SJW Group: The Dividend Aristocrat Approaches A Buy Zone

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SJW Group is a water utility company that offers stable income and has historically provided excellent total return.The company's shares have declined by nearly 40% and are now trading close to fair ...

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Listed water utilities are interesting investment options for income-seeking investors. In general, water utilities are stable businesses, offering a pure necessity in monopoly-like conditions in their respective geographies. Although their earnings are capped by regulations, historically the shares of water utility companies have provided excellent total returns. SJW shares have gone through a major decline of nearly 40% from the highs of 2023. After the decline, the shares are trading at a typical valuation of around P/E 20x. Now, the shares are trading around fair value. At the same time, shares provide a historically high dividend yield of 3% and relatively good growth prospects. A mid-sized water utility SJW is a water and wastewater utility operating in the states of California, Connecticut, Maine, and Texas. 57% of its net income comes from the business in California. 95% of its net income is derived from regulated business. In 2023, its revenue was approximately $730 million and the company employed 800 people. The market capitalization of SJW is $1.7 billion and enterprise value is $3.4 billion. SJW operates crucial parts of water infrastructure ranging from distribution to treatment of water and wastewater. It serves 1.5 million people. 60% of the supplied water is produced from surface and groundwater and the rest SJW purchases wholesale. In comparison, SJW is a mid-sized listed water utility behind giants such as American Water Works Company, Inc. (AWK) and Essential Utilities, Inc. (WTRG). Overview of SJW Group. (Investor presentation) In the last quarter, the revenue was unchanged compared to 2022, but earnings per share declined 46%. The decline is a result of 22% higher water production costs, explained mainly by rate increases of a water wholesaler, and a delay in a general rate case decision in San Jose, which is likely to be mitigated during the following quarters. The water production costs increased from Q3 when SJW reported a 12% increase. As a whole, in 2023 SJW's revenue increased by 8% and earnings per share increased by 10%. Data by YCharts Increased earnings potential as a result of higher investments At first glance, a water utility business can appear as a low-growth industry. High organic growth is naturally difficult to come by. Fortunately, in Texas SJW serves three out of five of the fastest-growing counties in the U.S. In Texas, compared to 2006, SJW has quadrupled the number of water connections. In the service area of SJW, there are plenty of new housing developments providing potential for organic growth. The water utility industry is fragmented and mainly consists of small publicly owned water utilities. In 2023 SJW acquired a small water utility called KT Water Resources in Comal County, Texas, with 570 connections. Compared to the much bigger water utility, American Water Works Company, SJW has not grown through acquisitions. Last year AWK closed 23 acquisitions for $77 million in 2023. From this perspective, acquisitions could be an underutilized growth opportunity for SWK, or perhaps it lacks the financial muscle to compete for the acquisitions. On the other hand, in the higher interest environment, the slow acquisition pace showcases the prudence of the management team in my opinion. In 2023 SJW spent $272 million in capital expenditures and plans to invest $332 million this year. The development represents a step change from a typical level of $130-240 million of capex in 2018-2022. SJW has a plan to invest $1.6 billion until 2028. This is likely to increase SJW's earnings potential through the mechanisms of regulated business and rate base growth, potentially guaranteeing approximately 10% ROE. Data by YCharts The stock is approaching a buy level For the past twelve months, the shares of SJW have been heading toward the level last seen in the pandemic bottom of the year 2020. The decline has happened along with the shares of other interest rate-sensitive utilities and water utilities. In the process, SJW's valuation measured simply with P/E-multiple has normalized to the 20x level seen in the period of 2016-2018. Data by YCharts Historically, SJW has grown its earnings per share at a pace of 8-9% on average. For 2024 SJW is guiding for an EPS of $2.68 to $2.78 and a long-term growth rate of 5%-7%. According to Seeking Alpha its average P/E for the past five years is over 40x. In the current interest environment, with increased financial costs and slower growth, one shouldn't expect multiple expansions. In the low interest rate environment utilities were a proxy for fixed-income investments and therefore in fashion. Now, the opposite is now the case. Estimating the fair value of SJW based on the guidance and historical performance gives us a fair value between $50 to $62 per share if the investor believes that the company deserves a P/E multiple of around 20x and an 8% discount rate. A lower discount rate and a rather high multiple could be justified by the track record, stable and clear business outlook, and relative safety. If we apply, for a margin of safety, the lower end of the guidance and modest dividend growth, we arrive at a fair value of approximately $50 per share. Fair value estimate with lower end of the guidance. (Author) When applying a higher end of the company's guidance and higher dividend growth, combined with a tad higher P/E, we arrive at a fair value of approximately $62 per share. When looking at the increased water production costs, reduced expectations for interest rate cuts, and lower growth guidance compared to historical levels, it is difficult to state that SJW would be undervalued. Fair value estimate with higher end of the guidance. (Author) Compared to its peers SJW is attractively valued. It trades at a discount on most of the multiples. This could be justified by growth and profitability as SJW has performed less well in some aspects compared to some peers. However, there's no evident pattern. Compared to American States Water Company, a similar-sized water utility, SJW has slower historical growth and lower profitability, and therefore the difference in valuation is justified in my view. Peer valuation. (Seeking Alpha) Downside considerations Like most utilities, SJW carries a significant amount of debt on its balance sheet. In 2023, its average cost of debt increased from 3.4% to 6.3%. Increased interest expenses reduced the earnings per share by $0.23 in 2023. Although regulatory processes ensure that higher production costs are mitigated, higher interest expenses will consume net income. Most of SJW's long-term debt is due after 2028. Drought and higher water production costs could be another element reducing water consumption and burdening SJW's earnings, even if water is a necessity. According to the American Water Works Association, the top three risks of water utilities are replacement of aging water infrastructure, availability of water supply, and financing of capital improvements. On the other hand, a private water utility could help public entities solve these challenges if it has access to capital. SJW has periodically issued new shares to finance its expansion and investments, therefore diluting shareholders but increasing its asset base. Data by YCharts Historically high dividend yield Currently, SJW pays an annual dividend of $1.6 resulting in a dividend yield of 3%. Against last year's EPS of $2.68, the payout ratio stands at around 60%. From the perspective of dividend yield, SJW looks attractively priced. According to Seeking Alpha data the four-year average dividend yield is 2.1%. The dividend yield of SJW has not exceeded the 3% mark in the past 10 years. Data by YCharts SJW has increased its dividend for 56 consecutive years. The five and ten-year average dividend growth rates have been 6.2% and 7.7%. Conclusion  Although a higher for longer interest rate environment could be unfolding, SJW starts to approach an attractive price level for an income-seeking investor. The underlying earnings growth supports the growing dividend stream. As interest rate expectations are still in the process of finding a grounded level, the stock might experience downward pressure, so building a position in steps is advisable.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2428324588"}