There's a saying on Wall Street: "Boring is beautiful." Sure enough, there's nothing glamorous about America's largest water utility, but its long-term shareholders aren't complaining. Over the last 15 years, shares of American Water Works (AWK 0.05%) have delivered an average annualized return of 11.6% that turned every $10,000 invested into $51,883. With dividends reinvested, that amount would have snowballed into $72,100.
You can probably think of a few stocks that have done better in that time frame. What makes this performance impressive is that it came with a fraction of the risk that tech investors were shouldering. American Water Works enjoys protections and advantages that make it one of the safer growth stocks on Wall Street. Here's why this "boring is beautiful" stock belongs in your portfolio.
America's only major pure-play water utility
Founded in 1886, American Water Works traces its roots to a band of entrepreneurs who joined forces in the post-Civil War years to bring clean drinking water to cities across America. By 1914, it was well on its way to becoming one of America's leading public utilities. After being purchased by a German energy company in 2003, it was spun back out as a public company again in 2008 in the biggest utility IPO in United States history.
Today, it provides water services to 14 million people in 24 states. While it's the largest public water utility, American Water Works still serves less than 5% of Americans. There are about 53,000 community water systems throughout America; 30,000 of them are investor-owned, while 23,000 are government-owned systems or individual wells.
Image source: Getty Images.
That may sound like a lot of competition, but the nature of water utilities makes it a huge opportunity for American Water Works.
Water utilities are highly regulated in the United States, so they must secure approval from the public utility commissions for each given region to operate in that area. In return for having their rates capped at a "reasonable" rate or an "allowed return," these utilities enjoy protection from competitors in those markets.
This means that American Water Works doesn't have to worry about competitors. The flip side is that it can't raise prices at will. In recent years, water utilities have averaged a return on equity of 9.61%, but American Water Works' is 10.46% -- near the maximum that public utility commissions are willing to green-light.
So, when your return on equity is capped, how do you grow earnings? You take on more customers.
Millions more customers are headed American Water Works' way
In October, American Water Works announced an agreement to merge with Essential Utilities in an all-stock deal.
The resulting company, which will be worth about $40 billion, will still be called American Water Works, and its current CEO, John Griffith, will remain in his position. The company's Camden, New Jersey, headquarters won't be changing.
What will change is American Water Works' rate base. The merger will add 1.9 million connections and $11.5 billion to American Water Works' current rate base of $22.1 billion.
Interestingly, Essential Utilities and American Water Works have both been in business for the same amount of time: 139 years. The deal brings a wealth of expertise to American Water Works, as well as 227 water treatment plants and 29,500 miles of transmission and distribution infrastructure.
In the meantime, American Water Works is adding to its empire elsewhere. Last quarter, it reported 87,000 new customer connections under agreement through deals totaling $535 million, including plans to add 47,000 customer connections through a deal with Nexus Water Group that will add $200 million to its rate base.
NYSE: AWK
Key Data Points
The company is serious about bringing on new customers, and will be helped in this by the fractured nature of America's water utility market. With the EPA estimating that $600 billion will be needed to repair aging water infrastructure nationally, many smaller firms or municipalities may accept buyouts rather than shouldering the costs of repairs on their own. This presents a great opportunity for American Water Works to add to its rate base and its bottom line.
A look at the fundamentals
With a forward price-to-earnings ratio of 21.1, American Water Works looks cheap next to the S&P 500, which has an average P/E ratio of 27.5. It also distributes a dividend that yields 2.6% at the current share price, more than double the S&P 500 average.
The company grew earnings by 8.3% year-over-year last quarter, while revenues climbed 9.7%. And on its Q3 earnings call in October, management reaffirmed its long-term target of 7% to 9% annualized growth for both earnings and dividends.
It raised its payout by 8.2% last spring, and has grown it by 143% over the last decade. That's well above the 37% inflation seen during that time frame, and a sign that management is serious about rewarding shareholders.
With a payout ratio of just 55%, the dividend is well supported, and management's plans to grow its rate base each year should allow it to meet its target.
American Water Works won't double your money within months, or even two years. But its industry-leading position in a sector people can't do without, its predictability, its hefty and growing dividend, and its long-term expansion plans make it a smart buy for investors seeking growth and stability.
