American Water Works Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2023

There are 11 speakers on the call.

Operator

Good day, and welcome to American Water's Third Quarter 2023 Earnings Conference Call. As a reminder, this call is being recorded and is also being webcast with an accompanying slide presentation through the company's Investor Relations website. The audio webcast archive will be available for 1 year on American Water's Investor Relations website. I would now like to introduce you to your host for today's call, Aaron Musgrave, Vice President of Investor Relations. Mr.

Operator

Musgrave, you may begin.

Speaker 1

Thank you, Chris. Good morning, everyone, and thank you for joining us for today's call. At the end of our prepared remarks, we will open the call for your questions. Let me first go over some Safe Harbor language. Today, we will be making forward looking statements that represent our expectations regarding our future performance or other future events.

Speaker 1

These statements are predictions based on our current expectations, estimates and assumptions. However, since these statements deal with future events, they are subject to numerous known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from the results indicated or implied by such statements. Additional information regarding these risks, uncertainties and factors as well as a more detailed analysis of our financials and other important information is provided in the Q3 earnings release and in our September 30 Form 10 Q each filed yesterday with the SEC. And finally, all statements during this presentation related to earnings and earnings per share refer to diluted earnings and diluted earnings per share. Susan Hardwick, our President and CEO, will share highlights of Q3 and year to date results and will comment on our 2024 EPS guidance and longer term targets.

Speaker 1

Cheryl Norton, our Executive Vice President and COO, will then discuss our new capital investment plan, including the expected impact of PFAS related investments and will conclude with a regulatory update, including our views on customer affordability. John Griffith, our Executive Vice President and CFO, will then discuss our year to date financial results in more detail, discuss our acquisition outlook, and we'll close with details behind our 2024 outlook and longer term goals and our 2024 to 20 28 financing plan. After a few final remarks, we'll then close by answering your questions. With that, I'll turn the call over to American Water's President and CEO, Susan Hardwick.

Speaker 2

Thanks, Erin, and good morning, everyone. Let's turn to Slide 5, and I'll start by covering some highlights from the Q3 year to date periods. As we announced yesterday, we delivered strong financial results in the Q3 of 2023, and we're pleased to again reaffirm our 2023 guidance on a weather normalized basis. Earnings were $1.66 per share for the quarter compared to $1.63 for the same period last year. In the 1st 9 months of 2023, earnings were $4.03 per share compared to $3.70 per share in the same period of 'twenty 2.

Speaker 2

The estimated net favorable weather impact year to date in 'twenty three is about $0.11 per share compared to $0.06 per share favorable in 'twenty two. These weather normalized results so far in 2023 continue to reflect our strong execution in line with our growth expectations for the year. John will elaborate further on results later. Moving on to some of our other key accomplishments to date in 2023. We have invested $1,800,000,000 in capital projects year to date, reflecting great work by our teams responsible for planning and completing these investments.

Speaker 2

As you will recall, the total capital investment plan for 2023 includes approximately $400,000,000 of acquisitions, including one sizable transaction in Pennsylvania we expect to close in December and another in Illinois around the end of the year. As you know, we completed an equity issuance of $1,700,000,000 in March and a $1,000,000,000 convertible debt issuance in June. These were the 2 key priorities of our 2023 financing plan. We were focused on completing these issuances in the first half of the year to reduce market related pricing risk and overall execution risk, which has served our investors, customers and our customers well considering the current market conditions. Turning to Slide 6, as we roll out our new 5 year plan today, we are affirming our long term targets, including 7% to 9 We are also initiating our 2024 earnings guidance of $5.10 per share to $5.20 per share, which John will discuss further later in the discussion.

Speaker 2

This represents our expectation of 8% EPS growth in 2024 compared to our weather normalized 2023 EPS guidance. One thing to note on this slide is that we have revised the look of our earnings growth outlook. Recall that we'd historically referred to it as our growth triangle. We believe this new version better highlights our compelling 7% to 9% earnings growth expectation and better represents the key drivers of growth. As a nearly 100% regulated water and wastewater utility, rate based growth and regulatory execution are the key drivers of growth for our company.

Speaker 2

Rate based growth continues to be driven by the accelerated CapEx plan we put forth 2 years ago and now with this updated plan. Combined with our robust regulated acquisition strategy on which we've proven we can execute, we continue to expect 8% to 9% rate based growth over the next decade. Later, Cheryl will review the amount of capital we expect to spend over the next 5 years, including related to acquisitions. On this slide, you can see we are highlighting our acquisition growth strategy measured by a compounded annual growth rate in customer connections of 2%. The timing of closing on acquisitions is often difficult to control within a calendar year, which can cause volatility This 2% customer additions CAGR target should be an easier way for investors to monitor and measure our growth through acquisitions.

