There are two types of industries: mature and growing. Growing industries require more capital and typically use the cash generated by the business to fund future projects. Mature industries, on the other hand, typically generate more cash than they can use internally, and either pay a dividend, repurchase shares, or even purchase competitors. The utility industry, and its sub industries, is the latter. It is a mature industry that is seeing some major consolidation.
Water, electricity and telecommunication services are three utility industries within the U.S. that are at different stages of consolidation. Investors would be wise to jump in before all of the consolidation is complete.
The water utility is the most fragmented of the three utilities. There are over 10,000 entities in the U.S. that distribute, sanitize and control water. Some major industry players are making compelling arguments to state and local officials to outsource their water services to reduce costs.
Aqua America Inc (NYSE:WTR) is a company that primarily operates in the water utility business in North America. The company is looking to utilize its scale and expertise to become the pre-eminent water and municipal waste company in the U.S. The company has stable revenues, and is looking to create a stable and growing company within a stagnant industry.
Aqua America Inc (NYSE:WTR) has completed seven acquisitions so far this year and is on the hunt for more. The company purchases assets from cities, and uses its experience to standardize and optimize local water distribution and municipal waste systems. The company has increased its operating income 10% each year for the past four years, and has a net profit margin of 25.6%. Aqua America pays out 47% of its earnings to support a dividend of 2.4%.
There are many opportunities for Aqua America Inc (NYSE:WTR) to increase its footprint in the U.S., as local governments seek to cut costs, and management holds firm on their desire to increase the size and scale of their operations. Aqua America Inc (NYSE:WTR) has a market value of $4.5 billion, and can expand a lot more before it will show up on regulators anti-trust radar.
Duke Energy Corp (NYSE:DUK) is one of the prime examples of how increasing size can correspond to increasing shareholder value. Duke merged with Progress Energy in a $32 billion deal. Duke Energy Corp (NYSE:DUK) moved more towards the regulated business of electricity distribution to customers and away from the increasingly commoditized electricity generation segment. Duke Energy, post merger, now has 85% of its revenue coming from traditionally regulated business, compared to 75% prior to the merger.
Duke Energy Corp (NYSE:DUK) can now use its 7 million customers across six states as leverage when negotiating terms for long term energy purchases. One year after the merger, the company committed to saving its customers $70 million in reduced electric costs because of its size advantage. When the numbers came in, Duke actually saved customers $90 million, $27 million more than expected.
For investors, the merger meant a more efficient company. Duke Energy Corp (NYSE:DUK) was able to identify 1,860 positions that were mostly redundant within the two companies, and has offered and completed buyouts to 1,051 jobs over the last year. This will translate into lower Sales and General Administration expenses moving forward.
Duke Energy Corp (NYSE:DUK) currently yields 4.6% and has a profit margin that is inline with its peers near 10%. The company’s move into more regulated markets means that Duke will be able to deliver solid results in good times and bad. The dividend has grown by nearly 3.3% over the past 5 years, and investors can continue to expect similar stable growth from this company.
The telecommunications industry is one crowded space. AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ) have been operating in a near duopoly for the better part of a decade in the consumer space, and have raised an eyebrow or two when they want to acquire another domestic competitor. Last year, AT&T Inc. (NYSE:T) tired to purchase Deutche Telecom’s T-Mobile unit, and was ultimately shot down by regulators because of anti-trust concerns.