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1 Dividend Stock to Buy in February

By Maxx Chatsko – Updated Apr 26, 2019 at 11:02AM

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Wall Street soured on this water utility after it announced a massive acquisition in a new industry, but that could change when full-year 2018 earnings are reported.

Big changes could be on the way for the nation's second-largest water utility. In October 2018, Aqua America (WTRG -1.88%) announced its intention to acquire Pittsburgh-based natural gas utility Peoples for roughly $4.3 billion. If approved by regulators, the transaction should close sometime in mid-2019.

It was a strange move for a slow-and-steady water utility built on significantly smaller acquisitions of local water infrastructure networks. What's more, Wall Street wasn't sure of the financial implications of the deal. How could a $6.4 billion water utility finance such a behemoth deal without imperiling the balance sheet?

Investors had no shortage of good questions. Management has already provided some answers, and when the company reports full-year 2018 earnings in mid-February, it will likely offer more. A deeper dive into the details and possibilities of owning Peoples shows there's a lot to like about the proposed deal -- in fact, I think it makes Aqua America a solid buy this month ahead of earnings.

Check out the latest Aqua America earnings call transcript.

A plant growing in a coin jar.

Image source: Getty Images.

By the numbers

The proposed acquisition weighs in at $4.3 billion, but that includes $1.3 billion in debt owned by Peoples. In other words, Aqua America only needs to finance the other $3 billion. It has proposed to do so with about $0.8 billion in term debt and $2.2 billion in equity, such as common stock, or equity-linked securities, such as bonds or convertible debt.

That's not to be taken lightly for a water utility currently sitting at a market cap of about $6 billion. However, it's important to note a couple of things. First, the acquisition will add more assets than debt, and would actually lower Aqua America's leverage ratio and provide greater financial flexibility. Second, any equity offering should have a muted effect on the share price, since the company's market cap will increase in lockstep with the share count.

Another important consideration: Peoples is owned by SteelRiver Infrastructure Partners, which is owned by pension and insurance funds that prize stability. That means they likely won't be looking to offload the shares of Aqua America received in the transaction, and might prefer convertible bonds instead of common stock anyway, which would spread out the share dilution over time. 

Natural gas meters outside of a building.

Image source: Getty Images.

The acquisition looks pretty favorable to investors

The combined company, which would trade under a new name, would offer shareholders some intriguing growth potential on account of its size. Most important, it would be more efficient at generating profits from its rate base than Aqua America can be alone.

That stems from the fact Peoples operates in one of the best markets for natural gas in the country, and also owns infrastructure feeding large industrial and commercial customers. Given Appalachia's poor renewable energy potential with current technology and bountiful natural gas reserves, the fossil fuel figures to have considerable long-term staying power. That helps to explain why the natural gas utility is growing at a faster clip than a water utility.

Metric

Aqua America

Peoples

Combined Company

Enterprise value

$9.0 billion

$4.3 billion

$13.3 billion

Rate base

$5.0 billion

$2.2 billion

$7.2 billion

Annual rate base growth, 2019-21

7%

8% to 10%

7.3% to 7.9%

Customers

1 million

743,000

1.74 million

Annual EBITDA

$489 million (est. 2018)

$289 million (est. 2019)

~$778 million

Annual EBITDA as % of rate base

9.8%

13.1%

10.8%

Source: Investor presentation.

The pro forma company would have no trouble keeping up Aqua America's streak of 74 consecutive years of dividend payments, including 28 increases in the last 27 years. The dividend yield now sits at a historically robust 2.5%.

Additionally, the combined company would be able to make a push to help privatize Pittsburgh's publicly owned water utility. The struggling utility has blundered its way into a myriad of issues: It's racked up $1 billion in debt, single-handedly held up the state's budget in recent years, and put customers at risk with health hazards ranging from lead leaching to microbial contamination. 

Aqua America and Peoples previously proposed to replace the city's water lines each time a natural gas line is replaced, saving time and money for residents. In return, each new water line would be owned by Aqua America and/or Peoples, which also proposed building a solar-powered wastewater treatment facility to further modernize Pittsburgh's infrastructure. City officials rebuffed the proposal, but a combined utility could make a stronger case. And with over 100,000 water customers in the area, it'd be a huge shot in the arm for the utility.

A bird's eye view of a wastewater treatment facility.

Image source: Getty Images.

Investors will win if this deal closes

The acquisition of Peoples isn't guaranteed to close. The next steps include completing the proper regulatory filings, securing financing through equity and debt offerings, and receiving approval from the state of Pennsylvania. Considering full-year 2018 earnings will be announced nearly four months after the original announcement of the acquisition, and the deal is expected to close in the middle of 2019, investors might expect management to provide a more detailed timeline for the road ahead soon.

Even without that, the information available today indicates the expansion into natural gas will provide healthy upside for Aqua America shareholders with a long-term mindset. It also makes Wall Street's pessimism appear a bit overdone. If management can wipe away some of the uncertainty tripping up Mr. Market on the earnings conference call later this month, then the stock may be able to return to its predictable ascension.

Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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