Defensives continue to rally
American Water Works (AWK) has definitely stolen the focus among defensives this year. So far, the stock has risen more than 30%—higher than its utility peers. The defensives have shown a solid rally in 2019 mainly due to investors’ leaning towards safe-haven stocks. American States Water (AWR) stock has risen ~13%, while the Utilities Select Sector SPDR ETF (XLU) has risen 15% this year. Aqua America (WTR) stock has risen ~27% year-to-date. American Water Works forms 2.6% in XLU.
American Water Works provides regulated water, wastewater services, and other water-related services to more than 14 million people in 46 states in the US and Canada. The stock has beaten its peers for the last several years. American Water Works has returned ~40%, including dividends, in the last year and more than 145% in the last five years.
American Water Works’ returns were mainly driven by its superior earnings growth. The company’s first-quarter earnings increased 14% year-over-year. American Water Works’ adjusted EPS grew by more than 8% compounded annually in the last five years. Utilities generally grow slowly due to their highly regulated operations. American Water Works will likely see higher earnings growth for the next few years. The company aims to grow its EPS 7%–10% compounded annually through 2023. The water utility expects to increase its rate base 7%–8% compounded annually by investing $8.0 billion–$8.6 billion in capital projects for the next five years.
Currently, American Water Works stock is trading at a dividend yield of 1.7%, which is close to the peer average. The company’s dividends grew more than 10% compounded annually in the last five years. American States Water and Aqua America yield 1.1% and 1.7%, respectively. American Water Works’ superior earnings growth largely influenced its dividend growth. Higher earnings growth for the next few years might maintain the company’s premium dividend growth.
Water utilities at a sky-high valuation
American Water Works looks expensive based on its valuation. The utility is trading at 31x its forward earnings based on the estimates for the next 12 months. The company’s five-year historical average valuation is ~25x. American States Water is trading at 27x its forward earnings, while Aqua America is trading at 29x its forward earnings.
Water utility stocks appear to be trading at a premium valuation. A valuation multiple close to 30x for a company growing at 7%–8% per year doesn’t seem justifiable. Even if the companies pay stable dividends or act as a hedge against the market downturn, the stocks look expensive.
Stock looks strong
American Water Works stock looks strong based on its simple moving average levels. The stock is trading at $118.4, which is almost 4% and 18% above its 50-day and 200-day moving average levels, respectively. The large premium to both of these support levels indicates strength in the stock. The levels close to ~$113.0 might act as a support for American Water Works stock in the short term. The company’s relative strength index was close to 65 as of July 3.
Target price and analysts’ views
Analysts have given American Water Works a mean target price of $113.1 compared to its current market price of $118.4. The target price indicates a potential downside of more than 4% for the next 12 months. Analysts’ views have been stable on American Water Works for the last few months. Among the 13 analysts tracking American Water Works stock, six recommended a “hold,” four recommended a “buy,” and three recommended a “strong buy.” The company hasn’t received a “sell” recommendation in more than a year.
American Water Works looks well placed to achieve its earnings and dividend growth for the next few years. Analysts are fairly positive on the stock. Currently, the company’s premium valuation appears to be a big concern.