22% Off Highs, is California Water Service Stock (NYSE:CWT) a Buy?

California Water Service Group (NYSE:CWT) has seen its shares march lower over the past few months. With the stock currently trading near six-month lows and 22% off its all-time high, underperforming all major indexes recently, it raises the question of whether California’s major water utility could present an attractive opportunity.

On the one hand, California Water Service is a respectable company, boasting 56 years of consecutive dividend increases. Its performance over such an extended period of time has been remarkable and is set to remain this way, given the unique qualities attached to its business model.

On the other hand, despite the stock’s downward trend, California Water Service appears to still be somewhat overvalued based on the current market landscape. Its dividend yield has stayed relatively thin as well. Accordingly, I am neutral on the stock.

What’s Unique About California Water Service?

California Water Service’s business model features multiple qualities serving as the foundation for its remarkable performance throughout the years. Its earnings per share have been consistently increasing over time at a very stable rate. Specifically, CWT’s earnings-per-share growth over the past decade has grown at a compound annual growth rate (CAGR) of about 4.3%. The company’s multi-decade dividend growth streak also illustrates CWT’s ability to thrive through all kinds of economic environments.

The most significant catalyst that has contributed to CWT’s robust performance, even during some of the harshest economic climates, is its recession-proof operations. Water is a fundamental necessity for human life and economic activities. Regardless of economic conditions, people and businesses require a consistent and reliable supply of clean water. This allows CWT to be less susceptible to economic downturns.

Even during recessions, the demand for water remains relatively stable, providing a steady revenue stream for the company. For context, CWT’s revenues still grew by 11.8% in 2008, 9.5% in 2009, and 11.6% in 2020, despite the 2008-09 Great Financial Crisis and the COVID-19 pandemic.

Being a regulated water utility brings along several additional benefits. Essentially, CWT has been bestowed with a privileged “monopoly status” in the regions in which it operates. This leaves practically no space for potential competitors to enter, thus creating a formidable moat.

Moreover, regulators allow water utilities to adjust their rates periodically to cover the cost of infrastructure upgrades, maintenance, and operational expenses. These predictable rate hikes provide high earnings-growth visibility for the company, which further contributes to cash flow resilience.

Do CWT’s Dividend Prospects Remain Exciting?

CWT’s 56-year-long dividend growth track record is undoubtedly commendable. However, while the stock’s dividend remains secure and dependable for investors, its overall potential may not be particularly thrilling. The company has managed to grow its dividend at a CAGR of 4.7% in the past decade, closely aligned with earnings growth.

Considering that management likely intends to maintain a healthy payout ratio of around half of CWT’s earnings (last year’s ratio stood at 56.5%) to adequately support future capital expenditures, it is unlikely that dividend growth will accelerate in the foreseeable future. This holds true for CWT’s earnings as well, given the mature nature of its operations.

A mid-single-digit increase in dividends wouldn’t necessarily be disappointing if the stock offered a substantial dividend yield. However, with a yield of 1.9% in a period of rising interest rates, the combination of modest dividend growth and thin dividend yield should fail to excite anyone beyond highly-conservative investors.

Is CWT’s Valuation Reasonable?

The fact that CWT has managed to increase its dividend for such a long time while featuring a relatively soft yield should hint that the stock has managed to sustain a relatively elevated valuation. Indeed, according to consensus estimates, CWT is expected to produce earnings per share of about $1.80 in Fiscal 2023, implying a year-over-year increase of about 1.6%.

Yet, despite the stock’s notable correction in recent months, this estimate implies CWT’s forward P/E hovers at above 30x. Besides the fact that this multiple is significantly higher than the S&P 500’s forward P/E of 20.4x, it’s hard to justify that it’s a reasonable one, given CTW’s mid-single-digit earnings growth trajectory.

Clearly, much like the scenario observed in the majority of water utility stocks that are currently commanding high premiums, it is evident that investors continue to display a willingness to pay a premium for CWT. This can be attributed to the company’s financial performance, which is expected to exhibit remarkable resilience in the face of any macroeconomic shifts for the reasons mentioned previously.

Additionally, when coupled with the modest yet remarkably consistent dividend, it becomes obvious why specific investors, particularly those with a conservative approach, are incentivized to keep accumulating shares in CWT, regardless of its rich valuation.

Is CWT Stock a Buy, According to Analysts?

Turning to Wall Street, California Water Service Group has a Moderate Buy consensus rating based on one Buy and one Hold rating assigned in the past three months. At $60.50, the average California Water Service stock price target suggests 7.6% upside potential.

The Takeaway

California Water Services displays decades of consistently rising earnings and dividends. This is a trend that is likely to last for decades to come, given the unique qualities that come attached to the company’s business model and market position.

While conservative dividend growth investors are likely to find CWT stock a decent fit for their portfolios, it’s unlikely that its overall prospects will be compelling. A low dividend yield, modest growth projections, and an elevated valuation create an unlikelihood of generating stimulating returns.

Disclosure