance of the listed US water utilities demonstrated this resilience with flying colours, as our portfolio only showed an annual downturn of 5%, compared with the bloodbath 38.5% decline in the S&P 500.
“Simply put, most people still pay their water bills, even during a recession,” said Debra Coy, an analyst with Janney Montgomery Scott. “The average household still uses the same amount of water and pays the bill regardless of the economy.”
New capital to invest in rate base was readily available in 2009, as American Water, Pennichuck, York Water and American States Water all pushed through secondary share offerings – most of which were priced at a discount, sending the respective share prices temporarily tumbling. Aqua America and American Water also made frequent visits to the bond markets to fund investment. Access to capital was particularly important for American Water, which raised $250 million of new equity over the summer in its first public share offering since being taken over by RWE in 2003.
“You had a slug of new supply coming from a company that was undervalued and had the highest dividend yield,” explained Michael Gaugler, an analyst with Brean Murray Carret, adding that the interest in American Water came at the expense of the other utility stocks’ performance. “You had one equity that looked very attractive to investors relative to the rest of the group, based on discount and based on yield.”
American Water’s stock price also perked up when the company finally ended its relationship with its former parent company. German utility RWE completed the sale of its remaining 23.5% stake in American Water in November at $21.63 per share, which sent the stock rallying by 6%.
“There was always this overhang,” explained Coy, pointing to ongoing investor uncertainty over when RWE would next dump a chunk of stock on the market. “The sale doesn’t really change the business operations, but it improves the perception of the company,” she added. Based on the fact that American still trades at a discount to its peer group, she has a target price of $26 on the stock, while Gaugler is more bullish still, at $28.
Aqua America also experienced the dampening effect that a surging market can have on water utility stocks. After flirting with a stock price somewhat north of $21.00 earlier in the year, the company ended 2009 at $17.51, some 15% lower than a year previously.
As investors piled into American Water following RWE’s final divestment, some of the resultant performance came at Aqua America’s expense, as certain accounts switched allegiances, executing a “pair trade” with American stock.
“Aqua America pretty much did everything right last year – good rate cases, improved their operating metrics, yet the stock declined through most of the year,” said Gaugler, noting that its liquidity made it the most logical pair trade for American. “You are starting to see that tick down now. I see that trend reversing itself [in 2010].”
Analysts consider Aqua America to be well poised for a strong 2010, with a particularly capable management team, a strong track record of dividend increases and a lively tuck-in acquisition rhythm. Shortly before year-end, Aqua announced its entry into the state of Georgia through the purchase of a wastewater system serving a community along the highgrowth Route 400 corridor. The deal brought the total number of acquisitions completed by the company in 2009 to 17.
Over in California, SouthWest Water spent most of 2009 attempting to regroup after an abysmal period in the doldrums. In November 2008, the company announced that it would review three years of quarterly statements and restate its results, and shortly thereafter found itself facing a possible de-listing from Nasdaq. After a disastrous performance in Q4 2008, the stock had only one way to go in 2009, and renewed investor confidence when the company finally got up to date with its filings meant that SouthWest ended the year 83% up on where it ended 2008.
Meanwhile, the seemingly bleak performance of San Jose Water and California Water Service in 2009 is a reflection of their strong performance in 2008. The strong showing in 2008 was both the positive result of water utility stocks’ perceived safety and rate-setting by the California Public Utilities Commission (CPUC), which ultimately determines much of the companies’ revenue.
In 2009, Cal Water watched its stock fall 21%, while San Jose tumbled nearly 25%. While some analysts are optimistic that California’s plans to address its water issues will benefit state water utilities, others say it will take time to see how these plans generate results. “The regulatory environment has been getting better but it’s one of these things that has been a story for a number of years now,” said Connors. “Some folks are growing impatient with that story. It has been out there for so long.”