American Water Works Company, Inc. (NYSE:AWK) Q3 2023 Earnings Call Transcript

American Water Works Company, Inc. (NYSE:AWK) Q3 2023 Earnings Call Transcript November 2, 2023

Operator: Good day, and welcome to American Water’s Third Quarter 2023 Earnings Conference Call. As a reminder, this call is being recorded and is also being webcast within an accompanying slide presentation through the company’s Investor Relations website. The audio webcast archive will be available for one year on American Water’s Investor Relations website. I’d now like to introduce you to your host for today’s call, Aaron Musgrave, Vice President of Investor Relations. Mr. Musgrave, you may begin.

Aaron Musgrave: Thank you, Chris. Good morning, everyone, and thank you for joining us for today’s call. At the end of our prepared remarks, we will open the call for your questions. Let me first go over some safe harbor language. Today, we will be making forward-looking statements that represent our expectations regarding our future performance or other future events. These statements are predictions based on our current expectations, estimates and assumptions. However, since these statements deal with future events, they are subject to numerous known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from the results indicated or implied by such statements. Additional information regarding these risks, uncertainties and factors as well as a more detailed analysis of our financials and other important information is provided in the third quarter earnings release and in our September 30 Form 10-Q, each filed yesterday with the SEC.

And finally, all statements during this presentation related to earnings and earnings per share refer to diluted earnings and diluted earnings per share. Susan Hardwick, our President and CEO, will share highlights of third quarter and year-to-date results and will comment on our 2024 EPS guidance and longer-term targets. Cheryl Norton, our Executive Vice President and COO, will then discuss our new capital investment plan, including the expected impact of PFAS-related investments, and will conclude with a regulatory update, including our views on customer affordability. John Griffith, our Executive Vice President and CFO, will then discuss our year-to-date financial results in more detail, discuss our acquisition outlook, and will close with details behind our 2024 outlook and longer-term goals and our 2024 to 2028 financing plan.

After a few final remarks, we’ll then close by answering your questions. With that, I’ll turn the call over to American Waters’ President and CEO, Susan Hardwick.

Susan Hardwick: Thanks, Aaron, and good morning, everyone. Let’s turn to Slide five, and I’ll start by covering some highlights from the third quarter and year-to-date periods. As we announced yesterday, we delivered strong financial results in the third quarter of 2023, and we’re pleased to again reaffirm our 2023 guidance on a weather-normalized basis. Earnings were $1.66 per share for the quarter compared to $1.63 for the same period last year. In the first nine months of 2023, earnings were $4.03 per share compared to $3.70 per share in the same period of ’22. The estimated net favorable weather impact year-to-date in ’23 is about $0.11 per share compared to $0.06 per share favorable in ’22. These weather-normalized results so far in 2023 continue to reflect our strong execution in line with our growth expectations for the year.

John will elaborate further on results later. Moving on to some of our other key accomplishments to date in 2023, we have invested $1.8 billion in capital projects year-to-date, reflecting great work by our teams responsible for planning and completing these investments. As you will recall, the total capital investment planned for 2023 includes approximately $400 million of acquisitions, including one sizable transaction in Pennsylvania we expect to close in December and another in Illinois around the end of the year. As you know, we completed an equity issuance of $1.7 billion in March and a $1 billion convertible debt issuance in June. These were the two key priorities of our 2023 financing plan. We were focused on completing these issuances in the first half of the year to reduce market-related pricing risk and overall execution risk, which has served our investors, customers — and our customers well, considering the current market conditions.

Turning to Slide six, as we roll out our new five-year plan today, we are affirming our long-term targets, including 7% to 9% EPS and dividend compounded annual growth rates. We are also initiating our 2024 earnings guidance of $5.10 per share to $5.20 per share, which John will discuss further later in the discussion. This represents our expectation of 8% EPS growth in 2024 compared to our weather normalized 2023 EPS guidance. One thing to note on this slide is that we have revised the look of our earnings growth outlook. Recall that we’d historically referred to it as our growth triangle. We believe this new version better highlights our compelling 7% to 9% earnings growth expectation and better represents the key drivers of growth. As a nearly 100% regulated water and wastewater utility, rate-based growth and regulatory execution are the key drivers of growth for our company.

