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Takeaways
1. AWK is a defensive utility stock with high, attainable growth prospects and a track record to beat guidance.
2. Management has identified numerous projects for regulated investment Capex.
3. Tailwind from improving regulatory environment benefits future acquisitions.
4. Other market-based business act as free call options, and may positively catapult AWK’s stock price.
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Table of Contents
Industry Overview
American Water Works Business Overview
Sustainable Investing
Investment Thesis
Risk
Valuation and Catalysts
Appendix
Section
I
II
III
IV
V
VI
2
I. Industry Overview
n American Water Works
n Aqua America
n California Water Service Group
n American States Water Company
n 52,000 community water systems in the US.n 90% of US residents receive drinking water from a utility,
and of those residents, 84% receive water from a publicly owned utility and 16% from a privately owned utility.
n Most utilities are municipal, and for the most part are governed by their own governing bodies unlike the investor in utilities that are under the jurisdiction of Public Utility Commissions (PUCs).
n Heavy regulation and high barriers to entry.
Water Provider and Wastewater Provision
Source: Company filings and website
Market Share
Water Utility
Major Players
Industry Metrics
Industry Overview
n Revenue from water utility: $73.1 billion
n Profit: $9.1 billion
n Annual Growth (2011-2016): 1.3%
n Forecasted Annual Growth (2016-2021): 0.58%
4.50%1.40%1.00%
0.60%
92.50%
American Water Works
Aqua America
California Water Service Group
American States Water Company
Others
4
American Waterworks
Aqua America California Water Service Group
American States Water Company
States § New Jersey§ Pennsylvania§ Missouri§ Illinois§ Indiana§ California§ West Virginia§ Georgia§ Hawaii§ Iowa§ Kentucky§ Maryland§ Michigan§ New York§ Tennessee§ Virginia
§ Pennsylvania§ Ohio§ Illinois§ North Carolina§ Texas§ New Jersey§ Indiana§ Virginia
§ California§ Hawaii§ New Mexico§ Washington
§ Texas§ Maryland§ California§ South Carolina§ North Carolina§ Florida
Operating income (2016)
$1,113.2 m $325.6 m $76.19 m $114.7 m
Market Share 4.5% 1.4% 1.0% 0.6%
Industry Overview
Competitor Comparison
5
Government Support
n Safe Drinking Water Act
– Focuses on ensuring that public drinking water meets appropriate safety standards
– This regulation is the underlying factor for the need of new equipment and modernization.
n Clean Water Act
– Regulates pollution in our nation's lakes, rivers, and other bodies of water.
– The Trump administration plans to overhaul this act because it believes this is too much regulation.
n National Pollutant Discharge Elimination System (NPDES)
– Sets a maximum discharge limit for wastewater, and exceeding this limit can result in fines.
– Compliance with NPDES slows down operations and may increase some costs.
n Clean Water State Revolving Fund (CWSRF)
– Federal-state partnership that provides communities a permanent independent source of low cost financing for a wide range of water quality infrastructure projects.
Industry Overview
6
How is the industry split up?
56%
21%
14%
5%4%
Households Commercial businesses Industrial Public sector use Agriculture
Industry Overview
7
Industry Outlook – Stable growth going forward
Industry Overview
71,500.00
72,000.00
72,500.00
73,000.00
73,500.00
74,000.00
74,500.00
75,000.00
2017 2018 2019 2020 2021 2022
Rev
enue
in M
illio
ns
Year
Forecasted Industry Revenue
8
Need for Renovation
n The American Society of Civil Engineers (ASCE) gave the nation’s water systems a D grade and the wastewater systems a D+ on the report card.
n The estimated cost for replacing and updating this equipment is $25 trillion over the next 25 years.
n Although the CWSRF provides funding, it is not nearly enough to cover the cost of renovation.
n The need for fresh infrastructure helps AWK because the company is planning to invest about $5.9 billion over the next 5 years, with a potential of nearly $25 billion in investments over the next 25 years.
