Aqua America (WTR) — a conservative holding in our model portfolio — produced a more than 22-fold return over the past quarter century, explains sector expert Roger Conrad, editor of Conrad's Utility Investor.
The simple formula for those gains: Acquiring small water systems unable to meet safe drinking water standards, upgrading them and passing along profits as consistent dividend growth.
Last month, Aqua augmented its wealth-building recipe by adding regulated natural gas distribution utilities to its list of acquisition targets. The first purchase is Peoples Gas, Pittsburgh’s principal natural gas utility, currently owned by privately held SteelRiver Infrastructure Fund.
Forged from merging the former Phillips Gas & Oil (2011), Equitable Gas (2013) and Delta Natural Gas (2017), Peoples is very much a regional fit.
The post-merger company will have 77 percent of its rate base in Pennsylvania, with the rest of its 1.7 million customers spread over 10 states. The 70 percent water/30 percent natural gas split offers multiple opportunities to add water customers in gas territory and vice versa.
Another attraction is Peoples’ annual rate base growth of 8 to 10 percent through 2021. That compares with 7 percent yearly for Aqua’s water utilities. Most growth is locked in with automatic recovery of investment such as pipe replacement. It will be further augmented by customer growth and future acquisitions.
Management expects the merger to be accretive to earnings starting in late 2019, following what should be smooth regulatory approvals in Kentucky, West Virginia and Pennsylvania.
In the meantime, Aqua continues to grow its water utility operations including wastewater, with CEO Chris Franklin projecting roughly 25 percent rate base growth between now and the merger’s close. The big question I have about this deal is whether it’s really a tacit admission Aqua’s strategy of acquiring municipal water utilities isn’t producing to expectations.
That’s still my suspicion. But water/gas convergence is a proven business model that should actually reduce risk, even as added scale increases opportunity to grow earnings. And in any case, it’s hard to see any real signs of weakness in Aqua’s very strong third quarter results.
Investors’ initial reaction to this deal was negative. But the result is Aqua is now trading at a great entry point, with the lowest valuation in the water sector and enhanced growth prospects. Buy below 35.