Rate-based growth continues to be driven by the accelerated CapEx plan we put forth two years ago and now with this updated plan. Combined with our robust regulated acquisition strategy on which we’ve proven we can execute, we continue to expect 8% to 9% rate-based growth over the next decade. Later, Cheryl will review the amount of capital we expect to spend over the next five years, including related to acquisitions. On this slide, you can see we are highlighting our acquisition growth strategy measured by a compounded annual growth rate in customer connections of 2%. The timing of closing on acquisitions is often difficult to control within a calendar year, which can cause volatility in acquisition investment on a year-to-year basis. This 2% customer additions CAGR target should be an easier way for investors to monitor and measure our growth through acquisitions.

And as I said, rate-based growth, which includes acquisition investment is the key driver to earnings growth. Our growth outlook also includes the organic revenue growth opportunities we expect from our military services group from the 18 installations we currently serve with an added upside for any new bases secured. One of our company’s competitive advantages is its diverse regulated operations across 14 states that provides us with flexibility in the timing of rate cases and capital deployment. We also have a very predictable and controllable set of capital projects annually, almost half of which are recoverable through infrastructure mechanisms. Along with our other regulatory approaches, we are confident we can deliver consistent earnings growth and dividend growth over the next five years and beyond.

While utility stocks, including ours, have seen the impact on the short term of higher interest rates, history has shown that over medium and longer term horizons, the utility sector and certainly American Water has delivered compelling value to investors. We believe the combination of our EPS and dividend growth supported by our significant yet low risk capital investment plan and our focus on customer affordability and ESG leadership will continue to be rewarded by investors. Based on this long-term plan and our history of executing on our strategies, we intend to continue to deliver a very competitive, sustainable shareholder return for many years to come. With that, let me turn it over to Cheryl to talk more about our capital investment plan and our focus on customer affordability and regulatory execution.

Cheryl?

Cheryl Norton: Thanks, Susan, and good morning, everyone. Before I jump into a discussion of our current long-term capital plan, starting on Slide eight, I want to first acknowledge that our teams have done a great job executing on our accelerated capital investment plans these last few years. We have consistently met our capital deployment goal and we’re on pace to do it again by meeting our overall capital plan of $2.9 billion this year, which includes acquisition investments. Looking ahead to 2024, we expect a modest increase in our investment spending level to roughly $3.1 billion. Over the next five years, we expect to invest approximately $16 billion to $17 billion, an increase of about $2 billion over our previous plan.

We expect constructive outcomes for this important water quality initiative, and we will continue to advocate that the ultimate responsibility for the clean-up of these contaminants should fall to the polluters. We will also continue to advocate that all water and wastewater utility providers, regardless of ownership, have equal access to any federal and or state funding related to treating PFAS. In addition, we’ll continue our efforts to request permanent federal funding for a water and wastewater low-income customer assistance program. The other two drivers of increased CapEx in the 2024 to 2028 plan are a higher level of spend related to prioritized renewal projects across our footprint, such as for hydrant, pipe and meter replacement, as well as a higher level of expected follow-on capital related to future acquisitions.

Following recent acquisitions, we have continued to experience a higher level of investment need in order to bring water and wastewater systems into regulatory compliance and up to our operating standards, which is driving the higher estimated capital need of $600 million. You can also see that we have deferred $500 million of lower risk projects to later years beyond the five-year plan. We did this as a part of our extensive risk-based project analysis in conjunction with our ongoing affordability analysis. For example, we deferred until later in the 10-year capital plan the replacement of some services in Maine where it was determined that they did not pose an immediate risk to service reliability or water quality. Let’s turn to Slide 10 and I’ll cover the latest regulatory activity across our states.

