Water Stock Investors: 3 Key Things From American Water Works' Q3 Earnings Call You Should Know

By Markets Fool.com

American Water Works Co.(NYSE: AWK)reported its third-quarter 2016resultson Nov. 2. The largest publicly traded water and wastewater utility in the United States posted revenue growth of 3.8%, while adjusted earnings per share jumped 9.4%.

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Earnings releases usually don't provide much color about a company's performance or future prospects. However, a wealth of information is shared in the analyst conference calls following these releases. Here are three key things that you should know from American Water's Q3 call.(Transcript viaThomson Reuters.)

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1. Slight positive summer weather impact on financials

CFO Linda Sullivan addressed the effects of this year's summer weather on the company's quarterly financials:

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[W]e experienced hot, dry weather throughout much of our service area this quarter, especially in New Jersey, which increased revenue by more than $12 million. This was partially offset by wet conditions in Missouri and Illinois, which decreased revenue by about $6 million. Net-net, we had a pickup in revenue of about $6 million this quarter compared to normal weather conditions, although the year-over-year third quarter weather impact was zero.

The positive summer weather impact on American Water's revenue in the quarter was minimal -- $6 million is only about 0.6% of its total revenue of $930 million. However, thistopic illustrates two related key points important in water utility stock investing. First, up to a point, weather that's warmer and drier than usual typically benefits utilities because people drink more, water their lawns more, and so on. However, in more extreme cases -- like droughts -- such weather usually has negative effects on the finances of utilities (at least over the near term, until potential rate increases to at least partially compensate for these impacts are approved.) During such weather conditions, utilities often incur additional operating costs, and their revenue drops if mandatory water-use restrictions are enacted.

The second key point is that American Water's industry-leading geographic diversity makes it less vulnerable to region-specific weather conditions. The company operates in 47 U.S. states and one Canadian province and operates as a regulated utility in 16 of these states. Its two largest competitors that do business in this country, Aqua America andAmerican States Water (NYSE: AWR), operate in eight and seven states, respectively, though the bulk of American States' business is in California, where it operates its only regulated business.

Largely because all of its regulated eggs are in one heavily drought-stricken basket -- California is in its fifth year of an epic drought -- American StatesWater's financial and stock-price performances have been suffering.

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2. The California desalination project is moving along

From Chief Operating Officer Walter Lynch's remarks:

We also received approval [in September] to begin construction of our new pipeline associated with Monterey Peninsula Water Supply project, which is due to start ... this month.

Investors and potential investors should know that American Water's subsidiary, California American Water, has a $322 million desalination project in the works in Monterey, Calif. The plant will have the capacity to remove salt from 6.4 million gallons per day of Pacific Ocean seawater to convert it into drinking water.This is a decent capacity, but much less than the highest-capacity desal plant in the U.S. -- the facility in Carlsbad, Calif., which began operating in late 2015, has a processing capacity of 50 million gallons per day.

As Lynch noted, the construction of the 10-mile pipeline that will deliver the desalinated water to the Monterey Peninsula will begin next month. Final plant approvals are slated for 2017 and early 2018, with construction scheduled to begin in the spring or summer of 2018. The plant is slated to begin operating in late 2019 or early 2020.

This is American Water's first desalination plant in California. The company does operate under a joint venture -- but does not own -- a desal plant in Tampa, Fla. This facility, which can process 25 million gallons of water per day, reigned as the highest-capacity desal plan in the U.S. until the Carlsbad plant began operating.

3. How American Water is improving efficiency

Lynch provided some examples of how the company is improvingits efficiency as it drives toward achieving an operation and maintenance (O&M) efficiency ratio (a non-GAAP metric) of 34% by 2020. This metric improved to 34.9% for the 12-month period ending with the third quarter.

In Indiana, we completed a local project to digitize customer requests to locate underground assets, so that customers can excavate on their own property. ... E-locate has been replicated now across six states and has provided over $1 million in annualized cost savings and efficiencies.

[O]ur investment in enterprise software and meter data management ... [We're] closing in on near 100% in actual meter reach for billing. We've seen cost savings of over $1 million as we reduced the time spent handling exceptions.

The importance of improving efficiency is driven home by the fact that for every dollar American Water saves in O&M costs, it can invest $7 in capital with no impact to its customers' bills, according to Lynch. So in the first example, that more than $1 million in annual savings means the company has essentially freed up $7 million that it can use for acquisitions or other investments in its business.

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Beth McKenna 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.