Industry Overview
9
Market Based Businesses
Industry Overview
Water services for Oil & Gas
Contract Operations
Water management solutions for companies in the E&P verticalSourcing, transporting and provision of water to oil and gas facilities on a contracted basisContracts 2-5 years
Home/Commercial Services
Provision of water and waste-water treatment services to basesContracts include a capital program fee for the construction/replacement of fixed assets and a service fee. Long-term contracts with yearly adjustments
Military Services
n Provision of protection programs for homeowners and commercial businesses
n Cost of interior and exterior water sewage repairs, typically not covered by insurers.
n Potential to expand into repairs to electric line repairs
§ Fee-based contracted services to industrial clients
§ all components of the industrial water cycle: water supply, water processing, steaming, wastewater treatment and residuals
10
II. Company Overview
2016 Revenue Breakdown
Military Services, Homeowner Services, Contract Services and Keystone Clearwater
Solutions
n American Water was founded by James S. Kuhn and W.S Kuhn in 1886
n Provides regulated and market-based drinking water, wastewater and other related services to customers in 30+states and Ontario, Canada
n High margins (~32.17 Operating margin (2016) & ~14.7 Net margin)
Business Description
Status: Public (NYSE: AWK)Founded: 1886Headquarters: Voorhees, New JerseyUsers & Clients: ~30+ states ~15 million+ clients
Company Overview
Revenue Breakdown
American Water Works
Utility services heavily concentrated in NJ, PA, MO, IN, IL
n Industry: Water Utilities
n Current Share Price: $77.00
n 52-Week Range: $68.09-$85.24
n Daily Trading Volume: 949,590
n Market Share: 4.80%
n Market Cap: $13.72B
Key Metrics
Net Income
($ million) P/B P/E
DividentYield (%)
O&M Efficiency
(%)
AWK 468 2.6 29.3 2.0% 32.9%
AWR 59 3.2 26.9 2.1% 25.6%
CTWS 23 2.5 25.4 2.1% 26.9%
CWT 48 2.5 34.4 2% 16.3%
Key Comparable Companies
12
Company Overview
13
American Water Works
Operating Regions
n Serves over 15 million customers in over 30 States
n Top Seven States: New Jersey, Pennsylvania, West
Virginia, California, Illinois, Missouri, and Indiana
n Both Regulated Business and Market-Based
– Regulated: provide water and wastewater
utility services to residential, commercial,
industrial and other customers
– Marked-based: provide services to military
bases, municipalities, exploration and
production companies, commercial,
industrial and residential customers that are
not subject to economic regulation
14
American Water Works
Operating Regions
15
American Water Works
n President & Chief Executive Officern Joined April 2013n Previously President and Chief Executive Officer of Southern Company Services
Susan N. Nory
n Chief Financial Officer, Principal Accounting Officer & EVPn Joined May 2014n Previously Senior Vice President and Chief Financial Officer of Southern
California Edison Company
Linda G. Sullivan
n Chief Operating Officern Joined in 2001n Previously President of Regulated Operations
Walter J. Lynch
Source: Company website
Management
16
American Water Works Business Overview
n Senior Vice President- Corporate Strategy and Business Development
n Joined December 2006
n Previously President of American Water Enterprises
Mark F. Strauss
III. Sustainable Investing
Environment: addressing climate variability, energy & fuel management, water quality management and GHG emissions
1. Carbon footprint: water conservation and
pump efficiency to reduce GHG emissions
2. Adaptation: environmental risk management
and efficiency leak-detection
3. Integrated water resource mgmt.: reused
water and desalinization
4. Resiliency: Critical Asset Study and Climate
Resiliency Strategic Plan
Sustainability Overview: ESG Analysis
18
Social: Labor relations, employee safety & well being, customer safety & water quality
1. Established a Safety Strategic Action Group to evaluate and collect feedback on employee
safety develops changes to safety plans
2. Contractor safety: comprehensive safety program reducing the Total Recordable Injury Rate
(TRIR) to 4.7 a year (2014), below industry average
3. Comprehensive Planning Study Program that continually assesses the reliability of the
company’s water supply and safety
4. Drinking water system 20x better than industry average
Sustainability Overview: ESG Analysis
19
Governance: transparency of payments and diversity & inclusion
1. Transparent political contributions: Disclosed in CSR
report and Electoral commission
2. Supplier Diversity Program: to seek, identify and retain a
diverse supplier base.
