San Jose Water Corp. (SJW, $61.20): Will
Regulators Chill the Waters at San Jose Water Group?
By: Daniel Ptacek, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
· San Jose
Water Corp. (NYSE, SJW) is a public utility holding company operating
in two segments: Water Utility Services and Real Estate Services. The Real Estate
segment manages property related to the Water Utility segment and investment
activities. The Water Utility segment acquires and provides water to customers
in California and Texas. The company was founded in 1985 and is headquartered
in San Jose, CA.
· Q3 saw revenue of $124.85M, an increase of
$275K over the same period for 2017. Net income for the quarter was $4M lower
than 2017 at $15.8M. The decrease was primarily due to increased operating
expenses related higher per unit water cost and merger expenses from the deal
with Connecticut Water.
· In August 2018, Connecticut Water and SJW agreed
to an all cash merger valued at $843M. After being initially rejected by the Connecticut
regulatory board, the companies are still committed to the deal and are currently
assessing what steps to take to complete the merger.
· Following the acquisition of Deer Creek Ranch
Water System in July 2018, the Texas segment has seen a year to date customer
growth rate of 12%.
· The board has increased the annual dividend
every year for the last 50 years and is expected to do so again for 2018. Q3 EPS was $1.08, a surprise performance beating
consensus EPS estimates of $0.94.
Key
Points:
Headed into 2019, SJW’s revenue increased over the same period of
2017. The increase was primarily driven by scheduled rate increases in
California. New customers were responsible for roughly $1M of additional
revenue, while seeing healthy organic customer growth in Texas. A shining light
in this geographic segment is the Canyon Lake water systems, which were
acquired in 2006 and has since doubled its customer connections.
An outstanding concern is management’s mistakes
related to the merger proposal with Connecticut Water (CTWS). After beating out
bids from another New England based utility company, Evsource Energy, with a
cash deal valued at $843 million the local regulatory authority rejected the original
plans. SJW withdrew the application, but both CTWS and SJW are committed to
reapplying for the merger after meeting PURA’s concerns. Acquiring Connecticut
Water has the potential to bring over 140,000 customer connections to their
current number of roughly 250,000 customer connections bringing geographic
diversity as well as exposure to different regulatory authorities.
SJW is poised to capitalize on the growth it is
experiencing in Texas and is expecting to generate in New England by acquiring
Municipal Utility Districts and privately held water lines in nearby
localities.
The third-quarter earnings for SJW were a
surprise beat at $1.08 per share. Furthermore, San Jose Water is expected to
increase its annual dividend for the 50th consecutive year by 7% to
$1.20 per share.
What has
the stock done lately?
On November 27th, 2018 after news
broke that the Connecticut Regulatory Board rejected the merger application
between SJW and CTWS, the price fell from $65.31 to $53.50 by November 29th.
Since the drop, the price has steadily increased to its YTD high of $61.20.
SJW’s 2019 H-L is $61.20-$54.74. Consensus estimates put the one-year price
target above $65.
Past
Year Performance:
Over the past 52 weeks, SJW has posted returns
of 11.6% from a low of $51.26. While the stock saw a large decrease at the end
of 2018, SJW has clawed a portion of those losses back with room to run. Q4
earnings for 2018 will be announced on Feb. 20th, 2019. Earnings are
expected to be lower due to increased operating costs and additional expenses
coming from merger activity. SJW has closely followed the Russell 2000 (Figure
1) especially during the sell off at the end of 2018. During the first two
months of 2019, SJW has been performing better than the index.
Source:
Factset
My
Takeaway:
There is huge potential in SJW’s pending merger with Connecticut
Water. If the companies can overcome the regulatory hurdles to close the deal,
SJW’s geographic reach will enable it to acquire a vast array of other
municipal water systems. While the deal not playing out is a real possibility,
it wouldn’t be the end of the world with management even suggesting a share buy
back of around $350M that will surely drive the price per share up. The water
utility industry is ripe for consolidation, and SJW’s strategic plan allows it
to do just that. The firm’s success in Texas proves it has the right process to
successfully implement new systems into its existing infrastructure. I
recommend that we hold our position in SJW and see how the regulatory battle
plays out.
