Stable Stock Turns Utility Into Player

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Water might be in short supply in California, but there’s been no shortage of investor interest in American States Water Co.

Shares of the San Dimas water company reached a five-year high earlier this month. The biggest driver of that gain was a wave of investor enthusiasm for utility stocks as a safe haven during uncertain times.

However, the company has also improved its outlook recently, thanks in part to winning approval to provide water for a massive new development in Northern California and the anticipation that it will pick up business on military bases.

“We’ve been looking to acquire additional customers for our water utility and looking to land more military base contracts and do more work on the bases we’re at,” said Chief Executive Robert Sprowls. “It’s a stick-to-the-knitting approach that our shareholders like.”

The company also recently took two steps to reward shareholders: a 5 percent dividend boost and a share repurchase program.

But the biggest factor boosting the rise has been a recent rally in utility stocks, which have gained 19 percent in the first half of the year, according to analyst Jonathan Reeder in the St. Louis office of Wells Fargo Securities.

Shares of American States rose 17 percent during the period, roughly in line with the sector, a significant premium over most other investments considered conservative.

“While American States Water shares recently hit a five-year high, the same can be said for many regulated utilities,” Reeder said.

That surge might be ending as the likelihood increases that the Federal Reserve will raise interest rates within the next 12 months, he said.

Meanwhile, company executives took two additional steps to pump up investor interest: raising the dividend by 5.2 percent starting in the third quarter and launching a two-year share-repurchase program. Sprowls said the repurchase program grew out of the 2011 sale of its Chaparral City Water Co. unit in Arizona.

“We felt we had more cash than we needed on the balance sheet,” he said.

New development

Meanwhile, the company’s water utility, Golden State Water Co., announced July 1 that it had won regulatory approval to serve the massive Sutter Pointe development in Sutter County north of Sacramento. When fully built out, the development will include up to 17,000 residential customers, a 7 percent increase in Golden State’s customer base.

“We view this announcement as a long-term positive for future organic customer growth and continued rate-base growth, which should eventually translate into future EPS power growth,” Reeder said.

On the day of the Sutter Pointe announcement, American States shares closed at $33.57, a level not seen in at least five years. Shares fell back to $31.00 on July 16 as investor enthusiasm for utility stocks cooled.

The Sutter Pointe announcement should offset any drop in customers if Golden State loses the right to serve nearly 3,000 customers in the Ojai area.

Two years ago, activists in Ojai, upset over what they claimed were excessive rate increases, launched an effort to dump Golden State. Ojai voters last year approved a measure to have neighboring Casitas Municipal Water District take over Golden State’s operation through the use of eminent domain. In April, a state court ruled against Golden State in its bid to stop the takeover. That ruling is on appeal in a legal battle that could continue.

Further uncertainty lies in an upcoming rate case before the California Public Utilities Commission.

The utility filed a proposal July 15 with the commission seeking rate changes ranging from a 3 percent decrease to an almost 5 percent increase for its nine service territories throughout the state. With Golden State’s water business accounting for roughly 70 percent of American State’s overall revenues, the stakes are huge for the company.

One key factor in the upcoming rate decision is the PUC allowance for the utility to recoup some of the revenue it loses as customers conserve. Normally, if customers reduce water use 20 percent one year compared with the previous year, then utility revenue would go down significantly. That in turn makes it difficult for water utilities to cover maintenance and fixed costs such as paying off pipelines.

But to encourage conservation, the PUC has allowed Golden State and other utilities to recover a portion of these lost revenues through future surcharges – enough to pay for fixed costs.

Sprowls also said Golden State might have to impose rationing measures in the near future.

“The water levels are dropping in our groundwater basins,” he said. “Also, if the dry conditions continue, the (wholesale) Metropolitan Water District may impose water rationing measures on us, which we will have to pass on to our customers.”

The main rationing measure would likely be stiff penalties for customers who exceed allocations.

Volatile military business

About 30 percent of American States’ revenue comes from its military base contracting business, chiefly providing water and wastewater services. But that business has proved quite volatile as military spending has been impacted by budget cutbacks and the government shutdown in the fall. Revenue for its military contracting subsidiary was down 32 percent in the first quarter compared with a year earlier, driven primarily by a slowdown in work at Fort Bliss in El Paso, Texas, and Fort Jackson in Columbia, S.C., and in paperwork for periodic price increases.

Sprowls said the company expected renewal and replacement activity at military bases to pick up during the second half of the year.

But analysts are cautious about the military work, saying much will depend on the amount of new business the company can win in coming months.

“The earnings potential in 2015 will be dependent on the level of new construction projects awarded over the next 12 months,” Reeder said.

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Howard Fine
Howard Fine is a 23-year veteran of the Los Angeles Business Journal. He covers stories pertaining to healthcare, biomedicine, energy, engineering, construction, and infrastructure. He has won several awards, including Best Body of Work for a single reporter from the Alliance of Area Business Publishers and Distinguished Journalist of the Year from the Society of Professional Journalists.

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