Nothing More Precious than Water

12/23/2008 10:40 am EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad, editor of Utility Forecaster, says water utilities are at their cheapest prices in years, and he likes one in particular.

It’s still no time to play the hero and try to time a bottom. But it is a fine time to be looking to invest incrementally in high-quality investments backed by companies with strong businesses from a wide range of industries.

Regulated utilities remain my favorite sector here in late 2008. First, the major utility averages are nearly a third off their highs. Dozens of strong companies fresh from reporting robust third-quarter earnings are selling at barely book value and yielding up to 6%. Payout ratios are coming in around 60% or less, and there are few, if any, credit challenges.

When inflation does again raise its ugly head, the group will become vulnerable, as it has in the past. But until that happens, utilities are set to lead the eventual market recovery, and they’ll hold their own in the marketplace as well.

Water utilities are at their cheapest levels since early 2000, including newly spun-off American Water Works (NYSE: AWK).

In early 2003, Germany’s RWEpaid a hefty premium for American Water Works. Five years later, new management took a $1-billion write-off to unload the company, handing investors a chance to buy the country’s biggest water utility for 75% of book value and a yield two times pre-takeover levels.

Since the April initial public offering, American Water has written off hundreds of millions [of dollars] in goodwill and overhauled oversight practices that had gone soft under RWE. But with third-quarter earnings surging 11% on a 6.2% revenue jump, its fortunes are building again.

Water utilities’ steadiness is their primary strength. American, however, is on track to grow earnings close to 10% a year in two ways. First, its regulated utility business is adding new customers as it builds and buys nearly $1 billion in supply infrastructure this year. Through September, it had won $73.9 million in new rates and has another $267.6 million awaiting final order in nine states.

American Water’s other growth avenue is managing systems owned by municipalities and military bases. Two new contracts will add $677 million in military business over 50 years, as American continues to use its unmatched reach to snare business.

Like every company investing heavily in infrastructure, American Water faced challenges getting capital this year. With that crisis now easing, the shares should begin to enjoy a sizable premium to stocks in other industries, translating into solid capital gains.

Buy American Water Works up to 23. (It closed at around $22 Monday—Editor.)

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