Better Buy: Aqua America, Inc. vs. Connecticut Water Service

Water stocks offer income investors respectable dividends and steady growth. That's because most water utilities operate within regulated markets, where investments in water distribution infrastructure are rewarded with higher rates over time. While they achieve relatively slow rates of growth, they do so with relatively low risks -- and investors usually end up paying a premium for it.

Individual investors essentially have two options in the industry. You can own large, national companies such as Aqua America (WTRG 0.58%), or you can own small, regional companies such as Connecticut Water Service (CTWS). If you had to choose only one, then which would be the better buy and why?

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The matchup

Aqua America is the second-largest publicly traded water utility behind American Water Works. While it operates in eight states, over half of its customers are in Pennsylvania. It boasts a market cap of $6 billion and turned in over $391 million in revenue during the first half of 2017. Twenty-eight percent of that amount trickled down to the bottom line as net income, resulting in EPS of $0.62 during the period. 

Despite its name, Connecticut Water Service operates in Maine, Connecticut, and New Hampshire. It's about one-tenth the size of its challenger in this matchup, but it's the largest publicly traded water utility in New England. The regional water utility reported first-half 2017 revenue of over $50 million and a net margin of 24%. 

Data source: Yahoo! Finance.

Aside from size, these two water stocks are pretty evenly matched. Aqua America pays a slightly higher dividend and is expected to be cheaper in the next 12 months, but the regional water utility is cheaper by most other valuation metrics. Its PEG ratio, a measure of expected growth in the next five years, is also slightly lower.

While both companies generate revenue from water distribution and wastewater services, Connecticut Water Service only just began acquiring wastewater treatment assets this year. That's pretty incredible considering pairing these water assets has been commonplace in recent years, but also considering that the regional player has maintained growth rates comparable to (and actually higher than) more diversified peers without them. 

In fact, the smaller company has outperformed Aqua America in the last one-, three-, five-, and 10-year periods when dividends are included.

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However, Aqua America has turned in a better performance in 2017. That's likely due to a temporary earnings slowdown for Connecticut Water Service in the first half of 2017 compared to the year-ago period, but it's still expecting net income from its water business to grow in the full year compared to that achieved in 2016.

In addition, Connecticut Water Service is well positioned to capitalize on growth in its core markets. Maine is home to some of the most favorable rate increases in the country. That has allowed the company to increase its operating margin from 23.6% in 2011 -- the year before acquiring Maine Water -- to 31.6% in the first half of 2017. Plus, thanks to the company's small size, every acquisition in the region results in higher growth than it would in a larger water utility's system.

Which stock is the better buy?

For the foreseeable future, the regional Connecticut Water Service seems poised to deliver more shareholder value than Aqua America. The company has lowered expenses, increased the pace of growth acquisitions, and has plenty of room to grow within New England. That said, water stocks are generally more expensive than stocks in other industries. So although they offer reliable and less risky growth, investors looking for high rates of growth and much higher long-term returns will want to consider looking elsewhere.