Strategic Acquisitions And Infrastructure Investments Poised To Amplify Revenue Streams

Key Takeaways

• Aggressive investment and acquisition strategies indicate potential for significant growth and revenue expansion not yet fully valued by the market.
  
• Successful rate cases and strategic leadership realignment suggest strong regulatory support and operational efficiency, potentially undervalued by investors.
  
• Regulatory challenges and a lower ROE in Pennsylvania indicate a riskier business environment that could impact future earnings and investor confidence.

Catalysts

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

• The anticipation of revenue increases from general rate case proceedings and infrastructure mechanism filings effective in the latter half of 2024 indicates a positive shift in revenue generation, enhancing future growth potential and possibly rectifying undervaluation by increasing profitability.
  
• The commitment to invest $1.4 billion in capital projects reflects an aggressive strategy to enhance infrastructure and services, potentially increasing the asset base and long-term revenue, which could be undervalued by the market not fully recognizing the future returns from these investments.
  
• The acquisition strategy, with nearly $500 million in acquisitions under agreement, suggests aggressive expansion that could substantially increase customer base and revenue streams, potentially impacting earnings positively if the market has not fully priced in these future growth aspects.
  
• The successful completion of rate cases in multiple states that authorized 100% of the capital investments made demonstrates the company's ability to recover investments and earn a reasonable return, indicating a strong regulatory environment that supports growth and could lead to upward adjustments in stock value as these victories impact future earnings.
  
• The leadership team expansion and strategic realignment, focused on enhancing the company's capacity for executing its strategies and operations efficiently, might be a forward-looking catalyst that the market hasn’t fully priced in, suggesting potential undervaluation especially if these changes lead to improved operational efficiency and profitability.

Assumptions

• Analysts are assuming American Water Works Company's revenue will grow by 7.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 21.9% today to 22.9% in 3 years time.
• Analysts expect earnings to reach $1.2 billion (and earnings per share of $6.29) by about August 2027, up from $956.0 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 27.1x on those 2027 earnings, down from 28.9x today. This future PE is greater than the current PE for the US Water Utilities industry at 24.4x.
• Analysts expect the number of shares outstanding to grow by 0.1% 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 recent Pennsylvania rate case resulted in a significantly lower return on equity (ROE) than requested (9.45% vs. 10.95%), indicating an increasingly risky business climate, which could potentially reduce future earnings and impact investor confidence.
  
• Concerns about the pace and scaling of infrastructure investments in Pennsylvania following the rate decision may lead to reallocating capital to other states, potentially affecting the company's revenue growth and investment returns in its largest market.
  
• Ongoing legal challenges and regulatory process delays, especially in Pennsylvania (e.g., Butler Area Sewer Authority acquisition appeal), could slow down acquisition timelines and impact expected revenue increases, affecting overall earnings.
  
• The need for continued investment in infrastructure across all states due to deteriorating systems and resiliency issues requires significant capital, which, if not adequately returned through rate cases, could strain the company's net margins and financial performance.
  
• Initiatives to maintain customer affordability while balancing the investment needs may require innovative tariff approaches and increased assistance programs, which could impact revenue growth if these efforts do not offset the costs associated with substantial infrastructure investments.

Valuation

• The analysts have a consensus price target of $144.72 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 $131.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $5.4 billion, earnings will come to $1.2 billion, and it would be trading on a PE ratio of 27.1x, assuming you use a discount rate of 5.8%.
  
• Given the current share price of $141.57, the analyst's price target of $144.72 is 2.2% 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.