For once, I'm going to come back to one of my old stocks that paid increasing dividends, American States Water, a US utility company (water and electricity). The latter is an aristocrat, with 64 consecutive years of dividend increases, no less. I bought this stock in 2013 and sold it a year ago, perhaps a little early, judging by its performance since then. One of my readers contacted me to ask what I thought of it. Indeed, he received a sell recommendation from his bank. I am usually quite circumspect about their watchwords, so that was enough to tickle me. Having been a seller a year ago, with a share price that has progressed well since then, I should logically still be of the same opinion. But if a bank issues a sell recommendation, then my contrarian side would tend to push me to buy. There is only one way to be sure: I have to do my homework. So here we go.
Valuation & dividend
AWR is trading at a particularly dissuasive price. The price is in fact:
- 32 times current recurring earnings
- 35 times average recurring earnings
- 4.2 times tangible assets
- 5 times sales
- 70 times current free cash flow
- 81 the average free cash flow
This is unsustainable! The EBITDA only amounts to 6.4% of the company value. This is all very expensive...
From a dividend perspective, the yield is not huge, with only 1.65%. With such an amount, one would expect a very conservative payout ratio, but nevertheless it still amounts to:
- 53% current profits
- 58% average profits
- 114% of the current FCF
- 134% of the average FCF
Ok, you might say, he's an aristocrat, and not the least. However, if the company fails to substantially increase its earnings and FCF in the future, AWR will have a hard time increasing its dividend as well as in the past (11.3% average annual growth over the last five years). It should also be noted that over the last five years the dividend has increased almost twice as fast as earnings, which is obviously not sustainable in the long term.
Balance sheet & result
We have seen that dividends have progressed well in recent years and earnings a little less. As for assets, their value is increasing at a very slow pace. As for cash reserves, they are on a downward slope. AWR creates value, but in half-tones, while the price outperformed outrageously, having more than doubled in the last five years. Obviously, here too, such a divergence is not sustainable in the long term, especially with the valuation levels we have seen above.
Unsurprisingly, cash reserves are low, with a current ratio of 0.99 (still slightly up) and a quick ratio of 0.69. The gross margin, on the other hand, is enormous, with 80% (very slightly down), for a free cash flow margin of 7,26% and a net margin of 15,65%. So nothing to complain about at this level, quite the contrary. Same story with regard to profitability, which is good, with an ROA of 4,87% (up), an ROE of 13% and a CFROA of 10,23%.
The long-term debt to assets ratio is high, at 22.65% (increasing). Fortunately, debts only represent 0.72 times equity. On the other hand, it would still take AWR 14 years to repay its entire debt using its free cash flow. This is obviously a very long time.
Interestingly, in addition to the policy of increasing dividends, the company also regularly buys back its shares, which allows it to concentrate the assets of its shareholders. AWR therefore behaves like a company that cares about the wallets of its owners 🙂
Conclusion
AWR is clearly a profitable company, with substantial margins, good profitability and low overheads. Debt is significant, but remains reasonable relative to equity. On the other hand, AWR is struggling to generate FCF, which is explained by significant capital expenditure requirements. Cash reserves are particularly affected.
Certainly, AWR, due to its history, size, profitability and margins, has little risk of going bankrupt. Altman's Z-Score of 2.1 places it in the gray zone. No absolute security, but no great immediate danger either. Piotroski's F-Score of 7 even tells us that the company is rather solid.
So from a fundamentals perspective, it's not bad. Nothing extraordinary, but not bad all the same. The problem is really the price. They say that when the price/sales ratio exceeds three, you have to sell. Here we are at five. I'll let you judge... You will tell me that the stock has a low beta, with only 0.09. But a low beta does not mean that a stock is not volatile, just that it varies little depending on the market. Even though the stock has almost only gone up over the last 12 months, its volatility has risen to 21.85%. I dare not imagine when it will start to go down. I would not be surprised if the price were divided by two.
I hate to say this, but this time the sell recommendation issued by the bank in question seems completely justified to me! Has the world of finance changed? Has it become wise? My God. Everything is going to hell!!!
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"But if a bank issues a sell recommendation, then my contrarian side would tend to push me to buy."