Speaker 2

And as I said, rate based growth, which includes acquisition investment, is the key driver to earnings growth. Our growth outlook also includes the organic revenue growth opportunities we expect from our military services group from the 18 installations we currently serve with an added upside for any new basis secured. One of our company's competitive advantages is its diverse Regulated operations across 14 states that provides us with flexibility in the timing of rate cases and capital deployment. We also have a very predictable and controllable set of capital projects annually, almost half of which are recoverable through infrastructure mechanisms. Along with our other regulatory approaches, we are confident we can deliver consistent earnings growth and dividend growth over the next 5 years and beyond.

Speaker 2

While utility stocks including ours have seen the impact on the short term of higher interest rates, history has shown that over medium and longer term horizons the utility sector And certainly, American Water has delivered compelling value to investors. We believe the combination of our EPS and dividend growth Reported by our significant yet low risk capital investment plan and our focus on customer affordability and ESG leadership will continue to be rewarded by investors. Based on this long term plan and our history of executing on our strategies, We intend to continue to deliver a very competitive, sustainable shareholder return for many years to come. With that, let me turn it over to Cheryl to talk more about our capital investment plan and our focus on customer affordability and regulatory execution. Cheryl?

Speaker 3

Thanks Susan and good morning everyone. Before I jump into a discussion of our current long term capital plans starting on slide 8, I want to first acknowledge that our teams have done a great job executing on our accelerated capital investment plans these last few years. We have consistently met our capital deployment goal and we are on pace to do it again by meeting our overall capital plan of $2,900,000,000 this year, which includes acquisition investments. Looking ahead to 2024, we expect a modest increase in our investment spending level to roughly $3,100,000,000 Over the next 5 years, we expect to invest approximately $16,000,000,000 to $17,000,000,000 an increase of about $2,000,000,000 over our previous plan. This level of spending reflects the result of our consistent Risk based project planning.

Speaker 3

Along with risk, customer affordability is a key variable in our analysis, which I will speak more about shortly. Looking out over the next decade, we expect to invest $34,000,000,000 to $38,000,000,000 in our regulated systems and acquisitions, which is $4,000,000,000 higher than the previous 10 year plan. In addition to tackling PFAS, we expect Follow on capital needs related to acquisitions to continue to increase over time and modestly higher costs for pipe and other capital goods over time. Continuing on slide 9, the increase in the 5 year capital plan is primarily driven by 3 needs. First, The plan includes approximately $1,000,000,000 of needed investment to treat water for PFOS contamination across our systems.

Speaker 3

As we've said many times, American Water supports the U. S. EPA's efforts to protect public health by proposing national drinking water standards for PFAS. And we believe our company is in a better position than any water utility to remove PFAS at the level that would be required under the rule as proposed. And we've also said the cost to comply will be significant.

Speaker 3

Roughly $1,000,000,000 of capital remains our best estimate based upon the proposed federal EPA rule, which we expect will be finalized in late 2023 or early 2024 without much modification. We expect Most of these PFAS related capital investments to occur over a 3 year period beginning later in 2024 and primarily in our larger states in terms of customers served like New Jersey as an example. The source water supplies for New Jersey American Water that have PFAS contamination include large surface water supplies that are more costly to treat than our groundwater sources. And as we've said, granulated activated granular activated carbon or GAC will be the primary treatment

Speaker 4

While much

Speaker 3

uncertainty exists around the topic of PFAS, including the recovery of related capital and operating costs, We expect constructive outcomes for this important water quality initiative and we will continue to advocate that the ultimate responsibility for the cleanup of these contaminants should fall to the polluters. We will also continue to advocate that all water and wastewater utility providers, regardless of ownership, have equal access to any federal and or state funding related to treating PFAS. In addition, we will continue our efforts to request permanent federal funding for a water and wastewater low income customer assistance program. The other two drivers of increased CapEx in the 2024 to 2028 plan are a higher level of spend related to prioritized Renewal projects across our footprint such as for hydrant, pipe and meter replacement as well as a higher level of expected follow on capital related to future acquisitions. Following recent acquisitions, we have continued to experience a higher level of investment need in order to bring water and wastewater systems into regulatory compliance and up to our operating standards, which is driving the higher estimated capital need of $600,000,000 You can also see that we have deferred $500,000,000 of lower risk projects to later years beyond the 5 year plan.

