American Water Works Could Offer Retirees Sustainable Income

By Scott Levine Markets Fool.com

If there's one thing retirees want, it's reassurance their golden years won't lose their luster. So to ensure financial security, retirees often turn to stable dividend-paying stocks to supplement their Social Security checks. These retirees, many times, opt for utility stocks -- utility stocks like American Water Works.

Continue Reading Below

Serving approximately 15 million customers, American Water Works is the largest publicly traded water service provider by market cap. The company has been providing water services to customers for more than 125 years, and in the years to come, it represents a great option for retirees -- one that pours steady income into their portfolios.

Image source: Getty Images.

A flood of dividends

How can retirees trust American Water Works will continue to put cash in their pockets throughout their retirements? There's no guarantee, but the company's history is a reassuring sign since it doesn't know what it's like to not return cash to shareholders. American Water Works' dividend has been flowing strongly since its IPO in 2008.

Company Market cap Dividend per share 5-year historical dividend growth rate Current dividend yield Payout ratio (ttm)
American Water Works (NYSE: AWK) $13.4B $0.375 63% 1.99% 55.9%
American States Water (NYSE: AWR) $1.5B $0.242 72.9% 2.24% 56.4%
Aqua America (NYSE: WTR) $5.4B $0.191 44.9% 2.45% 56%
California Water Service (NYSE: CWT) $1.6B $0.180 14.3% 2.02% 68.3%
Connecticut Water Service (NASDAQ: CTWS) $596M

$0.282

19% 2.09% 49.8%

Continue Reading Below

Data sources: Morningstar and YCharts. ttm = trailing 12 months.

According to American Water Works' management, the company's strong record of dividend growth will remain intact for the foreseeable future. In fact, on the company's recent conference call, Linda Sullivan, American Water Works' CFO, articulated this in no uncertain manner: "We also continue to be a leader in dividend growth, compared to the Dow Jones utility average, the UTY, and our water utility peers."

In an investor presentation from December 2016, management provided clarity into its dividend policy, noting its intent to maintain dividend growth in line with EPS growth. Specifically, management identified its target of EPS growing at a compound annual growth rate (CAGR) of 7% to 10% -- anchored by EPS of $2.64 in fiscal 2015 -- through 2021. And in a nod to those concerned that this would come at the expense of the company's financial health, management also stated during the December 2016 presentation that it expects to maintain a conservative payout ratio between 50% and 60%.

Not all water companies provide such clarity, nor do they have such high aspirations for growth. For example, Aqua America, American Water Works' closest competitor by market cap, provides no guidance on its dividend increases. American States Water, on the other hand, identified a five-year dividend CAGR of at least 5% during a recent investor presentation.

Keeping its head above water

Although American Water Works has high hopes for its dividend in the near future, investors would be remiss if they didn't confirm the company's financial health before getting excited. One reason for confidence in management's forecast is the fact that the company is afforded great clarity into its future revenue growth since most of it -- 87% in fiscal 2016 -- comes from the regulated businesses segment. It's also worth noting (though not a guarantee of future performance), the company's superior record of both operating revenue and net income growth.

AWK Operating Revenue (Annual) data by YCharts

Operating (among other facilities) approximately 81 dams, 1,400 pumping stations, and enough mains and collection pipes (more than 49,000 miles) to circle Earth twice, American Water Works estimates it reinvests approximately $1 billion each year in its infrastructure. Is the company drowning in debt in order to accomplish this? Not at all.

According to Morningstar, American Water Works currently has a debt-to-equity ratio of 1.10. This may have some investors reaching for a red flag, but let's consider some context. For one thing, the 1.10 ratio is lower than the company's five-year average ratio of 1.13, suggesting the company can competently manage a higher debt load. Further speaking to the company's ability to deftly service its debt is the opinion of Moody's and Standard & Poor's, which both gave American Water Works stable outlooks and credit ratings of A3 and A, respectively, as of December 31, 2016.

Mouth-watering might

Although the company seems dedicated to its dividend and financially fit, some may be wondering about the likelihood the tide turns -- about how long the company can continue to grow and support its dividend

Providing water, wastewater, and other services to approximately 15 million people in 47 states and Ontario, Canada, American Water Works doesn't intend to expand its customer base in drips and drabs through organic growth. In fiscal 2016, for example, American Water Works completed 15 acquisitions, adding approximately 42,000 customers, and as of January 18, 2017, the company had 17 pending acquisitions representing about 40,000 customers.

AWK Cash and Equivalents (Annual) data by YCharts

And with plenty of cash in its coffers, the company is well-poised to continue its shopping spree.

Another of the company's strengths is the geographic diversity of its operations -- something which management recognizes as a key competitive advantage. This serves two purposes.For one, the company seeks growth opportunities in areas where it already has operations. Articulating the importance, management claims it "allows us to integrate and manage the acquired systems and operations primarily using our existing management and to achieve operational efficiencies."

In addition, the diversification mitigates the risk of adverse weather conditions. Should one service area experience drier-than-usual weather in a given season, less source water would be available, which would adversely affect the company's operations. For companies like American States Water, which only operates in California, and California Water Service, which operates in four states, adverse weather conditions are a much more tangible threat.

Investor takeaway

Having tested the waters, we find that with an industry-leading position, sound financial health, and formidable competitive advantages, American Water Works offers a compelling investment thesis, which could provide sustainable income for years to come. And that may be just the thing to help retirees sleep easier -- to enjoy golden slumbers in their golden years.

10 stocks we like better than American Water Works
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and American Water Works wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of February 6, 2017

Scott Levine has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Moody's. The Motley Fool has a disclosure policy.