§ vendors who are more than 51% owned by a women,
disabled veteran or minority.
3. Female representation in management positions
increased from 23% (2010) to 25% (2015)
4. 50% of company officers are women, including the
CEO
Sustainability Overview: ESG Analysis
20
Case Study on adaptation to environmental regulation and climate changeSustainability Overview: Monterrey Peninsula Desalinization Plant
n Materiality: $322 million investment in a desalinization plant to replace the Monterrey Peninsula’s overreliance from freshwater sources under protection by the State of California
– Carmel River and Seaside Peninsula groundwater basin.
n Materiality: plant will be sized between 6.4mgd and 9.6mgd and will be connected to CAWC’s pipeline system
n Materiality: employ energy recovery devices to reduce the plant’s energy consumption
21
IV. Investment Thesis
Defensive stock play in volatile times, alternative to bonds but with upside
Consistent dividend yield from a high quality company
Outperforming competitors justifies higher multiplewith attainable 7-10% LT EPS Growth
Investment Thesis
Great regulatory environment for consolidation
23
n VIX is the implied volatility of options in S&P 500; also known as the fear index
n Now, known as FOMO index
VIX edging higher for past yearInvestment Thesis: Volatile Times
0
5
10
15
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25
30
Mar
-16
Apr
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May
-16
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Jul-1
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Aug
-16
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Oct
-16
Nov
-16
Dec
-16
Jan-
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Feb-
17
VIX
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n Past 1 year return closely tracking S&P
n Low beta of 0.583
VIX edging higher for past yearInvestment Thesis: Volatile Times
90
95
100
105
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115
120
125
130
Mar
-16
Apr
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May
-16
Jun-
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Jul-1
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Aug
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Oct
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Nov
-16
Dec
-16
Jan-
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Feb-
17
AWK S&P 500
25
Not quite bond proxy, but in line with treasuries, while having upside from future consolidations
Investment Thesis: Good floor return slightly below treasuries
1.94%
2.39%
1.00%
1.50%
2.00%
2.50%
3.00%
Mar
-16
Apr
-16
May
-16
Jun-
16
Jul-1
6
Aug
-16
Sep-
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Oct
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Nov
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Dec
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Jan-
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Feb-
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Dividend Yield 3 Year Treasury Rate
26
Current yield at 2%; management guides DPS growth of ~10%Investment Thesis: Good floor return slightly below treasuries
27
Guided 7-10% 5 year EPS growth; reliance of organic growth; A/A3 credit ratings allows for more borrowing if needed
Investment Thesis: Good floor return slightly below treasuries
Market Based Business
~ 2%
Regulated Acquisitions
1-2 %
Regulated Investment Capex
4-6%
28
Organic growth and asset renewal still dominates majority growth; storm water collection, desalination, portable wastewater management provide free upside
Investment Thesis: High, attainable growth from within
Asset Renewal60%
Capacity Expansion
14%
Quality of Service8%
Regulatory Compliance
6% Other12%
n Organic growth oriented around infrastructure improvement rather than expansion
n Technological deployments expected drive down O&M Efficiency to 32.5% by 2021
n Other market based businesses aren’t core to AWK (~12%) of revenue, but provide free upside if they do take off
29
FMV rule in many states that AWK operates in; increasing concern over water quality prompts consolidation; federal funding may go towards IOUs
