American Water: Flowing Profits

08/19/2014 8:00 am EST

Focus: STOCKS

David Dittman

Chief Investment Strategist, Australian Edge, Canadian Edge, & Utility Forecaster

Our latest spotlight growth stock is the largest and most geographically diversified investor-owned water and wastewater utility in the US, explains David Dittman, editor of The Utility Forecaster.

American Water Works Co. (AWK) has operations in 32 states and Ontario, Canada, serving approximately 15.6 million people. Its regulated utilities, which serve 3.3 million customers across 20 states, generate approximately 90% of total revenue.

Regulated utility operations are most heavily concentrated in New Jersey (24% of regulated revenue), Pennsylvania (21.7%), Illinois (9.2%), Missouri (9.2%), Indiana (7.4%), California (6.3%) and West Virginia (5.5%).

The majority of its regulated base is made up of residential customers (91%), who comprise more than 60% of regulated operating revenue. This is a predictable, rather inelastic demand base.

Non-regulated businesses mainly include the operation and maintenance of water and wastewater systems for municipal governments and the US military.

American Water plans to invest $5.8 billion over the next five years, with the majority of the budget allocated to its regulated operations.

Management is targeting operating expense reductions of $920 million through 2018 via software updates, plant automation, and the introduction of new technologies for water treatment and management.

The company is also focused on minimizing growth rate across its customer base, with a target of no more than 2% annual increases. Requests in its rate cases for operating expense recovery via pass-throughs to ratepayers versus recovery on investments have fallen substantially in recent years.

This strategy, including no anticipated needs for equity financing and an expectation of reaching free cash flow-positive status by the end of 2017, should provide more opportunity for the company to meet its 7% to 10% EPS growth target and investment plans without alienating customers and regulators.

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