Will Aqua America Give Life To Your Portfolio?

Every day I drive into a town next door to my house that is rationing water. This made me think about whether there are companies that make money off the vital liquid. A leader among such companies is Aqua America (NYSE: WTR) -- the $3.1 billion market capitalization water utility holding company. Should you add it to your portfolio?

53% of Aqua America's revenues come from its Pennsylvania subsidiary; however it also owns water utilities in Texas, North Carolina, Ohio, Illinois, New Jersey, New York, Florida, Indiana, Virginia, Maine, Missouri, and Georgia. And it makes acquisitions -- 19 in 2010 alone -- including one last month of a water utility in Texas.

There is one good reason to consider owning shares of Aqua America -- its rising dividend. Aqua America has had 65 years of consecutive dividends with 20 cash increases in the last 19 years. And it has been raising its dividend 4 cents every year since 2006 -- resulting in a 7% increase in 2010 to a dividend yield of 2.8%.

And there are four causes for concern:

• Long-term growth with shakier balance sheet. Aqua America has grown steadily. Its $726 million in revenues have increased at an average rate of 8% over the last five years and its net income of $124 million has risen at a 7.7% annual rate over that period. However, its cash has been falling while its debt has risen. Specifically, Aqua America's cash fell at a 39% annual rate between 2006 ($44 million) and 2010 ($6 million) while its debt rose at a 12% annual rate between 2006 ($952 million) and 2010 ($1.5 billion).
• First quarter earnings that beat expectations with disappointing revenues. Aqua America's adjusted income was $26 million or $0.19 per share -- a penny ahead of analysts polled by Thomson Reuters; however, revenues for the quarter grew 6.7% to $171 million -- 1.4% below analysts' consensus revenue estimate.
• Under-earning its capital cost. Aqua America earned less after-tax operating profit than its cost of capital, however it's improving. Aqua America's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was 1%, based on 2009 revenue of $671 million, and EVA that improved from negative $70 million in 2009 to negative $66 million in 2010, using a 6% weighted average cost of capital.
• Expensive stock. Aqua America's price to earnings to growth (PEG) ratio of 3.15 makes it somewhat over-valued (a PEG of 1.0 is considered fairly priced). Aqua America's P/E is 23.3 and its earnings are expected to grow 7.4% to $1.06 in 2012.

People need water and Aqua America supplies lots of it. But to get more, the company is larding up its balance sheet with debt and is not able to achieve sufficient cost savings from its acquisitions to out-earn the cost of the capital it's using to finance them.

I don't see a compelling reason to buy this stock.