Water Utility Industry Valuations Are Based On Low Commodity Risk And Relative Cost Of Service: An Interview With Wall Street Journal All Star Analyst Timothy Winter Of Gabelli And Company
June 1, 2011 - The Wall Street Transcript has just published Water, Waste & Environmental Services Report offering a timely review of the Water Utilities sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
Timothy Winter, CFA, has more than 17 years experience as an Equity Research Analyst covering the utility industry. Mr. Winter covered the water and electric utility industries at A.G. Edwards & Sons, Inc., from 1992 through 2007. He has received industry recognition as a three-time The Wall Street Journal "All-Star Analyst" and as a Senior Member of the Institutional Investor number-one-ranked electric utility team at A.G. Edwards for the years 2001 through 2005. In 2007, Mr. Winter co-founded SM Research, an institutional research platform specializing in the utility sector. Until recently, he was with Jesup & Lamont Inc., where he served as a utility Equity Analyst. Mr. Winter earned a B.A. from Rollins College in 1991 and an MBA from the University of Notre Dame in 1992.
TWST: What key industry-specific metrics would you tell investors to evaluate in order to select water utility stocks?
Mr. Winter: I think the first thing is this is an underfollowed industry, and the first thing I would emphasize is the risk of this industry is much lower than the gas utility industry or the electric utility industry. So when looking at the valuations of stocks, that needs to be taken into consideration, because the first thing some investors look at is the valuations multiples.
The water utilities trade at the highest multiples of any of the utility sectors. The group currently trades at roughly 21 times 2011 earnings, the gas utilities are at 15 or 17 times and the electric utilities are closer to 14 times. If you look at the credit ratings of the group, they are significantly higher across the board than the electric utilities.
You have Aqua America (WTR), Cal Water (CWT), American States Water (AWR) with A+ S&P credit ratings. We have less risk because we don't have a commodity risk that we see in the electric and gas utility sectors, and given that water bills are so low relative to the other utility services, there is less regulatory risk. So that will be the first thing to consider.
As you look at individual companies, I think management is very key, because all of the water utilities have the opportunity to grow earnings by taking advantage of opportunities to invest in regulated rate base, because the companies need to replace aging pipe and meet sector EPA standards. The key is capital allocation, and managing capital expenditures and the regulatory relationships so that one can earn returns.
Aqua America (WTR) has been the premier utility in executing that, and their earnings growth record shows that. But I think looking at management, looking at the regulatory environment, the growth strategy, which is growth in addition to your regulated rate base, I prefer the lower-risk method of growing, which is to try to buy smaller regulated water properties.
Another method of growing is to try to win municipal contracts, which would be privatization that are nonregulated, but represent larger risk and potentially lower returns. I think those are some of the key policies for management and regulatory environment strategy. And then obviously we look at the valuation relative to each other.
TWST: What is your current take on valuations within the space? Considering valuations and outlook for the next several quarters, is this the right time to invest in the space?
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