I would be happy to know more about this quote. Thanks!
Buying when the guns are calling and selling when the bugle is calling… This means going against the grain of the investor masses. Buying when everyone else is selling (when the outlook is very bad, like in wartime) and selling when everyone else is buying (when the outlook is very good, like right now). So when a major bank issues a recommendation, we do just the opposite. That’s the first reason.
The other explanation is that bankers are unable to take a step back from the world of finance. They are swimming in it. They often have difficulty seeing clearly because they are not only bombarded with short-term information, but above all they are formatted in a way that does not allow them to see things differently.
Finally, and this is more vicious, banks often have conflicts of interest in their recommendations. They have stakes in certain securities, issue buy signals on securities they want to sell or sell notices on securities they want to buy.
I remember AWR very well, which I held for a few years before selling at a nice profit (and some nice dividends along the way).
This is a company I love but it is clearly totally out of touch with a fair price, so much so that I even bought a few put options at the start of the year (which will unfortunately probably expire too early to benefit from them).
When we see the progression of the course since the beginning of 2012 it is impressive.
March 1, 2012: 6:40 p.m.
Today: 59.32
Add to that all the increasing dividends paid as you say... These are capital gains that we can usually have on technologies, and in any case not on "utilities"!
In short, it still smells of speculation here.
Indeed, I am always wary of banks' recommendations, because there are risks that these recommendations are not objective but serve their own interests. The risk of conflict of interest is significant. Such a maneuver is certainly prohibited by regulators, but as long as it is not too visible, in the "gray zone", I can imagine that the recommendations are not always based solely on an impartial analysis.
Regarding buying at the sound of the cannon and selling at the sound of the bugle, it is interesting, but it is easier to determine when the cannon thunders (directly after a crash) than when the bugle plays (positive periods or even euphoria can be long). If I take the example of the last major crash in 2008 (we will soon "celebrate" the 10th anniversary of this major and painful event!), the one who bought in 2008 before the crash (I was there...) took a big hit, while the one who was liquid and who did his shopping in 2009 did good business. The whole question is knowing when to be liquid, that is to say when to sell; in my opinion it is more difficult than knowing when to buy.
As you say. There are practices that are forbidden for banks. And they are supposed to be controlled for that. We saw how effective it was in 2008… it was even the banks that were at the origin of the massacre. So trust is at zero, even if for once I agree with their conclusions.
Regarding your second paragraph, it is impossible to do market timing. Research has proven that it does not work and that it is still better to stay invested at 100%. However, common sense tells us that it is better to lighten your most expensive positions when the market is overheating and start buying back when everyone is panicking. I do not necessarily think that it is easier to spot the sound of the cannon than that of the bugle. 2008 was a fairly rapid crash, so that was quite obvious, that is true. But the bursting of the Internet bubble was a completely different story. How many times did we say to ourselves, this time it is good, it cannot fall any lower. It still lasted almost three years to finish. Ok, sure, we are still very far from the 10 years of euphoria that we have now, but it must be said that we came back from very far after two big bear markets and that valuations remained correct for a very long time after the start of the recovery... It should also be noted that the US market is completely manipulated by Trump's policy. He is not wrong when he says that if he is deposed, the market will collapse, but it is not because he is good, just because he cheated 🙂
That's right: crashes don't always have the same consequences: some cause a sudden plunge followed by a more or less slow or rapid rise (as in 2008; but in reality the market peak dates back to the end of 2007, even if the most brutal descent took place in the fall of 2008, against the backdrop of the bankruptcy of Lehman Brothers) and the bottom was hit in February 2009) and others cause a more or less slow or rapid descent (bearish market) before the trend reverses (with the crash of the internet bubble, the descent began around September 2000 to hit rock bottom and start again in March 2003, with the Gulf War II).
I note that the markets have risen less rapidly since February 2009 than before the peaks of September 2000 and December 2007. In addition, there was a serious dip in 2016, which does not have its counterpart with the aforementioned peaks.
In the end, it is true that market timing is random. We always come back to the same conclusion: the only thing that should count is the analysis of the quality of a company, on the one hand, and its current valuation, on the other.