Talk About Liquid Assets

Conservative investors who are feeling burned by electric utilities might consider cooling off with water-company stocks. These are stable, dividend-paying investments with a projected average annual total return of 8.5% over the next three to five years.

Of the 60,000 water systems in the U.S., only 17 are publicly owned, and the biggest one has a market capitalization of $750 million. These serve about 30% of the nation's population. The rest of the systems are run by a hodgepodge of local municipalities and private developers.

Recent water-quality scares in Milwaukee, Washington, D. C., and New York City are fueling environmental regulation--to the detriment of many financially strapped local water operations. But the larger investor-owned water utilities have been gearing up for changes and are seizing the chance to buy or service the smaller systems.

In addition, the threats of deregulation and competition that are tearing up electric utilities don't exist in water systems because companies are limited by the geographic location of their reservoirs and pipelines.

NO SURPRISES. With dividends of around 6%--compared with 7% for electrics--and water rates rising at three times the rate of inflation, "water is good for someone who doesn't want any surprises but has a very long-term bullish outlook," says Roger Conrad, editor of investment newsletter Utility Forecaster.

The biggest of the water utilities, American Water Works in Voorhees, N.J., is a tightly run ship, serving more than 5 million people in 21 states. This geographical diversification makes it a good play because water usage is dependent on the weather: Too little or too much rain, and people stop washing cars and watering lawns. American is now trying to buy a big water system in prosperous and fast-growing Orange County, Calif.

American has a potential annual total return of 11%, says Jim Krekeler, an investment banker who raises money for water utilities at Edward D. Jones in St. Louis. Its current 4% yield is low, but Krekeler projects its dividend will grow 7.5% a year for the next five years--considerably more than the 2% average for all utilities (including electric, telecommunications, and gas). American is trading close to its 52-week low of 26. Revenues grew 9% last year, and earnings per share rose 10.6%. And its price-to-earnings ratio of 11.3 falls below the industry average of 12.

TOP PROSPECTS. Other good dividend-growth stories, says Krekeler, are Philadelphia Suburban and Connecticut Water Service. Philadelphia, a $200 million company that is expanding into nearby municipal systems, is yielding 6.4%, and its dividend should grow 3% a year. Trading near its 17 1/8 52-week low, its p-e is 13.4. Connecticut, a $55 million company that runs three systems in that state, 1ields 7.0% and should grow 2% to 2.5% a year. It's cheap at 23 1/2. Although these utilities lack American's diversity, "all three are at the top of the industry in terms of quality and management," says Krekeler.

Other companies worth a look include United Water Resources in Harrington Park, N.J. It recently became the second-largest water utility, at $250 million in market capitalization, when it merged with General WaterWorks. This puts United in 14 states, serving some 2 million people. Selling at around 13 3/4, its yield is 7%. Although it has bullish long-term prospects, dividend growth should stagnate for a while, says NatWest Holdings utility analyst Ed Tirello. Some smaller companies with decent yields are E'Town and Middlesex Water in New Jersey and California Water Service.

Investors should be wary of companies with payout ratios of over 90%, such as Aquarion in Bridgeport, Conn., and iwc Resources in Indianapolis, because they have little cushion between their earnings and dividend. By comparison, American's payout ratio is 47%. And though many water utilities have met the standards of the Safe Drinking Water Act, more regs are in the offing. That means companies face ongoing nonrevenue-producing construction costs. However, they can apply to the state for permission to raise rates, and most states have been accommodating.

Perhaps the greatest near-term risk of investing in water companies is rising interest rates. Like electric utilities, water companies have an inverse relationship to rate levels, so you might want to wait to buy. Even so, the pressure is on for the industry to keep consolidating and creating greater and more profitable economies of scale. And regardless of interest rates, water rates aren't likely to decline.

          A Stream Of Water Stocks
      Company         Stock   52-wk.  P/E**   Dividend
                      Price*  High            yield
      American        26 7/8  32 1/4  11.3    4.0%
      Water Works
      Connecticut     23 1/2  30 1/4  11.4    7.0
      Water Service
      E'Town          25 5/8  32 5/8   12.1    8.0
      Philadelphia    17 5/8  19 5/8   13.4    6.4
      United Water    13 3/4  15 1/8   13.5    6.7
      Average                          12.0    6.0
      *11/7/94  **11/7/94 price/1994 estimated earnings per share
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