Essential Services and Shareholder Value Delivered with Integrity
Essential Utilities Inc. (NYSE: WTRG; formerly Aqua America, Inc. [WTR]) is one of the largest publicly traded water, wastewater, and natural gas providers in the U.S., serving approximately five million people across 10 states under the Aqua and Peoples brands. The company recognizes the importance water and natural gas play in everyday life and is proud to deliver safe, reliable services that contribute to a better quality of life in the communities it serves.
- Delivered consecutive quarterly cash dividends for 75 years and increased the dividend 30 times in the last 29 years
- Expects to invest approximately $3 billion through 2023 to replace and expand water and wastewater utility infrastructure and to replace and upgrade natural gas utility infrastructure, leading to significant reductions in methane emissions
- Published a 2019 Environmental, Social and Governance (ESG) report highlighting the company’s commitment to environmental stewardship, sustainable business practices, employee safety, diversity and inclusion, customer experience and community engagement
Advisor Access spoke with Essential Utilities CEO Chris Franklin
Advisor Access: Let’s start with your business model. Please describe the origins and traditional focus of Essential Utilities.
Chris Franklin: Essential Utilities provides a unique combination of experienced, regulated utility companies offering essential services to customers and a unique investment opportunity for investors. Our business model allows us to play an important role in solving our nation’s water and natural gas infrastructure challenges through thoughtful capital investment, operational excellence, environmental stewardship, and a commitment to strengthening local communities.
With estimated infrastructure needs across the U.S. of $473 billion in water and $271 billion in wastewater, many cities and municipalities face difficulty maintaining their systems and meeting state and federal compliance requirements. The need for substantial capital investments represents an opportunity for Aqua, our legacy water business, to be a solution. Aqua began 135 years ago in suburban Philadelphia, has over 1,600 employees, and serves more than three million people across eight states (Pennsylvania, Ohio, Illinois, Texas, North Carolina, New Jersey, Indiana, and Virginia). A combination of large surface-water systems, small groundwater systems, and wastewater treatment systems of all sizes helps us provide safe and reliable service to our customers.
The recent acquisition of Peoples, a 136-year-old natural gas distribution company based in Pittsburgh, provides similar investment opportunities. Our capital spending will increase the safety and reliability of the natural gas infrastructure while growing rate base and improving the environment. Over the next fifteen years, as the company replaces nearly 3,000 miles of natural gas mains, the associated reduction in fugitive methane will reduce the gas utility’s carbon footprint by 60%. Essential provides natural gas to more than two million people across three states (Pennsylvania, Kentucky, and West Virginia), employs over 1,500 employees, and has over $2.4 billion in rate base.
The combination of the second largest, stand-alone, regulated water utility in the U.S. and fifth largest, stand-alone, regulated gas local distribution company in the U.S. allows us to bring more than 260 years of combined expertise and service to our 10-state footprint.
AA: Tell us about your motivations for the acquisition of Peoples. Why did you decide to wander outside your area of expertise (water)?
CF: I think it is important to discuss our growth strategy first, to be able to understand why the acquisition of Peoples was the right fit for the strategic growth of our company. Our growth strategy focuses on three core competencies: infrastructure investment, regulatory affairs, and operational excellence, which supports our three-pronged approach to growth.
The first and primary driver of our growth strategy is municipal initiatives in the water and wastewater industry. We have seen more progress on municipal deals than I think anyone expected. In fact, since 2015 we have added over 265,000 customers and $625 million in new rate base through transactions we have either announced or closed.
The next prong of our growth strategy is strategic mergers and acquisitions (M&A), which is where we would categorize the unique opportunity Peoples presented.
The third prong is the non-regulated or market-based activities in the marketplace, and while we continue to evaluate opportunities in this area, our focus remains on the municipal initiative and strategic M&A.
Why did Peoples make sense? Peoples isn’t just any gas company; it provides us with the ability to have a second platform for growth, in a state that we know well, with significant organic rate base growth and less than 1% exposure to unregulated business. Peoples is based in Pennsylvania, which traditionally has been viewed as a favorable regulatory environment and sits on top of one of the largest shale deposits in the country. Peoples has no exposure to fracking, but has access to a plentiful supply of gas from the Marcellus-Utica supply basin, and natural gas is the most effective and low-cost energy source for the colder climates we serve. Most important, its capital investments, largely in 2,700 miles of pipe replacement, will grow rate base, which leads to earnings growth—and at the same time, result in significant methane reductions and increased safety.
