American Water Works Continues To Invest, Regulations A Woe

American Water Works Company’s (NYSE:AWK) ongoing capital expenditure to improve its water and wastewater systems will aid the company in providing efficient services to its expanding customer base. However, the water service provider is subject to stringent regulation and demand variation due to fluctuating weather patterns.

The company aims to invest $6.7–$7.3 billion from 2017 through 2021, which will help it to improve earnings 7–10% per year in the aforesaid period from a 2015 base. For 2017, American Water Works’ capital investment budget is $1.5 billion, with $1.3 billion directed toward its water and wastewater system improvements and upgrades. In 10 years, the company aims to invest $10 billion to strengthen its existing infrastructure.

In addition, the company is controlling its expenditure, which is also having a positive impact on its margins. The company has been able to lower its Operation & Maintenance (O&M) efficiency ratio through systematic cost savings and increase in revenues. Notably, O&M efficiency ratio is regulated O&M expenses divided by regulated operating revenues. The company has lowered the O&M efficiency ratio from 44.2% in 2010 to 34.9% in 2016.

The company continues to widen its market footprint through strategic acquisitions. In 2016, the company added 42,000 customers to its existing base through acquisitions. Another 33,000 customers will be added when the pending acquisitions are completed by the company in 2017. Year to date, the company added 13,000 consumers through closed acquisitions.

American Water Works needs to comply with increasingly stringent laws and regulations that could increase its operating costs. Water that is being supplied is subject to extensive environmental as well as water quality, and health and safety laws and regulations.

Additions and improvement in the existing water infrastructure requires huge capital investments. A major portion of the existing water lines and mainline are nearing the end of their effective usage life. Capital investment requirements to maintain the integrity of its systems could increase in the future. Rising interest rates will surely increase the capital servicing costs of the company.

Price Movement

Shares of American Water Works have outperformed the Utility- Water Supply industry in the last six months. Shares of American Water Works have returned 7.8% compared with the Zacks categorized Utility Water Supply industry’s gain of 5.7% in the last six months

We believe that customer additions, new water rates and consistent investment to upgrade existing infrastructure will boost its performance in the long term.

Stocks to Consider

American Water Works currently has a Zacks Rank #3 (Hold). Some better stocks in the utility space are Consolidated Water Co. Ltd (NASDAQ:CWCO) , Unitil Corp. (NYSE:UTL) and Avangrid, Inc. (NYSE:AGR) . All of them presently carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Consolidated Water Co. reported a positive earnings surprise of 63.64% in the first quarter of 2017. Its 2017 earnings estimate moved up 13.8% to 66 cents in the last 60 days.

Unitil Corp. reported a positive earnings surprise of 2.33% in the first quarter of 2017. Its 2017 earnings estimate moved up 0.9% to $2.09 in the last 60 days.

Avangrid reported a positive earnings surprise of 7.35% in the first quarter of 2017. Its 2017 earnings estimate moved up a penny to $2.21 in the last 60 days.

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