Momentum In The Spotlight: American Water Works Company Inc. (AWK)
American Water Works Company Inc. (NYSE: AWK) is one of the new inclusions in our May 2016 portfolio of US momentum stocks. Here is a US water utility that is blitzing the performance of the S&P 500, highlighted in Figure One below. At first glance it looks like a stock that is due to see some heavy profit taking after a great run; however, upon closer look there are some interesting dynamics that could see buying continue to support the current trend.
The company has two main markets to which it provides services: firstly it has a regulated business, which is responsible for 87% of revenue, providing services to residential, commercial and industrial customers. The second is its market-based operation, which accounts for 13% of revenue, servicing military bases, municipalities, industrial and commercial clients which are not subject to regulation.
Figure 01. AWK vs S&P500
Source: Bloomberg, Updata, Rivkin
Since going public in 2008 with an IPO price of US$21.50, AWK has not experienced one negative year, which has helped the stock achieve a market capitalization of US$13.15 billion based on the current share price of US$73.93.
Being a utility company, the beauty of AWK is in its government contracts. As is the case for Australian health insurers, AWK is exposed to escalting costs, but these are underwritten via government contracts that allow it to increase prices to its 15 million customers to pay for the works required. The result? Earning growth despite increasing cap expenditure. Data provided by AWK show that over 25% of pipes are seventy years or older, meaning there is a need for heavy spending on upgrades in the next few years, equating to higher rates. Based on this and other opportunities, including regulated acquisitions, growth in revenue is expected to be between 7% to 10% in the next year.
Figure Two highlights the relative fundamental performance compared with AWK’s peers. While its earnings per share (EPS) & dividend yield are lower than some competitors, it has outperformed significantly on price performance, operating profit margin & revenue growth. Part of this price performance can be attributed to the expected growth based on investments and acquisitions in the next few years, as discussed above.
Figure 02. AWK vs Global Peers
Source: Thomson Reuters, Rivkin
Recent quarterly reporting showed that earnings per share was $0.46 as operating revenue increased from US$698 million to US$743 million, allowing the quarterly dividend to be increased by approximately 10.3% to 37.5 cents.
Based on my calculations, AWK’s forecast earnings growth of 7.1% for 2016 and 8.0% in 2017, while not guaranteed, is certainly bolstered by the company’s ability to on-cost its spending increases. With a 2016 forecast price to earnings multiple of 27.85, the price earnings growth ratio is 3.92 and therefore it certainly isn’t cheap. Therefore, one would be relying upon a strong tailwind of price momentum and a trend that favours defensive stocks, so we will be nimble when it comes time to sell this one if momentum slows.