3 Things to Look For When American Water Works Reports Q2 Earnings

By Markets Fool.com

Image source: Getty Images.

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American Water Works (NYSE: AWK) is set to release second-quarter earnings on Aug. 3. Finding yourself interested but equally worried about drowning in a flood of facts and figures? It's not uncommon during earnings season. Let's prepare by keying in on three things we can expect management to address in its report.

Let the good times flow

Amid Brexit concerns, market volatility, and political uncertainty, the S&P 500 has struggled to keep its head above water; currently, it's up about 4% over the past 52 weeks. Investors, consequently, have been gushing over American Water Works. Shares have steadily floated up about 60% since last summer, but Wall Street doesn't necessarily agree with the direction of thing=, as Merrill Lynch downgraded of the stock from "buy" to "neutral."

Shares may seem pricey, but the company's fundamentals are strong. And though its peers may seem more attractively priced, American Water Works has demonstrated a superior ability to consistently and effectively use of one of its many tools -- equity -- to provide returns to shareholders. Currently, American Water Works doesn't sport the best return on equity (ROE) among its peers, including Aqua America (NYSE: WTR), American States Water Company (NYSE: AWR), and California Water Services Group (NYSE: CWT). But it has proved to be far better at improving its ROE over the past five years.

Company ROE (Trailing 12 Months) ROE % Change
American Water Works 9.43% 37.82%
Aqua America 11.93% 2.53%
American States Water Company 12.30% (1.68%)
California Water Service Group 6.75% (27.2%)

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Data source: YCharts.

Look for the company to continue the trend and improve upon the currentROE of 9.43%. Of course, you can do the calculations yourself by referring to the company's 10-Q, identifying the net income, and dividing the shareholders' equity. You may find it a lot more practical, though, to use some of the available Foolish tools.

Swimming upstream

Though it accounted for only $0.03 of the company's total EPS of $0.46 in Q1, the market-based business is an important area to watch. Growth from this side of the business enables the company to mitigate risk as it represents diversification in the company's revenue sources.

When evaluating the market-based businesses, it's essential to take note of Keystone Clearwater -- a $133 million acquisition in 2015 that provides water and related services to natural gas exploration and production companies in the Appalachian Basin. Earlier in the year, management had forecast that Keystone would be accretive to earnings for fiscal 2016.

Puddles has been the company's mascot since 1996. Image source: American Water Works.

Recognizing the downturn in the oil and gas industry, however, management revised its estimate and suggested that Keystone would not contribute to earnings per share, though it would be operating cash flow-positive.

Another important facet of the segment is the military services group. In Q1, American Water reported a $45 million increase year over year in operating revenue. Of that amount, management attributed $15 million to incremental revenue from the military services group and contract growth in the homeowner services group.

The future doesn't look as bright, though. On the conference call, Linda Sullivan, executive vice president and CFO, suggested that the company was facing headwinds in the military services group because of federal budgetary constraints.

But most importantly: swimming efficiently

One figure that will surely show up in the earnings release is the company's operations and maintenance (O&M) efficiency ratio. The company relies heavily on this non-GAAP metric, which is similar to the operating margin, to assess its ability to control costs.

As of March 31, American Water achieved a ratio of 35.6% for its trailing-12-month period. Management has the long-term goal of achieving a 34% ratio by 2020. And it seems as though the company is on track, steadily improving upon this measure from 2010 through 2015.

Look for the ratio to fall again in the earnings release. Should management fail to report an improvement, it may be an indication of a much greater problem.

The takeaway

Management, in the first quarter, affirmed its guidance for fiscal 2016, forecasting EPS to fall between $2.75 and $2.85 per share. I'd be surprised if the company didn't affirm this again; however, if it provides a downward revision, it may suggest management is doubtful of achieving its long-term goal of an EPS compound annual growth rate of 7% to 10% (anchored in the $2.38 it reported for fiscal 2014) from 2016 to 2020. But equally important, investors should monitor the company's return on equity, market-based businesses segment, and O&M efficiency ratio as additional signs of the company's financial well-being.

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Scott Levine has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.