Shown in the slide is a summary of our pending general rate cases with some key facts for each. In the appendix, you’ll also find some details related to infrastructure charges as well as a snapshot of the key outcomes from the most recent general rate case in our top 10 states. Our general rate cases in California, Indiana, West Virginia and Kentucky, are all progressing well and as expected. All of these cases, except perhaps California, will most likely be resolved in early 2024. Just yesterday, we filed a general rate case in Virginia reflecting $110 million in system investments covering May 2023 through April 2025. We’re seeking $20 million of additional annual revenue and expect interim rates to go into effect in May of next year. Outside of our general rate cases, as we discussed last quarter, we filed a request as authorized by California’s water cost of capital mechanism seeking a 52 basis point increase to our ROE in 2023, which was approved on July 25, or increasing the return on equity to 9.5%, effective July 31.

We filed a similar request in October for an additional 70 basis point increase to go into effect January 01, 2024, which would bring our ROE to 10.2%. And finally, related to the customers we have proudly served in the Monterey community for over 100 years, in October, a local entity adopted a resolution enabling it to file an eminent domain lawsuit with respect to the Monterey system assets. This is not a new issue, just the latest chapter in a long-running effort by an entity that we believe lacks the expertise to own and operate a very complex water distribution system serving these Monterey customers. Bottom line, we believe based upon existing legal precedent, we’ll be able to successfully defend against an eminent domain lawsuit if it’s filed.

You can find more information on this topic in our SEC filings, including this quarter’s 10-Q. Moving to Slide 11, I’ll wrap up with a discussion of customer affordability and this new capital investment plan. Using U.S. Census Bureau data specific to the geographies we serve, our research and analysis concluded that projected rising levels of median household income combined with conservative assumptions around an increasing customer base would allow us to stay within our target for residential water bills of 1% or less of median household income. One of the most difficult challenges we face in the water and wastewater industry is balancing customer affordability with the magnitude of the system investments that are needed. Thankfully, today, our industry and our company are in very good relative positions in terms of affordability or wallet share.

At the same time, we realize we must continue to evolve our strategies around rate design and programs to assist our customers who are challenged with affordability. We must also continue our focus on technology, efficiencies of scale, and cost management in order to deliver on customer affordability. Our dual focus on operating efficiency and customer affordability has been a valuable part of our company’s DNA for many years. As you know, we’ve historically used O&M efficiency as one of our benchmark metrics to measure our success at managing costs as we grow the business. In recent years, we’ve emphasized that revenue growth has been just as impactful to the O&M efficiency metric as managing costs. As we look ahead, we’re continuing to evaluate whether this is the best metric by which to judge our effectiveness at managing costs and running an efficient business.

More to come on this in 2024. With that, I’ll hand it over to John to cover our financial results and plans in further detail. John?

John Griffith: Thank you, Cheryl, and good morning, everyone. Turning to Slide 13, let me provide a few more details on year-to-date results. The appendix also has details of third quarter EPS, which has many of the same drivers as year-to-date results. Consolidated earnings were $4.03 per share year-to-date, up $0.33 per share compared to the same period in 2022, and up $0.28 per share on a weather normalized basis. Increased revenues were driven by general rate cases we completed in late 2022 and early 2023 in our larger states. These additional revenues are driven by the significant investments we have made and continue to make in our systems. As noted, earnings were higher year-to-date by an estimated net $0.11 per share as a result of weather in the second and third quarters due to warm and dry conditions, primarily in Missouri, New Jersey and Pennsylvania.

This compares to net favorable weather in the third quarter of 2022 of $0.06 per share, which related mostly to warm and dry conditions in New Jersey. In looking at operating costs, higher pension expense of about $0.10 per share and increased chemical costs of about $0.09 per share, including inflationary pressures, are being recovered in large part through higher revenues we proactively sought through the use of forward test years and traditional updates to base cost of service and general rate cases we completed in the last 12 months to 18 months. This strategy has limited the bottom line impact of those higher costs in 2023 and is a strategy we are continuing to use in our recently filed and upcoming cases. Supporting our investment growth, depreciation expense increased $0.17 per share, and the cost of additional long-term financing increased $0.28 per share, primarily related to share count dilution.

