The average human body is generally made up by a considerable amount of water – more than 50% of your body weight is water.
Water is at the heart of all we do.
Without water, a human being cannot survive.
And so one could argue that water is more important than oil, gold, or pretty much anything else out there.
Why care about this?
You should care because there’s a good chance you can profit with this information.
See, there’s a company out there providing water, electricity, and wastewater services to thousands of people – and they’re handsomely profiting as a result.
Wouldn’t you want to profit from that as well?
You have an opportunity to do just that.
That opportunity is American States Water Co. (AWR).
This company has been providing valuable water services to thousands of customers for decades, enriching their shareholders in the process.
The company has claimed in past annual reports that water is more valuable than gold. I can’t say I disagree.
If you found yourself stranded on a deserted island, you’d rather have clean drinking water than gold. There’s no doubt about that.
American States Water provides operations, maintenance, and infrastructure services for water and wastewater services. They also provide regulated electricity utility services.
The company operates in three segments: Golden State Water Company – Water Utility, 70% of fiscal year 2016 revenue; American States Utility Services, Inc., 22%; Golden State Water Company – Electric Utility, 8%.
Think of how many people are being born every single day.
The Earth’s population is rapidly expanding all the time.
You have an increasing demand for water not only for personal use, but also for industrial use.
Water is used in almost everything we do.
Yet, the amount of water in the world today is the same as it was billions of years ago.
So you have more and more people, yet the commodity necessary to sustain life isn’t increasing.
As such, you have to like the idea of investing in companies that control water supply and usage.
That’s where an investment in a water utility like American States Water comes in.
This business has grown at a comfortable rate over the last 10 years, though big growth rates isn’t what an investor is seeking when looking at a water utility.
Rather, one is looking for stability and low risk, which is what this business model offers.
Their fiscal year ends December 31.
Revenue has grown from $301 million in FY 2007 to $436 million in FY 2016. That’s a compound annual growth rate of 4.20%.
Very respectable top-line growth; however, revenue has essentially gone nowhere since FY 2011.
Earnings per share improved from $0.81 to $1.62 during this 10-year period, which is a CAGR of 8.01%.
The excess bottom-line growth appears to have been largely driven by margin expansion. While that’s a wonderful thing, making the business more appealing and high quality than it was a decade ago, one wonders how much more potential for further margin potential still exists.
Nonetheless, this investment is for a conservative investor seeking a growing dividend.
And this company is one of the best in the world at delivering on that.
American States Water increased its dividend for 63 consecutive years.
That’s one of the longest dividend growth streaks in the world, putting this stock in rarefied air.
As such, this stock easily qualifies as a “Champion” on David Fish’s Dividend Champions, Contenders, and Challengers document, which tracks more than 800 stocks with at least five consecutive years of dividend raises.
But company hasn’t given token dividend raises simply to appease shareholders and keep their streak alive.
No, they’ve actually meaningfully increased their dividend regularly and consistently over the last decade.
The 10-year dividend growth rate stands at a hearty 7.6%.
That’s inflation-beating dividend growth from a rock-solid business that’s about as reliable as it gets.
Meanwhile, the payout ratio is fairly modest, at 55.7%.
That leaves plenty of room for solid future dividend increases, especially if the company continues to grow at a mid-single-digit pace annually.
The one drawback to the dividend might be the current yield. It’s sitting at just 1.9%.
That’s lower even than the stock’s five-year average yield of 2.2%, which is already arguably fairly low.
Not much current income to be had when a yield is down here.
But one has to weigh that low yield against the safety of the dividend, knowing that you can almost set your watch to the dividend payments and increases.
Looking at the balance sheet further shows a well-managed firm.
The long-term debt/equity ratio, at 0.65, is fairly healthy.
And the interest coverage ratio is over 5.
These are good numbers for any utility. Furthermore, the company hasn’t loaded up on debt in recent years.
Profitability is surprisingly strong, as hinted at earlier.
Over the last five years, the company has averaged annual net margin of 12.94% and annual return on equity of 12.55%.
These are impressive numbers for a regulated utility. Net margin, for perspective, was routinely in the upper single digits less than 10 years ago.
I’ve said many times before, I like to invest when the odds are on my side.
That’s basically what you see when you look at my entire portfolio – a real-life and real-money collection of some of the highest-quality dividend growth stocks in the world.
I invest in companies with easily understood business models, lengthy track records of earnings and dividend growth, and great odds that their products and/or services will be in strong demand for the next 10 years and beyond.
Well, what could possibly be in more demand than water?
Try living without water for just one week and see how far you get.
Water is necessary for life, yet we have to work with the same amount of water that we’ve always had.
So when you have more people clamoring for a limited product, demand goes up.
And when demand goes up, prices naturally do as well.
That’s where I, as a long-term dividend growth investor, see opportunity.
Shares are trading hands for a P/E ratio of 29.2 right now, which seems unfortunately pricey.
That’s quite a bit higher than the broader market. And it’s also substantially higher than the stock’s own five-year average of 24.0.
Investors are also currently paying much more for the company’s revenue than the average paid over the last five years.
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 7%.
I’m giving the stock the benefit of the doubt here, considering the most recent dividend increase was under 6%. In addition, further margin expansion potential seems limited relative to the past, which could thus limit excess top-line growth. That doesn’t bode well for EPS and dividend growth when looking at flat-ish sales growth over the last 4-5 years.
That said, the payout ratio is moderate, the company is managed extremely well, the business model is about as stable and necessary as it gets, the product is ubiquitous, and the long-term track record speaks for itself.
The DDM analysis gives me a fair value of $36.38.
The stock looks overvalued here, but one could argue the quality and reliability is worth a premium. Whether that’s worth this much of a premium is a tough argument to make, however.
Bottom Line: American States Water Co. (AWR) provides one of the most valuable products in the entire world: water. More and more people will need ever greater supplies of water in the future, and so it makes sense to have some exposure to high-quality water companies with longstanding track records of rewarding shareholders with rising dividends and rising profits. And with 63 consecutive years of dividend raises, this is one of the surest bets out there. It might behoove one to wait for a pullback, but this stock should definitely be on every dividend growth investor’s radar.
— Jason Fieber