Investment Thesis: Strong regulatory environment
30
V. Risk
1. Utility operations are subject to extensive economic regulation
• Regulation affects the rates we charge our customers and has a significant impact on our business and results of operations
• However, maintaining a good relationship with PUCs and investing in sound acquisitions in line with government regulation can help avoid negative regulations
2. Indebtedness could affect our business adversely
• Our regulated businesses require significant capital expenditures and may suffer if we fail to secure appropriate funding to make investments
• High level of debt (1.71:1) in comparison to industry average impairs ability to access capital markets for debt and equity
• However, due to the revolving credit of around $1.4 billion there is no inherent short term risk
3. Environmental factors can hamper our ability to carry out operations
• Contamination of our sources of water provided to our customers could result in service limitations and interruptions
• Depletion of groundwater and surface water resources can hamper our ability to service customers
Risks
32
VI. Valuation and Catalysts
Valuation and Catalysts
RPMDriversRegulatedBusinesses 2564.43 2594.00 2674.00 2743.00 2871.00Market-BasedBusinesses 307.37 303.00 355.00 434.00 451.00 7.00% 6.50% 6.50% 6.00% 5.50% 5.00%
RegulatedBusinesses 2564.43 2594.00 2674.00 2743.00 2871.00 3085.20 3271.53 3468.78 3677.58 3898.59 4093.52RateBase 9987 10764 11302 11867 12461 13084 13738 14425Growth 7.78% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%ROR 10.12% 9.82% 10.10% 10.20% 10.30% 10.40% 10.50% 10.50%OperatingExpenses 1686 1700 1726 1732 1852 1944 2061 2185 2317 2456 2579%ofRev 65.74% 65.54% 64.55% 63.14% 64.51% 63.00% 63.00% 63.00% 63.00% 63.00% 63.00%OperatingIncome 1114 1182 1253 1328 1408 1479
Market-BasedBusiness 307.37 303.00 355.00 434.00 451.00 505.12 565.73 633.62 709.66 794.82 890.19Growth -1.42% 17.16% 22.25% 3.92% 12.00% 12.00% 12.00% 12.00% 12.00% 12.00%OperatingIncome 60 66 63 77.6 86.9 97.3 109.0 122.1 136.7Margin 16.90% 15.21% 13.97% 15.36% 15.36% 15.36% 15.36% 15.36% 15.36%
Interest -308 -325 -345 -360 -379 -398 -418 -439%ofRateBase -3.08% -3.02% -3.05% -3.04% -3.04% -3.04% -3.04% -3.04%ProvisionforIncomeTax 847.0 908.3 971.0 1039.6 1112.4 1176.7NetIncome 476 468 508 545 583 624 667 706
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Valuation and CatalystsWACC
CostofDebtWeightedAverageInterestRate 4.72%AfterTaxCostofDebt 2.83%
CostOfEquityUnleveredBeta 0.54LeveredBeta 0.71ERP 6.00%RiskFreeRate 2.40%CostofEquity 6.66%
MarketEquity 13680.0MarketDebt 7182.0EnterpriseValue 20862.0WACC 5.34%
WACC
35
Valuation and CatalystsDiscounted Cash Flow
ExitEV/EBITDAmultiple 13.0x Longtermgrowthrate 2.5%
EBITDAatendofProjection 2,345.5 FreeCashFlow(t+1) 901.6TerminalValue 30,491.3 TerminalValue 31,717.6
PresentValueofTerminalValue 22,312.7 PresentValueofTerminalValue 23,210.0EnterpriseValue 22,630.7 EnterpriseValue 23,528.0TVas%ofEV 98.6% TVas%ofEV 98.6%
CalculationofEquityValue CalculationofEquityValueEnterpriseValue 22,630.7 EnterpriseValue 23,528.0Less:NetDebt 7,182.0 Less:NetDebt 7,182.0
EquityValue 15,448.7 EquityValue 16,346.0EquityValueperShare(Basic) 86.7 EquityValueperShare(Basic) 91.7EquityValueperShare(Diluted) 86.7 EquityValueperShare(Diluted) 91.7ImpliedROI 12.6% ImpliedROI 19.1%
TerminalValue:ExitMultipleMethod PerpetuityGrowthMethod
36
Valuation and CatalystsCatalysts
n Further consolidation in industry
n Ability to meet and exceed forecasted growth
n Ability to significantly improve O&M
n Meeting and exceeding rate case
37
Takeaways
1. AWK is a defensive utility stock with high, attainable growth prospects and a track record to beat guidance.
2. Management has identified numerous projects for regulated investment Capex.
3. Tailwind from improving regulatory environment benefits future acquisitions.
4. Other market-based business provide are act as free call options, and may positively catapult AWK’s stock price.
38
Appendix
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