Regulated Infrastructure Investments And Military Contracts Propel Revenue And Shareholder Value

Key Takeaways

• Expansion in regulated utility infrastructure and approval of new rate cases indicate a strong potential for revenue growth and improved net margins.
  
• Strategic contracts for water management at military bases, alongside a dividend increase, highlight financial health and commitment to shareholder value.
  
• Heavy reliance on regulatory approvals and uncertainties in rate cases and contract secures could lead to volatility in revenue, earnings, and compressed net margins.

Catalysts

Through its subsidiaries, provides water and electric services to residential, commercial, industrial, and other customers in the United States.

• The settlement with Cal Advocates allowing for the investment of approximately $573.1 million in capital infrastructure over three years signals a strong growth in regulated utility infrastructure, influencing future revenue through higher rates from 2025 to 2027. This expansion can impact net margins by allowing for more efficient operations and potentially lower per-unit costs of providing service.
  
• Approval of Golden State Water's general rate case by the end of 2024 with new rates effective from January 1, 2025, will directly lead to revenue increases, estimated at about $23 million compared to 2024 without accounting for additional revenues from advice letter capital projects. This proposed rate adjustment directly affects revenue growth.
  
• Expanded operations and management of water and wastewater systems at two new military bases with sizeable contracts, including a $378 million contract at Naval Air Station Patuxent River, should boost revenue from contracted services segment, impacting both top-line revenue and contribution to net income due to the typically stable and predictable cash flows associated with such long-term contracts.
  
• The dividend increase to $0.55 per share, marking a 70-year consecutive annual increase, showcases strong financial health and commitment to shareholder value, indirectly supporting the stock's value through attracting income-focused investors, which can increase share demand and potentially its market value.
  
• The significant cash provided by operating activities, jumping from $17.8 million in the previous period to $70.5 million, demonstrates a robust cash flow improvement, which is critical for funding ongoing capital expenditures without necessitating high levels of debt and thus positively affecting net margins by maintaining lower interest expenses.

Assumptions

• Analysts are assuming American States Water's revenue will grow by 5.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 18.8% today to 21.0% in 3 years time.
• Analysts expect earnings to reach $139.9 million (and earnings per share of $3.62) by about September 2027, up from $106.7 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 28.1x on those 2027 earnings, down from 28.4x 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 1.3% 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

• The company's heavy reliance on regulatory approval for rate increases and cost recovery could lead to volatility in revenue and earnings, particularly as decisions like the electric general rate case are subject to delay.
  
• Higher operating and interest expenses, as highlighted in the call, could compress net margins if these are not adequately passed through in rate cases.
  
• The pursuit of full revenue decoupling mechanisms and other regulatory mechanisms, while potentially beneficial, introduces uncertainty into earnings projections as their approval is unpredictable.
  
• Investments in capital infrastructure, while necessary for long-term growth, require significant upfront costs and depend on regulatory approval for cost recovery, potentially impacting cash flow and earnings in the short term.
  
• The competitive process for securing contracts to manage water and wastewater systems at military bases, though lucrative, carries uncertainty and can be subject to delays, impacting expected revenue growth from this segment.

Valuation

• The analysts have a consensus price target of $87.5 for American States Water based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $667.4 million, earnings will come to $139.9 million, and it would be trading on a PE ratio of 28.1x, assuming you use a discount rate of 5.8%.
• Given the current share price of $80.98, the analyst's price target of $87.5 is 7.5% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.