AA: Can you provide an update on integration since closing the Peoples acquisition?
CF: We closed on March 16, 2020, the same day we activated our business continuity plan and asked all our office employees to begin working from home due to the COVID-19 pandemic. Since then, we have come together even faster than we could have imagined, with company leaders supporting both the water and natural gas utilities. Our operations teams worked together to solve COVID-related challenges, and have been working closely ever since. Our engineers have accelerated the pipeline replacement program at Peoples. We have leveraged our scale in purchasing vehicles, equipment, and technology. We are building efficient back-office infrastructure and applications to support both utilities, and to better serve our customers. Sharing best practices related to operations, construction, and safety have been key to the success of our integration process.
AA: You mentioned that the primary driver of your growth strategy is municipal initiatives in the water and wastewater industry. Can you discuss how fair market value (FMV) legislation has impacted this initiative?
CF: Fair market value legislation allows regulated water companies to pay fair market value for the purchase of water and wastewater systems, encourages consolidation in the fragmented water and wastewater industry, and enables resources to be shared among a larger service area, which ultimately benefits local governments and other water utility owners, customers, and the environment. Prior to FMV, the value of municipal water and wastewater systems were determined by their depreciated original cost, which generally did not reflect a reasonable market value for the assets.
With the passing of FMV, we are able to provide a solution for municipalities that face challenges and costs in maintaining and operating water and wastewater utilities. Local governments can use the proceeds of a utility sale to fund meaningful initiatives and services for their residents, knowing their communities will have safe and reliable systems.
We have a history of successful and ethical collaboration with legislators and regulators to implement constructive regulatory mechanisms, and FMV has been enacted in all eight of our water and wastewater states. In the last five years alone, we have closed or signed agreements with over 60 municipalities, including with the Delaware County Regional Water Quality Control Authority (DELCORA).
DELCORA marks the largest municipal acquisition in our company’s history, and is the largest municipal deal in the state of Pennsylvania. DELCORA is a municipal wastewater authority serving 42 municipalities and approximately 500,000 people in the southeastern part of the state. The regulatory filing is currently at the Pennsylvania Public Utility Commission and is expected to close spring 2021.
We have business development professionals active in every state to foster and develop our robust pipeline. While most of our municipal deals have been in Illinois and Pennsylvania, since they were early adopters of FMV, we expect the municipal acquisition activity to accelerate in many of our other states. Overall, the current acquisition environment is strong, and we continue to evaluate opportunities to partner with municipalities looking for a solution.
AA: Can investors expect Essential’s long-standing policy of paying increasing dividends will continue going forward?
CF: Nearly a third of Essential’s stock is owned by retail shareholders, many of whom have enjoyed our long history of paying dividends. Our most recent increase of 7% marks the 30th increase in 29 years, and the 75th consecutive year of quarterly dividend payments.
We take great pride in our long, consistent record of delivering shareholder value and believe our dividend policy is indicative of our financial strength. Our dividend payout target remains in the 60-65% range.
AA: Everyone seems to be talking about ESG these days. Tell us about Essential’s ESG program.
CF: ESG has always been a core part of our corporate culture, and has been a personal priority of mine. Since becoming CEO in 2015, the company has made ESG a priority. We started with board refreshment, since I truly believe diversity helps to facilitate better discussion and better outcomes.
Prior to closing the Peoples transaction, our ESG team published our first ESG Tear Sheet and dramatically enhanced our 2020 proxy. To ensure we provide transparent and comprehensive reporting on our work, we hired a full-time, in-house ESG manager. Most recently, we issued a new and more detailed ESG report in a digital microsite format. Our ESG website will be the home for all related news and disclosures.
We made some important announcements in 2020. We have committed to sourcing 60% of our energy at the water utility from renewable sources by 2022. We believe we stand alone, as a multistate water utility, in our commitment to test every source of water in our eight states, and treat any source where we detect PFAS (polyfluoroalkyl substances) above 13 PPT (parts per trillion). This is significant, since the federal health advisory level is at 70 PPT.
