Better Buy: American Water Works vs. American States Water

Although President Trump's interest in repairing the nation's infrastructure had seemed auspicious for water utility stocks, it's unclear whether they will actually benefit. Nonetheless, water utilities remain ideal investments for investors of a more conservative bent. Usually, these stocks don't aspire for growth like that of the trendiest tech stocks, but they're sound investments in a timeless commodity -- one whose value will never waiver. 

So, let's consider two of the leaders in the industry, American Water Works (AWK 0.83%) and American States Water (AWR 2.36%), to see which company affords investors the best choice in terms of getting their feet wet (or wetter) with a water utility investment.

Image source: Getty Images.

Dipping our toes in the water

The only water-utility member on the S&P 500 and Dow Jones Utility Average, American Water Works has been providing water and wastewater services to millions of customers for more than 130 years. American Water Works, the largest publicly traded water service provider by market cap, provides water service in 47 states and Ontario. 

Although it can't trace its history to the 1800s, American States Water has been satisfying customers' thirst for a long time; the company can trace its roots back to 1929. Don't let its name fool you. Besides providing water service to about 261,000 customers throughout 10 counties in California, the company also distributes electricity to approximately 24,000 fun-seekers in Southern California's recreational area, Big Bear.

To round out the introduction to these companies, let's compare them on some important metrics.

Data source: Morningstar.

Now that we've got our bearings, let's weigh the companies against each using three perspectives. 

Is the tide rolling in or away?

With over 15 customers, it's no surprise American Water Works reports higher revenue than American States Water. The important question, though, is which trend the companies are following.

AWK Revenue (Annual) data by YCharts.

Unsurprisingly, neither company has reported meteoric growth; nonetheless, American Water Works, unlike American States Water, has successfully grown its top line at a steady pace. Although water stocks report organic growth, rate increases, and improved efficiencies from infrastructure upgrades, it's not as significant as growth from acquisitions. Over the past three years, American Water Works has committed $410 million to acquisitions, adding 41,000 customers. In fact, its ability to execute acquisitions is one of the company's primary competitive advantages.

Born in 1996, Puddles is American Water Works' corporate mascot. Image source: American Water Works.

Besides the fact that American States Water has completed none, its revenue is actually ebbing. Clearly, the fact that the company primarily operates in California -- which recently suffered from a record drought -- has wreaked havoc on its top line.

In its first-quarter 2017 earnings presentation, American Water Works forecast regulated businesses customer base through acquisitions between 1% and 2%. Although in a recent investor presentation, American States Water articulated its goal to grow its base through acquisitions, the company's recent history doesn't inspire much confidence that this will amount to much -- if any. Further speaking to the future, American Water Works projects its earnings per share (EPS) to rise at an compound annual growth rate (CAGR) of 8% to 10% through 2021. American States Water is also guiding for EPS to climb 8%, but I'm skeptical of whether this will be achieved.

Winner: American Water Works

A trickle or roaring white water?

One of the most important considerations with water utilities is the companies' investments in asset renewal, for upgrading aging infrastructure ensures that companies can improve efficiency and grow their bottom lines. Ideally, companies are able to fund these capital expenditures from operational cash flow instead of relying too heavily on debt.

AWK Cash from Operations (Annual) data by YCharts.

The fact that American Water Works has a geographically diversified customer base has helped it generate operational cash flow at a steady clip over the past three years despite adverse weather conditions. Conversely, American States Water has suffered tremendously. Although American States Water also deals in electricity distribution, it's not enough to compensate for the deleterious effect the California drought has had on the company's financials.

Maintaining infrastructure -- water mains and treatment plants, for example -- is vital to a water utility's success, and it doesn't come cheap; consequently, investors want to see that management's reinvestment in the business is effective. Again, in this regard, American Water Works excels. In fiscal 2016, the company reported a 34.9% O&M (operations and maintenance) efficiency ratio, a modified operating margin for its regulated businesses. American States Water doesn't break out this number in its earnings report, but based on figures from Golden State Water Company -- its regulated water business -- reported a ratio of 72%. Moving forward, American Water Works forecasts improving this ratio to 32.5% by 2021, while American States Water has provided no guidance. 

Clearly, American Water Works has far exceeded American States Water's ability to generate a return on its invested capital, and it's fair to conclude that it will continue to do so in the future.

Winner: American Water Works

Drowning in debt?

So far, it seems American Water Works is eating American States Water's lunch. But let's take one last look at the companies' balance sheets.

Date source: Morningstar and author's calculations.

Of the two companies, American States Water seems more conservative in its approach toward taking on debt. That's not to say American Water Works is in trouble, for it has proven to be adept at managing a larger debt load for several years. Nonetheless, American States Water appears to have the more enviable balance sheet.

Winner: American States Water

And the winner is...

At this point, American Water Works offers more enticing waters for investors to dive into. The company far outperforms American States Water in terms of revenue growth and cash flow, and though it seems to burdened with heavy debt, the company's strengths suggest the debt should not be a problem moving forward. Between EPS growth and O&M efficiency figures, management has provided ample material for investors to monitor to ensure that the company's business remains sound. American States Water, at this point, appears far more challenged by its customer base -- concentrated in California -- to offer a more compelling proposition than its competition.