Greater than two years in the past, I said that California Water Service (NYSE:CWT) was richly valued and therefore traders ought to have waited for a correction of at the very least 20% earlier than buying the inventory. Since my article, the inventory has remained flat, whereas the S&P 500 has gained 5%. After such a protracted interval of flat efficiency, some traders could also be tempted to conclude that the utility inventory is prepared for its subsequent leg up. Nevertheless, on this article I’ll analyze why the inventory stays totally valued.
California Water Service was based in 1926 and is the third-largest publicly-owned water utility within the U.S. The utility has six subsidiaries, which offer water to roughly two million customers, primarily in California, but in addition in Washington, New Mexico, and Hawaii.
California Water Service has one of many strongest enterprise fashions an investor can hope for. Even underneath probably the most adversarial financial circumstances, individuals and firms don’t scale back their consumption of water, which is probably the most important element of life. Because of its rock-solid enterprise mannequin, California Water Service has proved proof against recessions. In 2020, which was marked by the fierce recession attributable to the pandemic, the utility posted all-time excessive earnings per share of $1.97.
The strong enterprise mannequin has enabled the corporate to develop its dividend for 55 consecutive years. Subsequently, California Water Service is a Dividend King, with one of many longest dividend progress streaks within the investing universe.
California Water Service has grown its earnings per share by 6.3% per 12 months on common over the past 9 years. That is definitely a passable progress fee for a utility. The corporate has grown its earnings at this tempo due to the approval of fee hikes by regulatory authorities in addition to first rate progress of the variety of clients.
Whereas California Water Service is on a dependable progress trajectory in the long term, it has had a adverse begin to this 12 months. Within the first quarter, the corporate incurred a 24% lower in working income and a web lack of $22.2 million or $0.40 per share, in comparison with web earnings of $1.1 million or $0.02 per share in the identical quarter of the earlier 12 months.
The principle issue behind the poor outcomes was the extreme climate, particularly moist and chilly circumstances in California, which brought about a 12% lower in gross sales. The extraordinarily moist winter additionally affected unbilled income accrual, decreasing it by $5.8 million in comparison with the earlier 12 months. As well as, the regulatory mechanisms that have been beforehand in place to offset such income losses are not lively in 2023. If these mechanisms have been legitimate this 12 months, they’d have mitigated the lower in revenues and earnings.
Furthermore, in reference to regulatory updates, there was one other extension of the deadline for the price of the pending capital case till August 2023. The California Common Fee Case had no important updates through the first quarter whereas administration said that it can’t predict the result of this case. General, California Water Service has had a poor begin to the 12 months.
Then again, it’s only pure that the utility is delicate to adversarial climate circumstances. Because the impact of deviations of climate from regular tends to decrease in the long term, traders shouldn’t be involved over the losses of the corporate within the first quarter. As an alternative, they need to relaxation assured that California Water Service will continue to grow its earnings in the long term due to materials fee hikes 12 months after 12 months.
Supply: Investor Presentation
Certainly, analysts anticipate the corporate to develop its earnings per share by 8.4% per 12 months on common over the following 5 years, from $1.77 in 2022 to $2.65 in 2027. That is undoubtedly a gorgeous progress fee for a utility, as it’s mixed with minimal danger and resilience to virtually any type of downturn.
California Water Service is at the moment buying and selling at a ahead price-to-earnings ratio of 31.7, which is way increased than its historic 10-year common price-to-earnings ratio of 26.3. The present earnings a number of of the inventory is definitely excessive for a medium-growth firm, corresponding to a utility. Such a excessive price-to-earnings ratio would usually accommodate a high-growth tech inventory, not a utility inventory.
It is usually value noting that California Water Service is buying and selling at 21.6 occasions its anticipated earnings in 2027. Which means the market has already priced a few years of future progress within the inventory. Furthermore, traders ought to word that rates of interest have surged to multi-year highs this 12 months. Excessive rates of interest have rendered the dividend of California Water Service a lot much less engaging than it was during times of depressed rates of interest. Subsequently, it’s considerably stunning that the utility is buying and selling at 31.7 occasions its earnings this 12 months within the present setting of rates of interest.
The wealthy valuation of the utility needs to be attributed, at the very least partly, to its immunity to recessions. The financial system has remarkably slowed down because of the aggressive rate of interest hikes applied by the Fed and the danger of an upcoming recession has considerably elevated. It’s thus pure that traders could also be in search of protected havens. Nonetheless, the nosebleed valuation stage of California Water Service is prone to end in lackluster returns within the upcoming years. The primarily flat inventory value over the past 4 years is only a reminder that traders ought to pay nice consideration on the valuation of the inventory earlier than buying it.
As talked about above, California Water Service has one of many longest dividend progress streaks within the investing universe, with 55 consecutive years of dividend progress. The corporate has grown its dividend by 4.9% per 12 months on common over the past decade, roughly consistent with the 5.1% median dividend progress fee of the utility sector. This progress fee renders California Water Service a gorgeous candidate for income-oriented traders.
Then again, the inventory is at the moment providing a dividend yield of only one.8%. Given its affordable (for a utility) payout ratio of 76% and its first rate progress prospects, California Water Service is prone to proceed elevating its dividend at a mid-single-digit fee for a lot of extra years. Nonetheless, the present dividend yield is simply too low to justify an funding within the inventory proper now, particularly given the multi-year excessive prevailing rates of interest. To offer a perspective, if California Water Service grows its dividend by 5% per 12 months, it should attain the present yield of the 10-year U.S. treasuries in 15 years.
California Water Service has many interesting traits for income-oriented traders. Because of the regulated nature of its enterprise, it’s on a dependable progress trajectory and has proved proof against recessions. It’s thus protected to anticipate the corporate to continue to grow its dividend for the following a number of years. Then again, the market appears to have seen the engaging options of this inventory. Because of the wealthy valuation of the inventory, traders ought to most likely await an approximate 20% correction, in direction of the technical assist round $45, earlier than buying the inventory. Such a inventory value corresponds to a extra affordable price-to-earnings ratio of 25.0 and a dividend yield of two.3%.