We are now bringing this focus on ESG to Peoples. As a new, combined water and natural gas company, we announced the aggressive and achievable emissions reduction target of 60%. This was a high priority; we felt it was important to do this before we reached the one-year mark of ownership.
To give you a sense of what this means, in 2035 the emissions we will avoid are roughly equivalent to the emissions from 76,000 passenger cars on the road over the course of the year. We have significant leak-prone pipe to replace at Peoples, and each mile of pipe replaced quantifiably reduces fugitive methane emissions by about 50 metric tons of CO2e (carbon dioxide equivalent), which is the equivalent of taking 11 passenger cars off the road each year. This pipe replacement program will simultaneously contribute to safety and annual rate base growth over the next 15 years. These reductions will be included in our ESG reports in the future.
We see positive results in all our ESG efforts. In 2019 we outperformed the national average on drinking water quality by seven times, and continue to advance our wastewater system compliance. We have also been awarded Industry Leader Accident Prevention Award from the American Gas Association and were recognized by 2020 Women on Boards as a Winning “W” company, with women comprising one-third of our board of directors. Achievements like these make our entire company more resilient.
AA: Is there anything else you’d like investors to know about Essential Utilities?
CF: Essential Utilities is 135-year-old company that plays an important role in solving our nation’s water and natural gas infrastructure challenges. Our commitment to capital investment, operational excellence, environmental stewardship, and strengthening local communities is part of our culture. Our employees deliver on our mission to improve quality of life and economic prosperity by safely and reliably delivering earth’s most essential resources. Aligned with our proven growth strategy we are focused on delivering shareholder value while remaining a stable industry leader.
AA: Thank you, Chris.
A fixture of the Essential leadership team, Christopher Franklin is chairman and chief executive officer of Essential Utilities, Inc. Since being named CEO in 2015, Franklin has refocused the company on growing its regulated business, purchasing municipal water and wastewater systems, and shedding its underperforming unregulated businesses. The company also broadened its strategy by adding a natural gas platform. The accomplishment of which Franklin is most proud is building a strong management team and bringing diversity to the company’s board of directors, employee base, and management team, including the appointment of nine women to leadership roles in the company since being named CEO. Additionally, Franklin was named one of the Philadelphia Business Journal’s Most Admired CEOs in 2017. In 2019, Franklin was recognized by EY (formerly Ernst & Young) with their “Entrepreneur of the Year” award. Prior to his role as CEO, Franklin was president and chief operating officer. A 27-plus-year veteran of the company, Franklin has held executive roles in public affairs, customer service and operations. In addition to serving as the chairman of Essential’s board of directors, Franklin is active in the community and serves on six nonprofit boards, including as director and past chairman of the National Association of Water Companies and as a director on the Chamber of Commerce for Greater Philadelphia. Franklin earned his bachelor’s degree from West Chester University and his MBA from Villanova University.
“We believe the new U.S. administration’s focus on water infrastructure and water quality could help accelerate consolidation of the fragmented U.S. water and wastewater system, offering a long-term growth driver for WTRG while addressing the estimated $750bn of water infrastructure investment needs.”
—Insoo Kim, Goldman Sachs Equity Research
Nov. 19, 2020
“With FMV legislation now in all eight water & wastewater states in WTRG’s footprint following the passage in Virginia earlier this year, the company continues to execute on tuck-in acquisitions and discussions continue to highlight a robust pipeline of opportunities.”
—Julien Dumoulin-Smith, BofA Global Research
Nov. 12, 2020
“Finally, we talked about the water and wastewater M&A pipeline and there continue to be attractive, sizeable opportunities that not too long ago WTRG would have never thought possible. We reiterate our Overweight rating and increase our 12–18 month price target to $52/share (29X our 22E EPS of $1.78) from $47.”
—Neil Kalton, Wells Fargo Securities
Dec. 10, 2020
Investors and others should note that Essential Utilities Inc. posts important financial information using the investor relations section of the Essential Utilities Inc. website, https://www.essential.co/investor-relations, and Securities and Exchange Commission filings.
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