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Growth & Income

American Water Works Company Inc. (AWK - Snapshot Report) is a premier water utility with relatively low risk earnings growth and an expanding dividend that yields a solid 2.7%. Positioned in a niche industry with high barriers to entry, this Zacks #1 Rank (Strong Buy) enjoys near-monopoly status in its area of operation. On top of this, the utility’s best-in-class cost control and recession-proof business model presents a unique opportunity to own a safe stock.

Strong 2Q, Guidance Raised

American Water Works reported second quarter earnings per share of 66 cents on August 2, beating the Zacks Consensus Estimate of 49 cents by 35% and the year-ago earnings of 42 cents by 57%.

Revenues of $745.6 million were up 11% year over year from $668.9 million, and also surpassed the Zacks Consensus Estimate of $707.0 million. Results were driven by positive rate relief, favorable weather conditions, contribution from acquisitions and cost controls.

Based on the impressive start to the year and higher-than-normal temperatures so far in the third quarter, American Water Works raised its full year earnings guidance. The utility expects earnings per share for 2012 between $2.12 and $2.22, up from the previous guidance of $1.90 to $2.00.

U.S. Shale Boom to Support Future Growth

Investor-owned water utilities like American Water Works are expected to deliver solid long-term earnings growth, as they take advantage of the shale gas revolution. In particular, American Water Works has entered into agreements with energy companies in the Marcellus shale to supply fresh water – the prime component of hydraulic fracturing – at their drill sites in the region. The utility also benefits by providing services to purify contaminated water, a byproduct of the shale drilling.

Consistent, Secure and Regularly Expanding Dividend

American Water Works pays an annual dividend of $1.00 per share, yielding a solid 2.7%. The utility hiked its dividend payout by 8.7% in May, marking the 4th dividend increase in as many years.

Moreover, the utility’s current dividend caps the payout ratio at less than 50%, slightly below the peer average. This indicates enough headroom for future dividend increases given its strong management and solid financial position.

Earnings Estimates Moving Up

Following the second quarter earnings beat, all 14 earnings estimates for 2012 have moved higher, sending the Zacks Consensus Estimate up by 23 cents (or 12%) to $2.18.

For 2013, thirteen of 14 estimates moved north in the past 30 days, helping the Zacks Consensus Estimate advance by 11 cents (or 5%) to $2.20.

Given the $1.75 per share earned in 2011, the projected growth rate stands at 24% for 2012.

Valuation Picture

Shares of American Water are going for about 17.2 times forward estimates, a 6% discount to the peer group average of 18.4x. Its price to book ratio of 1.5 is also below what similar firms offer. The PEG ratio of 2.1, though seemingly overvalued, is again less than the industry median of 2.9. With the expectation for consistent growth in earnings and dividend, shares of American Water Works are set to close the valuation gap to the group.

Market Performance & Technicals

American Water Works operates in an industry where large earnings surprises are relatively unheard of and, therefore, the stock more often than not trades at a decent level without wild movements. But since late-June, shares have been in an upward channel, rising approximately 14% and setting a new 52-week high in the process. As hot and dry weather continue to scorch the U.S., the stock looks poised to add to its gains.

Opportunities for drinking water suppliers like American Water Works are set to improve, as it captures the economic benefit of dealing with a natural resource that has no substitute and with a projected imbalance in future demand/supply.

Founded in 1886, Voorhees, New Jersey–based American Water Works Company is the largest publicly traded regulated water and wastewater utility holding company in the U.S., catering to approximately 15 million residents across the country and parts of Canada.

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