Rate Hikes, Infrastructure Investments, And Sustainability Efforts Poised To Propel Growth

Key Takeaways

• Anticipated approval of rate increases in key regions expected to drive revenue growth through enhanced pricing structures, improving ability to cover costs.
  
• Investments in infrastructure and sustainability initiatives, such as solar generation, aim to improve service reliability, efficiency, and reduce long-term operating costs.
  
• SJW Group faces challenges including regulatory decisions, rising production costs, drought impacts, large capital expenditures, and increased borrowing costs affecting profits and revenue.

Catalysts

Through its subsidiaries, provides water utility and other related services in the United States.

• The anticipated approval and implementation of rate increases from local operations, including California and Maine, are expected to drive revenue growth through adjusted pricing structures, enhancing the company's ability to cover costs and improve margins.
  
• Investments in infrastructure, prominently through the $332 million 2024 capital expenditure plan, aim to bolster the reliability and efficiency of water and wastewater services, which could lead to reduced operational costs and therefore improve net margins.
  
• The expansion of eligibility and financial assistance programs, such as the Water Rate Assistance Program in Connecticut, may enhance customer retention and growth by addressing affordability and access, potentially leading to increased revenue through higher usage among served communities.
  
• The strategic approach to engage and negotiate with regulatory bodies and stakeholder groups for favorable rate cases and infrastructure investments, demonstrated by the settlements in California and improvements in Connecticut, could lead to more predictable and favorable regulatory outcomes, enhancing earnings predictability and growth potential.
  
• The company's focus on sustainability and environmental stewardship, through projects like solar generation and advanced acoustic leak detection, not only addresses regulatory compliance and community expectations but may also reduce long-term operating costs and support margin expansion through lower energy costs and efficient water loss management.

Assumptions

• Analysts are assuming SJW Group's revenue will grow by 3.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 12.5% today to 18.1% in 3 years time.
• Analysts expect earnings to reach $140.9 million (and earnings per share of $3.27) by about September 2027, up from $87.6 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $175 million in earnings, and the most bearish expecting $102.8 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 19.4x on those 2027 earnings, down from 22.0x today. This future PE is lower than the current PE for the US Water Utilities industry at 23.8x.
• Analysts expect the number of shares outstanding to grow by 2.97% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.8%, as per the Simply Wall St company report.

Risks

• Regulatory decisions may not fully align with SJW Group's revenue needs or growth forecasts, impacting net margins and revenue growth due to potentially lower rate increases or denied expense recoveries.
  
• Rising water production expenses, particularly from wholesaler rate increases and higher customer usage, could squeeze profit margins if not adequately offset by rate adjustments, affecting net income.
  
• The ongoing severe drought in Texas and resultant water usage restrictions may lead to lower water sales, impacting revenue, especially if the drought conditions persist or worsen.
  
• Large capital expenditure commitments, including the $1.6 billion over five years for infrastructure improvements and PFAS remediation, may pressure cash flows and earnings, especially if projected regulatory recoveries are not fully realized.
  
• Increased borrowing costs, as evidenced by the higher average borrowing rate for line of credit advances, could impact SJW Group’s financial expenses and net income, especially with plans to raise $160 million in long-term debt to pay down short-term borrowings.

Valuation

• The analysts have a consensus price target of $66.0 for SJW Group 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 $73.0, and the most bearish reporting a price target of just $63.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $777.3 million, earnings will come to $140.9 million, and it would be trading on a PE ratio of 19.4x, assuming you use a discount rate of 5.8%.
  
• Given the current share price of $58.79, the analyst's price target of $66.0 is 10.9% 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.