Invest in the Most Scarce Resource: Water

Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Food, water, shelter are listed as the three necessities of human life. How often have you thought of investing in water? Investing in water may not bring overnight riches but it is a sustainable resource that cannot be easily substituted. The United States has a number of water-based utilities that offer a stable and consistent investment.

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AWR Free Cash Flow Yield data by YCharts

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AWR Return on Invested Capital data by YCharts

American States Water Co. (NYSE: AWR) is a small utility with a market cap around $900 million. The majority of the firm's interests are in California but through its ASUS division, it provides water and wastewater services to a number of military bases throughout the U.S. Water and wastewater services provide the majority of revenue, but electricity makes up around 9% of total revenue.  

In California specifically water is a highly contested resource. AWR owns the rights to approximately 76,500 acre-feet of adjudicated groundwater rights and 11,300 acre-feet of surface water rights along with related unadjudicated groundwater rights. This serves as a major asset for the firm over the coming decades as water becomes scarcer and desalinization plants continue to attract environmental protests.

AWR's involvement in regulated and unregulated markets helps to drive their relatively strong ROA of 3.9% and ROI of 6.4%. The 3.0% yield rate is not enormous but their 5-year EPS growth of 12.2% and conservative payout ratio of 45 point to a secure dividend source that can grow with inflation. AWR is not near the size of America's large electrical utilities but AWR's niche in the water market gives investors a dependable dividend. The fact that the company has a number of water rights helps to make the company a safer investment as water becomes scarcer. 

California Water Service Group (NYSE: CWT) provides water services in Hawaii, Washington, California, and New Mexico. These markets are highly regulated and the political happenings in California have a huge impact on CWT. The vast of majority of CWT's customers are strewn throughout California. The company's yield of 3.4% is relatively high but their payout ratio is only 57. Their total debt to equity ratio of 1.15, EBIT margin of 13.6%, and profit margin of 8.4% are not as healthy as those of AWR. CWT's 5-year dividend growth rate of 1.44% is also lower than AWR's 3.91%. California Water Group is a strong water utility but I believe that American States Water is the stronger firm with less debt, greater dividend increases, and mix of military customers. 

Connecticut Water Service (NASDAQ: CTWS) is a small utility that operates in Maine and Connecticut. In 2011 water services provide $10.123 million of net income, services and rentals provided $1.001 million, and their real estate segment provided $0.176 million. CTWS recently acquired Aqua Maine and has a large total debt to equity ratio of 1.67. The company has healthy margins with an EBIT margin of 27.4% and a profit margin of 17.4%, while their ROA is around the industry norm at 2.5%. If it weren't for the relatively high debt load, their 3.2% yield would make CTWS an attractive water utility. AWR remains a better choice with less debt and stronger margins. 

Middlesex Water (NASDAQ: MSEX) operates in New Jersey, Delaware, and Pennsylvania. Most of the company's operations are in regulated markets though around 9% of 2011 net income came from unregulated markets. MSEX's total debt to equity ratio of .76 is the lowest of the companies analyzed in this post and their EBIT margin of 26.1% is the second only to CTWS. The downside is that MSEX's high yield of 3.9% is sustained by a payout ratio of 88, which is the highest of any of these companies. If the company sacrifices capital expenditures for a high dividend then eventually the operating margins will suffer and their dividend will shrink. Their ROA of 2.5% is the industry norm and shows that this company is quite similar to its competitors apart from their high dividend and high payout ratio. 

Conclusion

America's form of capitalism is a particular mix of markets, governments, and monopolies. The markets that provide those daily necessities like electricity, water, and food are heavily regulated to ensure a stable supply of these critical goods. Investing in the heavily regulated water market is not the best way to look for ten-baggers but it is a good way to find stable and dependable investments. AWR offers a good yield at a reasonable payout ratio with a strong history of dividend increases and a reasonable debt load. The one downside to this company is the high amount of exposure it has to the fickle California government, but as long as the state remains favorable to reasonable rate increases then AWR will be a strong investment. 


MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend California Water Service Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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