American States Water Company (AWR) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Figures below are AWR consolidated unless otherwise stated; dollar amounts are in millions except per-share data. The combined filing also reports on wholly owned Golden State Water Company (GSWC).
Business context
AWR operates regulated water and electric utilities in California and contracted water and wastewater services at U.S. military bases through American States Utility Services (ASUS). On July 1, 2020, GSWC transferred its electric utility assets and liabilities to Bear Valley Electric Service (BVESI), which became a direct AWR subsidiary. This common-control reorganization did not materially change AWR’s consolidated operations, but it affects comparisons of GSWC standalone results.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Operating revenue | $133.7 | $134.5 | $364.0 | $360.9 |
| Operating income | $39.8 | $42.7 | $101.2 | $102.3 |
| Net income | $26.5 | $28.0 | $66.2 | $67.6 |
| Diluted EPS | $0.72 | $0.76 | $1.79 | $1.83 |
| Dividends declared per share | $0.335 | $0.305 | $0.945 | $0.855 |
Q3 revenue decreased 0.6%, operating income fell 6.8%, and net income declined 5.3% year over year. For the first nine months, revenue grew 0.9%, while operating income declined 1.1% and net income declined 2.1%. AWR’s reported diluted EPS comparisons include a $0.07 per-share retroactive electric rate-case benefit in Q3 2019; excluding that item, adjusted Q3 EPS was $0.72 versus $0.69. Adjusted nine-month EPS was $1.79 in both years; reported 2019 EPS included a $0.04 per-share retroactive benefit.
- Water: Revenue rose 3.6% in Q3 and 3.7% year to date, primarily reflecting CPUC-approved rates. Water gross margin, a company-defined non-GAAP measure, increased 3.6% to $68.9 million in Q3 and 4.8% to $185.4 million year to date. Q3 billed consumption rose 5%; usage effects were generally moderated by regulatory balancing mechanisms.
- Electric: AWR electric revenue fell 30.9% in Q3 and 10.3% year to date, largely because Q3 2019 included retroactive rate-case revenues. Electric gross margin declined 35.2% to $5.8 million in Q3 and 2.6% to $19.1 million year to date; the Q3 comparison is affected by the prior-year retroactive rate adjustment.
- Contracted services: Revenue declined 2.0% in Q3 and 3.4% year to date. Lower construction activity was partly offset by higher management fees and, in Q3, lower travel costs.
Operating expenses increased 2.3% in Q3 and 1.7% year to date. Nine-month maintenance expense rose 25.7%, while administrative and general expense rose 3.5%. AWR’s effective tax rate increased to 24.3% for the nine months from 23.3% in 2019.
Cash flow, capital spending and liquidity
- Nine-month operating cash flow was $87.8 million, versus $84.3 million. Capital expenditures were $94.8 million, versus $111.1 million; operating cash flow less capital expenditures was approximately negative $7.0 million.
- Cash and cash equivalents were $8.1 million at September 30, 2020, compared with $1.3 million at year-end 2019. Management said operating cash flow, credit facilities and capital-market access should be adequate for normal operations and financing needs.
- AWR reported long-term debt of $440.3 million, $92.0 million of bank notes payable and $0.4 million of current long-term debt. AWR’s revolving credit facility had $89.0 million outstanding; BVESI’s separate $35 million facility had $3.0 million outstanding.
- GSWC issued $160 million of unsecured notes in July: $85 million at 2.17% due 2030 and $75 million at 2.90% due 2040. Proceeds repaid most intercompany borrowing from AWR, which used the funds to reduce revolver borrowings. GSWC had $34.1 million of intercompany borrowing classified as current, subject to a required paydown by November 2020.
- Capital expenditures by the water and electric segments were estimated at $105–$120 million for 2020, subject to possible schedule delays. S&P affirmed AWR and GSWC at A+ with stable outlooks; Moody’s reaffirmed GSWC at A2 with a stable outlook.
Outlook, commentary and material risks
- GSWC’s 2020 water rate step increase was expected to add approximately $10.4 million to 2020 water gross margin. The 2019–2021 rate decision also allows a potential approximately $11.4 million gross-margin increase in 2021, subject to an earnings test and inflation assumptions.
- GSWC filed a 2022–2024 water general rate case seeking approximately $450.6 million in capital budgets over three years, plus $11.4 million of projects to be submitted separately. A decision was scheduled for Q4 2021, with rates expected to take effect January 1, 2022.
- The CPUC’s August 2020 decision limits future proposals to continue WRAM and MCBA mechanisms and permits alternatives. GSWC and other parties sought rehearing; management could not predict the outcome. A change in these mechanisms could increase earnings volatility and affect recovery of authorized water margins.
- Management expected contracted-services construction activity to improve in Q4 compared with the first three quarters, barring further weather delays. The company reported $13.7 million of new military-base construction awards during the first nine months. These projects and future awards may vary.
- COVID-19 measures included suspending residential service disconnections for nonpayment through April 2021, increasing telework and delaying some water capital projects. The company increased customer receivable allowances; approximately $1.4 million of incremental pandemic costs had been recorded as regulatory assets for future recovery. Management could not predict the pandemic’s remaining 2020 financial impact. ASUS had not experienced a material operating impact to date.
- California drought conditions, reduced water supplies, wells out of service and water-quality requirements remain risks. As of October 27, 2020, approximately 68% of California was in moderate drought and 36% in severe drought. GSWC also reported PFAS monitoring and removal of some wells from service; related costs were being tracked for potential rate recovery.
- Other notable exposures include wildfire and public-safety power shutoff risks for BVESI, utility infrastructure and environmental obligations, regulatory cost-recovery uncertainty, and possible delays in U.S. government payments or adjustments for ASUS contracts. Ordinary-course litigation was not considered material. A $1.3 million estimated additional remediation cost at GSWC’s Chadron site was recorded with a corresponding regulatory asset and accrued liability.
- No formal consolidated earnings guidance was provided. AWR’s board approved a fourth-quarter dividend of $0.335 per share, payable December 1, 2020. Management stated a long-term dividend growth objective above 7% annually.
Important facts for investors to verify
- Whether the CPUC’s WRAM/MCBA decision is reheard or changed, and the resulting effect on future water earnings and recovery mechanisms.
- Customer delinquencies, bad-debt expense and the timing and approval of recovery through COVID-19 memorandum accounts.
- Actual 2020 capital spending and whether pandemic-related project delays affect infrastructure plans or rate recovery.
- Water supply availability, drought restrictions, well outages and PFAS-related treatment costs and recovery.
- Contracted-services construction timing, government funding and payment collection, and the extent of any Q4 recovery in project activity.
- Debt, covenant headroom and liquidity, including GSWC’s intercompany borrowing paydown requirement and the effect of new long-term debt on interest expense.
- Comparability of electric results with 2019, which included retroactive rate-case amounts, and the impact of the July 2020 transfer on GSWC standalone reporting.