As I mentioned last quarter, the EPS impact of the higher share count from our equity issuance offsets the avoided interest expense in the current interest rate environment. We expect the impact to be approximately neutral to EPS for the full year as well, based on the current outlook. Turning to Slide 14, this graph illustrates that our continued execution on capital investments, both infrastructure projects and acquisitions, are succeeding in growing regulated rate base at a long-term rate of 8% to 9%. Rate-based growth, of course, will drive earnings growth. We believe the high degree of visibility to our capital investment plan, combined with the low-risk nature of the plan, uniquely positions American Water in the utility sector and is fundamental to our investment thesis.

Turning to Slide 15, you’ll see that we continue to be set up for strong growth through acquisitions. We closed on 14 acquisitions, totalling $36 million across six states in the first nine months of 2023, which demonstrates our continued ability to close deals in many states. We also had 32 transactions under agreement across 10 states through the end of September, totalling $611 million, two of which we closed in early October, including one in West Virginia for $27 million. This total also includes both the Butler Area Sewer Authority wastewater system in Pennsylvania and the Granite City wastewater treatment plant in Illinois we previously announced. We expect the Butler acquisition to close later this year in Granite City around year end, pending regulatory approvals for each, and we look forward to serving those customers.

Also included in our acquisitions under agreement is the Towamencin Township Wastewater System in Pennsylvania we expect to purchase for $104 million, as announced back in March. We expect to close this acquisition in late 2024 or early 2025, pending final regulatory approval, and we look forward to serving those customers as well. Our outlook for future acquisitions remains very strong, as we expect to have over $250 million of acquisitions under agreement at the end of 2023 after the expected closings of Butler and Granite City. Of course, as we close on transactions, the work to build and refill the acquisition pipeline is continuous. Our pipeline of 1.3 million customer connections is a strong leading indicator that supports this piece of our rate-based growth outlook.

On Slide 16, we provide some considerations regarding our outlook for 2024 results in our newly established EPS guidance range of $5.10 to $5.20 per share. First, as you would expect, our growth will be driven by capital investment to serve our customers and earning a return on that investment. As we’ve talked about previously, 2023 is year two of our accelerated CapEx plan following the HOS sale. So we see that ramp up reflected in earnings in 2024, both from base rate increases and infrastructure mechanisms. As a reminder, approximately 45% of our CapEx is recoverable by infrastructure mechanisms, so it’s a very meaningful driver of consistent earnings growth for us. Recent regulated acquisitions that are being incorporated into active or just completed rate cases will also drive growth next year.

I’d like to note that our military services group does add incrementally to our earnings growth expectation, as we have continued to show in our growth outlook. MSG’s great work on the 18 military installations it serves has built trust and resulted in the U.S. government allocating additional funds for improvement projects, driving increased revenues. Just as critical to our growth strategy is our ability to prudently manage the operating costs it takes to run the business, which goes to my final point on this slide. Because of our strong culture of operating efficiency and cost management, we expect only modest increases in O&M in 2024. These efforts go to the heart of the customer affordability construct we want to protect, which is closely aligned with the interests of regulators and ultimately investors in managing affordability of customer bills.

Finally, related to pension, I’d simply remind you that our pension obligation remeasurement will be done at yearend 2023, and that will drive the determination of our 2024 pension expense. Turning to Slide 17, I’ll provide a financing plan update before closing with a look at our balance sheet and liquidity profile. In our prior five-year plan through 2027, we expected a total of $2 billion of equity financing need. We successfully issued $1.7 billion of the $2 billion earlier this year, leaving $300 million of equity financing needed toward the end of that prior plan. Based on our new capital plan, our financing plan now includes an estimated $1 billion of equity issuances from 2024 through 2028. The $1 billion of equity in our new plan is expected to be issued near the middle of the 2024 to 2028 period, subject to market conditions.

