Aqua America, Inc. (WTR)

ikkyu2 (91.72) Submitted: 8/20/2007 4:34:20 PM : Start Price: $22.92 WTR Score: +13.98

A lot of CAPS folks are greenthumbing this stock with eloquent pitches like "water play" and "water sector." Although both domestic and global demand for water is rising, this is not a good enough reason for me to buy a domestic water company. The domestic water market is extremely fragmented and highly regulated, and water doesn't travel; so what matters to me is the individual company, not the sector; its management and execution; and its relationship to regulatory events and interest rate cycles. This being a utility, i.e. a regulated monopoly, regulatory events and interest rate cycles are going to determine earnings.The company's annual report believes that consolidation of the fragmented markets under unified leadership, technology and engineering expertise will lead to economies of scale. Accordingly, they've been acquiring vigorously and expanding their market over the last few years. They stumbled in Feb 2006, the stock price peaked, they had to cut their dividend, and the stock has been sideways since then. Interestingly but perhaps predictably, all these acquisitions have not been accretive to EPS, which has also been sideways. I think this gives the lie to the economy-of-scale idea - there may be something to it but it's not big enough that it's going to give this company any kind of competitive advantage.However, the company has been expanding hugely aggressively, taking full advantage of the lax credit environment to leverage itself to 110% debt/equity and 0.45 current ratio; while managing to more-or-less sustain a 2% dividend yield. In a business that could experience competition, I'd be shaking my head sadly at these numbers. But for a utility - a regulated monopoly that can count on steady demand and steady revenue - this makes sense. Since regulatory ("rate case") events determine revenue, expansion into different regulatory zones is optimal; if PA denies a revenue increase request this year, for instance maybe TX or ME will approve one, buffering the overall downward leverage that a single set of regulators could exert on the company's earnings. To my mind this is the true benefit of the company's growth strategy.I also think that the company's been very wise to max out its credit lines and take on all this debt in the last 4 or 5 years, because I don't think there's going to be any cheap credit around for some years to come. That means its competitors (those who would compete to acquire WTR's targets) who may not be so heavily leveraged are caught somewhat flat-footed for the next year or so.So I think WTR's stuck with what it has right now for the next 2 to 4 years; fully leveraged, good revenue stream, positioned to start paying down some debt. So what this boils down to for me is a market-timing pick. I think the market's looking pretty grim over the next 2-3 years in terms of earnings; WTR's earnings look like they'll be flat. Flat beats grim. So this gets a green thumb.Full disc: I'm much less certain about this pick than my usual pick. Since the usual pick I make goes wrong about half the time anyway, I doubt this matters much.