Regulatory Compliance And Acquisitions Will Create New Opportunities In Water Services

Key Takeaways

• Strategic capital investments and regulatory compliance are expected to drive revenue growth and enhance earnings through infrastructure and rate base expansion.
  
• Acquisitions and customer affordability initiatives aim to expand the customer base and stabilize revenue, supporting efficient operations and profitability.
  
• Regulatory and financial challenges could pressure earnings and net margins, with uncertainties in rate adjustments and increased operational costs impacting revenue and returns.

Catalysts

Through its subsidiaries, provides water and wastewater services in the United States.

• The company's focus on accelerating capital investments, particularly in infrastructure renewal and regulatory compliance like the EPA's Lead and Copper Rule Improvements, is expected to drive rate base growth, which will positively impact revenue and earnings.
  
• The acquisition strategy, exemplified by recent acquisitions such as the Butler Area Sewer Authority in Pennsylvania, expands the customer base and contributes to the regulatory asset base, enhancing future revenue.
  
• Expected rate base growth of 8% to 9% over the next decade is poised to underpin consistent earnings growth, driven by strong capital execution and efficient cost management, which supports net margins.
  
• The company's initiatives in customer affordability and expanded affordability programs are intended to enhance customer relationships and stabilize revenue, potentially leading to improved operational efficiencies and net margins.
  
• Strategic investments in the Military Services Group and expanded projects could offer additional revenue opportunities and incremental earnings growth, thereby impacting overall profitability positively.

American Water Works Company Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming American Water Works Company's revenue will grow by 7.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 21.8% today to 22.7% in 3 years time.
• Analysts expect earnings to reach $1.3 billion (and earnings per share of $6.36) by about December 2027, up from $983.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 26.5x on those 2027 earnings, up from 25.6x today. This future PE is greater than the current PE for the US Water Utilities industry at 23.8x.
• Analysts expect the number of shares outstanding to grow by 0.45% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.92%, as per the Simply Wall St company report.

American Water Works Company Future Earnings Per Share Growth

Risks

• Concerns regarding the cybersecurity incident and its potential impact, even though currently assessed as immaterial, could still raise investor concerns about future costs or risks associated with maintaining network security, potentially affecting net margins or earnings.
  
• The increased operational and maintenance costs, such as employee-related expenses and production costs, could pressure net margins if not adequately offset by revenue increases.
  
• Difficulty in obtaining rate increases in certain jurisdictions or unfavorable rate case outcomes (e.g., in Pennsylvania) might lead to challenges in recovering costs or achieving expected returns, impacting earnings and revenue growth.
  
• Higher financing costs due to increased long-term debt or planned equity issuances to fund the capital investment plan could dilute earnings per share and affect net margins.
  
• Regulatory uncertainties, such as the outcome of decoupling measures in California or potential delays in rate cases, could pose a risk to revenue stability and the company's ability to predictably manage earnings growth.

Valuation

• The analysts have a consensus price target of $142.18 for American Water Works Company based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $164.0, and the most bearish reporting a price target of just $124.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $5.5 billion, earnings will come to $1.3 billion, and it would be trading on a PE ratio of 26.5x, assuming you use a discount rate of 5.9%.
• Given the current share price of $129.18, the analyst's price target of $142.18 is 9.1% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.