York Water: High quality And Security Come At A Hefty Value (OTCMKTS:YORK)
Over the past few months we’ve covered a wide variety of stocks in the water industry. In late September, we launched York Water (OTC: YORK), the oldest investor-owned water company in the United States, with over 200 years of uninterrupted dividend payments to shareholders.
Since then, the company has released its third quarter results. This shows why its financial data is once again of the highest quality, while also explaining its 600th dividend payment. In honor of its dividend anniversary, the company increased its DPS by 4% and has currently posted dividend increases for 23 consecutive years.
In this article we will:
- Discuss the company’s Q3 results
- Evaluate dividend, valuation, and future investor returns
- Bottom line: why York Water may not offer very attractive returns but could be used as a means of maintaining prosperity with some associated growth prospects.
The latest results from York Water: Rock solid
As we mentioned in our previous articles, stocks in the water industry tend to attract high investor interest and relatively high valuations. The reason is their unique ability, due to the nature of their business model, to generate incredibly stable and reliable cash flows, i.e. providing the most important benefit of all, water.
York Water’s Q3 results once again underscored this sentiment, with revenue growing 4.2% and net income growing around 8.1%.
Source: Third Quarter Results
The increase in sales was mainly due to the higher per capita consumption of residential properties and the growth in the customer base. Increased individual consumption and growing customers are the two most important drivers of York Water’s sales growth. As the company slowly but gradually expands its distribution network, investors should continue to have thriving return on sales over time. As you can see in the table below, these two elements increase at any stable rate. In addition, the need for water for its various uses prevents volatile consumption of gallons per day. York Water’s current and future financial data remains and should remain surprisingly stable.
Additionally, revenue increased due to the company’s rate hike in March 2019. Effective March 1, 2019, the Pennsylvania Public Utility Commission (PPUC) approved an increase in water rates for additional annual revenue of approximately $ 3.4 million and an increase in sewage rates to generate approximately $ 289,000 in additional annual revenue. The new rates were added about $ 1.00 per month, or 2.5% more for the average home water customer. Due to the tax relief provided by the Tax Act of 2017, water customers saw their water bills decrease by an average of $ 0.80 per month for the first year. Hence a win-win situation.
Interest rate hikes should continue to be a driver of revenue growth over the long term. They will guarantee the company won’t lag behind inflation, while York Water’s organic growth and acquisitions should ensure the company expands over time. For example, in September the company acquired the Letterkenny City Council’s sewage system. As a result, York Water increased its customer reach again, as Letterkenny Township is now the 50th parish the company operates in York, Adams and now Counties Franklin.
Dividends, Valuation, and Investor Return
204 years of consecutive dividend payments are certainly no mean feat and add to the York Water brand as a dependable dividend growth stock. As you can see, York’s mature and stable business model has helped the company grow its EPS steadily, with DPS following a similar path. As the green line shows, the average 10-year DPS-CAGR (Compound Annual Growth Rate) in York averaged between 3% and 5%. The company’s most recent 4% dividend hike is keeping that ratio up as management ensures a comfortable payout ratio.
Despite the modest dividend growth, York Water’s dividend yield has declined every year and is currently around 1.53%. In other words, the company’s valuation has increased. As you can see by the purple line, the company’s Forward P / E ratio is currently just below 40.
The first question that comes to mind is why arguably dull water stock should attract such a powerful valuation multiple.
First, the York Water dividend, along with most dividends in the industry, is recession-proof and hard to cut. Not only is the payout ratio in York very pleasant at around 57%, but the organic catalysts mentioned above, the regulatory rate and the need for water consumption further protect the company’s cash flows. Even if something were to “go wrong”, the industry is so mature that such hurdles would be slow and easy to spot, which means management would have enough time to react / adjust its operations.
Because of the certainty of the York dividend, market participants looking for an extremely safe low yield have upgraded the stock’s valuation. As you can see in the graph above, York’s dividend yield is highly correlated to the 10-year bond yield. Since T-bills don’t even cover inflation, it makes sense for investors to rush for York’s yield, which has an element of growth, with minimal risk.
As a result, however, future returns should be limited now. As you can see below, we have assumed modest growth of 4% for both EPS and DPS in York, which should come pretty close to actual future numbers for the reasons stated above. In addition, we have included an appropriate selection of future valuation multipliers. If the stock is to maintain its current P / E ratio of around 36, investors should achieve a CAGR return of around 5% over the medium term, thanks to our moderate growth rates.
The reason the company remains an attractive investment for those looking to park their cash is because, despite significant valuation compression, the returns on this stock should outperform the T-bills. As you can see, even if stocks lose some of their valuation premium and trade around 30 times their underlying net income, investors will see higher annualized returns versus the return on a T-bill. In our latest article on American Waterworks (AWK), we already discussed the potential of water stocks to sustain wealth versus T-bills.
Quality and safety come at a high price. The company’s third quarter again demonstrated York’s ability to deliver incredibly safe and reliable cash flows. However, because investors were keen to capture the stock’s return, we don’t think current investors should expect near double-digit returns going forward. Based on York’s highly predictable business model, we expect mid-single-digit returns with a constant valuation multiple and low single-digit returns with valuation compression. While York may not have much to offer the average investor, it should serve as a means of maintaining wealth versus government bonds, offering both a resilient dividend and a modest element of growth.
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Disclosure: I / we have no positions in the stocks mentioned and no plans to open positions within the next 72 hours. I wrote this article myself and it expresses my own opinion. I don’t get any compensation for this (except from Seeking Alpha). I do not have a business relationship with any company whose stocks are mentioned in this article.
Editor’s Note: This article describes one or more securities that are not traded on a major US stock exchange. Please be aware of the risks associated with these stocks.