The $700 million increase in the anticipated external equity need is driven by the incremental $2 billion of CapEx in the new plan. As we’ve said many times now, we expect incremental CapEx to be funded roughly 50-50 debt and equity, which includes both external equity and cash flow from operations. Our financing plan design also takes into account the goal of maintaining a strong balance sheet and continuing to meet our long-term debt-to-capital target of less than 60%. Another assumption inherent in our new plan is that we will continue to be a cash taxpayer, especially as we will likely become subject to the new corporate alternative minimum tax in the coming years. On Slide 18, we provide a summary of our continued strong financial condition.

Our total debt-to-capital ratio as of September 30, net of roughly $630 million of cash on hand remains at 54%, which is comfortably within our long-term target of less than 60%. As we are all aware, the current higher interest rate environment is challenging. We are, however, in a position of strength on a number of fronts in dealing with the challenge. Our strategy of issuing debt at the holding company level allows us to take advantage of our scale and pricing debt issuances. We remain confident that we will have strong access to capital for the long term. In fact, we just extended the maturity of our revolving credit facility to October 2028, which has a capacity of $2.75 billion. Our diversified banking relationships with some of the largest and strongest banks in the world, coupled with our fully regulated business model and strong credit ratings, gives us great confidence around liquidity.

Our laddered approach to long-term debt financings over the years is very important in environments like the current one to manage cash flows and minimize interest rate risk, which contributes to managing customer affordability. And our short duration between general rate cases allows us to minimize any lag we may experience related to recovery of debt costs. With that, I’ll turn it back over to Susan for some closing thoughts. Susan?

Susan Hardwick: Thanks, John. To close on Slide 20, you’ve heard our latest strategic thinking today, and it should sound very familiar. It’s all about execution at every level. As we continue to demonstrate our ability to consistently execute, we believe our industry leading EPS and dividend growth, combined with our focus on affordability and ESG leadership will continue to be highly valued and rewarded by investors. We believe these aspects of our business and strategy separate us from all utilities. They are underpinned by our significant low-risk capital investment plan, which includes our best-in-class execution on acquisitions and our excellent regulatory execution, all while maintaining a strong balance sheet with a well-planned debt maturity profile and a differentiated affordability proposition.

Through our consistent achievement of high operating standards, including our leading safety culture and water quality accolades, our team at American Water has raised the bar for success in the water and wastewater industry and that includes the outstanding efforts by our Military Services Group team to proudly serve the 18 military installations in our footprint. Our history of executing on our strategies has delivered a very competitive, sustainable shareholder return. With this long-term plan, we have full confidence in our ability to achieve the goals we talked about today and continue our track record of delivering superior shareholder value. And with that, let me turn the call back over to Chris to begin Q&A and take any questions you may have.

Operator: [Operator instructions] Today’s first question comes from Richard Sunderland with JP Morgan. Please proceed.

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Q&A Session

Richard Sunderland: Hi, good morning. Am I coming through clearly?

Susan Hardwick: You are, Rich. Good morning.

Richard Sunderland: Great, thank you. Appreciate the details around the update here. I wanted to start with the CapEx revision and the bill outlook. Looking back to 2021, when you first outlined the Accelerated Investment Plan, you gave some details on the customer affordability angle, but I’m curious, kind of bridging, not back to last year, but back to ’21, is there anything different in that outlook now? Obviously, CapEx is up significantly. Also curious if the 2% customer additions target in the language around there for M&A has factored into how you’ve crafted this new capital plan around the customer affordability angle as well.

