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What American Water Works' Management Wants You to Know About Its Future

By Scott Levine - May 27, 2016 at 12:56PM

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The company reported a great start to the year, but what is it doing to ensure that the smooth sailing will continue?

The nation's largest water utility, American Water Works (AWK 3.13%) provides water and wastewater services to approximately 15 million people in 47 states as well as Ontario, Canada. The company usually attracts attention to its regulated businesses segment -- 87% of its total operating revenue in fiscal year 2015. After it has booked another solid quarter, its other business endeavors also deserve a look. Let's take a look at some highlights from the conference call to find management's perspective on where the company is headed.

Time is key

Expanding American Water Works' market-based business segment, Keystone Clearwater -- a $133 million acquisition in 2015 -- provides water and related services to natural gas exploration and production companies in the Appalachian Basin.

Whereas Keystone only had 20% market share when American Water acquired it, that figure has grown closer to 30% as it picked up several large customers during the quarter. On the conference call, Susan Story, American Water's President and CEO, suggested that the long-term, optimistic outlook for Keystone remains intact:

We believe our business model, growing market share and solid balance sheet for the business will be a competitive advantage for us as the market recovers and other water services providers have found it difficult to survive.

The business didn't meet the company's expectations, reporting a net loss of $1 million, or $0.01 per share. And contrary to prior expectations, management doesn't believe it will be accretive to earnings for FY 2016. Nonetheless, management recognizes gains made in the quarter.

Serving our soldiers

Elaborating on the market-based businesses segment, management recognized opportunities in the Military Services Group. Currently, American Water provides services at 11 military bases. This will grow to 12 when it takes over operations at Vandenberg Air Force Base in California in June.

While in the short term, management anticipates lumpiness in revenue for the remainder of 2016 from the Military Services Group due to federal budgetary constraints, they are keen on the future. Identifying increased activity in the Requests for Proposals, management reports that it is active in nine of the current proposals that the Department of Defense has out.

Another opportunity that may emerge from the company's dealings with the military is in providing capital upgrades related to storm water services -- an area that had not been previously identified by the company but could be beneficial in the future.

Image source: American Water Works Investor Presentation.

Speaking to this, Linda Sullivan, Executive Vice President and CFO, said that the company is "working to get clarifying language so that on the bases we serve, we would have an additional opportunity to help them address their needs from a storm water standpoint. So we see that as a potential opportunity in the future."

Other opportunities 

American Water also seeks to leverage its proficiency in the regulated businesses segment to grow its market-based businesses segment. According to Story:

Now in terms of growing the business ... we believe at American Water that there is enough opportunity related very tightly to our core competency that we like to keep our growth engines related pre-directly to water and wastewater.

In addressing this approach, management cites a pilot project at a school on Long Island that uses the company's water main system with a geothermal system to heat and cool the building. Due to its excessive costs, geothermal hasn't gained favor. Should American Water figure out how to reduce the costs by using its already installed infrastructure to make the systems cost effective, the opportunity could be substantial. Additionally, management recognizes that many military bases are striving to become net-zero installations, and the geothermal technology could reduce energy costs between 30% and 50%.

Besides geothermal, American Water sees opportunity in desalination; it's in the process of building a facility in Monterey, California. Management reported that the project has been delayed and will probably not start construction until mid to late 2018. Like geothermal, desalination sounds good in theory, but the high costs associated with the projects make it a less favorable option. If American Water can find a way to make it cost-competitive with other systems, the opportunity is ample -- not just in drought-ridden California but in coastal locations throughout the country. 

The takeaway

According to management, American Water Works has conservatively forecast steady growth into 2020. But the company isn't turning on cruise control; it's seeking new opportunities to grow. Investors should watch for growth in the market-based businesses. Success in these endeavors may make an already attractive company even more so. 

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