California Water Earnings Take a Hit From the Drought

Image: California Water.

The drought in California has gotten publicity worldwide, as conditions have gotten so bad in the American West that residents have had to comply with mandatory usage restrictions and increased conservation efforts. For water utility California Water Services Group (CWT 1.98%), the drought has caused financial pain as well, and coming into Wednesday night's second-quarter financial report, investors had bid down shares of the utility company during the first half of the year as they waited for the drought's impact on the company's financials. California Water's actual results took a pretty big hit from the drought, and that should have investors thinking about what could lie ahead for the water utility going forward. Let's take a closer look at California Water and whether its latest results are just the beginning of a long rough patch for the company.

Not a drop to drink
The numbers for California Water's second quarter showed just how big an effect the drought has had. Revenue fell by 9% to $144.4 million, surprising investors who had expected a 5% increase for the period, with the utility blaming a large drop in accrued unbilled revenue on consumption decreases late in the quarter. Such financial impacts are common for utilities, and they showed up much more dramatically in the company's net income, which plunged by 43% to $9.8 million. Earnings of $0.21 per share were far less than the $0.37 per share consensus forecast among those following the company.

Looking more closely at the results, California Water's performance reflects a number of offsetting factors. In particular, various accounting mechanisms, including the modified cost balancing account and the water revenue adjustment mechanism, help to balance out the impact of large short-term fluctuations resulting from changing market conditions. For instance, balancing-account revenue rose $2.1 million to offset some of the lost revenue, and the water revenue adjustment mechanism will kick in once the unbilled revenue actually gets billed to customers.

The drought had some positive impacts on California Water as well. Operating expenses fell 5%, with water-production expenses declining by 14%. Water production in total fell by more than a fifth because of the restrictions, and while that hurt sales, it also reduced the utility's costs. Still, overhead expenses rose by 11%, with pension and other labor-related costs contributing to the climb.

CEO Martin Kropelnicki took the results in stride. "Our California customers are doing a great job at reducing their water consumption," Kropelnicki said, and "we continue to take a customer-first approach and are working hand-in-hand with customers and communities to help them continue to hit their water conservation targets this summer." Given the tough situation for the company, California Water is doing its best to walk the fine line between supporting customers and seeking higher earnings.

Can California Water recover?
Going forward, California Water thinks it can treat shareholders well even while serving state residents. "We will continue our customer-first approach while continuing to focus on operating efficiently and investing prudently in capital to deliver results for our shareholders and high-quality, reliable water service to our customers," Kropelnicki said.

One move California Water made to boost its financial prospects was to apply for a rate increase in all of its regulated operating districts within California. Filed earlier this month, the rates would take effect at the beginning of 2017, and California Water hopes to raise rates by about $95 million in 2017 and a further $45 million over the following two years. The higher rates would help support capital spending of almost $700 million between 2016 and 2018, which the utility says will allow it to keep providing a safe and reliable water supply.

Looking forward, the beauty of a regulated utility is that with the help of regulators, companies can request rate changes that reflect the economic conditions that they're going through. If the drought continues well into the future, the poor results that California Water saw this quarter will only serve as evidence of the need for higher rates to compensate. The utility won't produce huge amounts of growth, but with a 3% dividend yield and the regulatory backstop helping it, California Water should weather the drought without endangering its status as a stable investment for risk-averse investors.