Susan Hardwick: Okay, Rich, yeah, there’s a lot in there. Let me start and then Cheryl and John can add to it. I would say our focus has sharpened over the last number of years related to customer affordability. And that sharpened focus, I think, has really been around this sort of wallet share concept that Cheryl talked about. I think it’s important for us to understand the communities that we operate in and the demographics of those communities and what are the challenges of customers in those communities and we’ve been able to do a lot of analysis at a very detailed level around affordability, around household income, around just economic impacts in the various communities that we serve and our focus has been, I think, very clearly defined around our wallet share as a percentage of that household income and we’ve been developing this concept here now for a number of years and I think that our ability to confidently say this plan as we’ve continued to grow it, we’ll continue to maintain our position of roughly 1% or less of a customer’s bill in the communities that we serve specifically and I think that focus has allowed us to really think about how to build this plan, how to continue to grow it, how to continue to grow rate base while not overburdening customers with our growth expectations.

I think this plan fits very nicely in that concept. Cheryl, you want to add anything?

Cheryl Norton: Yeah, I would just add, Rich, that as Susan said, we look at all the communities that we serve. We look at the demographics, and yet the capital investments are not that different from community to community. And we need to make sure that we are investing at the right level in all of those communities. New regulations like PFAS, but also the lead and copper rule, that is driving a lot of capital investment across the board and so we have to continue to do that and we need to do that in all the communities. So these affordability calculations, the risk priority model that we use, we think it’s really the best balance to getting the right amount of infrastructure investment in all of the communities that we serve and as we grow the number of communities that we’re serving, that will continue to increase, but we think we’re getting the right balance there because we have to treat all of our customers in a fair way.

They all deserve clean, safe drinking water.

Susan Hardwick: And Cheryl, I might just add one additional comment. From a regulatory perspective, this is also a concept that we’ve been sharing very transparently with regulators. This affordability analysis that we’ve done, and as we lay out in every jurisdiction, the plan and the investments that we have made, we’re right alongside it talking about impacts to customers and how we’ve thought about the plan and how it affects affordability for the customers in the service territory. So again, it’s a concept and a view that we’ve taken that we think is differentiating here and I think regulators, just as one party, are certainly recognizing that.

John Griffith: And Rich, I’ll pick up on the 2% part of your question. As Susan mentioned in her commentary, 2% is a metric that we think is good to think about as a long-term metric given just the short-term variability around acquisitions, but you’re right to point it out in this context. As you know, the 8% to 9% rate-based growth is what drives the 7% to 9% earnings growth, but being able to spread that 8% to 9% rate-based growth over a larger customer base is a healthy element of our growth.

Richard Sunderland: Great. That was very helpful, color there. Thanks for laying all of that out. And then separately, turning to the financing plan here, you were clear on the drivers around the equity relative to the CapEx. I’m curious on the operating cash flow side. It looks like a significant step up, ’24 to ’20 versus ’23 to ’27, is that just normal course kind of rate recovery, any discrete items in there, just how to think about prior versus new?

John Griffith: Yeah, it’s a good question, Rich. Really, there is a big step up. If you think about the increase in our capital plan as we go back from 2021, 2022, 2023 and forward, it’s such a significant step up that when you drop 2023 out of the plan and you bring 2028 into the plan, the accumulation of the capital spend through that period, it accounts for a very significant portion of that operating cash flow step up and then as you would also intuitively think, there is increased cash flow in the interim years as well, just given the increase in capital plan.

Richard Sunderland: Got it. Well, thank you for the time today.

Operator: Our next question is from Paul Zimbardo with Bank of America. Please proceed.

Paul Zimbardo: Hi, good morning, team. Just to clarify on that last line, confirm my understanding, so there’s effectively no change in the growth triangle, as you call it, it’s just kind of a representation.

Susan Hardwick: Yeah, I think that’s fair. We want to continue to emphasize that rate-based growth is the driver. Rate-based investment, which includes acquisitions, is the driver. What we’re trying to do here, I think, is just give some clarity around or maybe a better view as to how you can measure our progress toward growth through acquisition by giving you that sort of metric around customer additions. The investment that we’ll continue to make in acquisitions just rolls into rate-based, which it always has. So no real change in that. I just think it’s a better view potentially for investors to be able to see progress we’re making around the acquisition strategy.