You must have water to live, but does your portfolio need water?
The stereotypical water utility is swimming in debt and pays a dividend. That's an odd combination, isn't it?
Consider Southwest Water (NASDAQ:SWWC). Over the last five years the stock has increased 70% -- an almost 12% compounded growth rate. Add in the dividend, which is currently a less than Motley Fool Income Investor-tempting 1.75%, and those results certainly beat long-term stock market returns. Remember, this is the low-risk (high-leverage) water business.
Ah, but Southwest's debt-to-equity (D/E) level sits at a miserly (at least in this industry) 52%. When compared with the 459% at industry giant Veolia Environnement (NYSE:VE) or the 143% at Aqua America (NYSE:WTR), Southwest has the financial flexibility to make acquisitions in the consolidating water business.
The comparison does not worsen when you look at the mid-tier companies. Consolidated Water (NASDAQ:CWCO), California Water Services (NYSE:CWT), and SJW (AMEX:SJW) have D/E ratios that range from 86% to 116%.
Southwest, like its peers, sells water to make money. The company, though, was a pioneer in writing long-term contracts to manage public and private water systems. When you can't own the water, you might as well make money managing it or treating it.
The company reported today that sales had increased 10% and net income soared 35% in its latest quarter. Ignore the spike in earnings. This is no high-tech jackrabbit. Analysts are looking for 10% long-term earnings growth and continued dividend hikes.
Does Southwest belong in your portfolio? Great investors such as Warren Buffett of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) say that near-term compounded growth will be unimpressive. Southwest looks to continue producing 10% growth, not including dividends, with a necessity -- water.
Mathew Emmert recommended California Water in the October 2003 issue of Motley Fool Income Investor. Since then the stock's returned 7.6%, beating the S&P, and still boasts a 4.12% dividend yield. Sign up for a free, 30-day trial to learn more.
Fool contributor W.D. Crotty owns stock in Berkshire Hathaway and Aqua America.