Speaker 3

We did this as a part of our extensive risk based project analysis in conjunction with our ongoing affordability analysis. For example, we deferred until later in the 10 year capital plan, the replacement of some services in mains where it was determined that they did not pose an immediate risk to service reliability or water quality. Let's turn to Slide 10 and I'll cover the latest regulatory across our states. Shown in the slide is a summary of our pending general rate cases with some key facts for each. In the appendix, you will also find some details related to infrastructure charges as well as a snapshot of the key outcomes from the most recent general rate case in our top 10 states.

Speaker 3

Our general rate cases in California, Indiana, West Virginia and Kentucky are all progressing well and as expected. All of these cases, except perhaps California, will most likely be resolved in early 2024. Just yesterday, we filed a general rate case in Virginia, reflecting $110,000,000 in system investments covering May 2023 through April 2025. We are seeking $20,000,000 of additional annual revenue and expect interim rates to go into effect in May of next year. Outside of our general rate cases, as we discussed last quarter, we filed a request as authorized by California's Water cost of capital mechanism seeking a 52 basis point increase to our ROE in 2023, which was approved on July 25, or increasing the return on equity to 9.5 percent effective July 31.

Speaker 3

We filed a similar request in October for an additional 70 basis point increase to go into effect January 1, 2024, which would bring our ROE to 10.2%. And finally, related to the customers we have proudly served in the Monterey community for over 100 years, in October, a local entity adopted a resolution enabling it to file an imminent domain lawsuit with respect to the Monterey System assets. This is not a new issue, just the latest chapter in a long running effort by an entity that we believe lacks the expertise to own and operate a very complex water distribution system serving these Monterrey Bottom line, we believe based upon existing legal precedent, we'll be able to successfully defend against an imminent domain lawsuit if it's filed. You can find more information on this topic in our SEC filings, including this quarter's 10 Q. Moving to Slide 11, I'll wrap up with a discussion of customer affordability and this new capital investment plan.

Speaker 3

Using U. S. Census Bureau data specific to the Geographies we serve, our research and analysis concluded that projected rising levels of median household income, combined with conservative assumptions around an increasing customer base, would allow us to stay within our target for residential water bills of 1% or less of median household income. 1 of the most difficult challenges we face in the water and wastewater industry is balancing customer affordability with the magnitude of the system investments that are needed. Thankfully, today our industry and our company are in very good relative positions in in terms of affordability or wallet share.

Speaker 3

At the same time, we realize we must continue to evolve our strategies rate design and programs to assist our customers who are challenged with affordability. We must also continue our focus on technology, efficiencies of scale and cost management in order to deliver on customer affordability. Our dual focus on operating efficiency and customer affordability has and a valuable part of our company's DNA for many years. As you know, we've historically used O and M efficiency as one of our benchmark metrics to measure our success at managing costs as we grow the business. In recent years, we've emphasized that revenue growth has been just as impactful to the O and M efficiency metric as managing costs.

Speaker 3

As we look ahead, we're continuing to evaluate whether this is the Best metric by which to judge our effectiveness at managing costs and running an efficient business. More to come on this in 2024. With that, I'll hand it over to John to cover our financial results and plans in further detail. John?

Speaker 5

Thank you, Cheryl, and good morning, everyone. Turning to Slide 13, let me provide a few more details on year to date results. The appendix also has details of 3rd quarter EPS, which has many of the same drivers as year to date results. Consolidated earnings were $4.03 per share year to date, up $0.33 per share compared to the same period in 2022 and up $0.28 per share on a weather normalized basis. Increased revenues were driven by general rate cases we completed in late 2022 early 2023 in our larger states.

Speaker 5

These additional revenues are driven by the significant investments we have made and continue to make in our systems. As noted, Earnings were higher year to date by an estimated net $0.11 per share as a result of weather in the second and third quarters due to warm and dry conditions, primarily in Missouri, New Jersey and Pennsylvania. This compares to net favorable weather in the Q3 of 2022 of $0.06 per share, which related mostly to warm and dry conditions in New Jersey. And looking at operating costs, Higher pension expense of about $0.10 per share and increased chemical costs of about $0.09 per share, including inflationary pressures are being recovered in large part through higher revenues we proactively sought through the use of forward test years and traditional updates to base cost of service and general rate cases we completed in the last 12 to 18 months. This strategy has limited the bottom line impact of those higher costs in 2023 and is a strategy we are continuing to use in our recently filed and upcoming cases.

Speaker 5

Supporting our investment growth, depreciation expense increased $0.17 per share and the cost of additional long term financing increased to $0.28 per share, primarily related to share count dilution. As I mentioned last quarter, the EPS impact of the higher share count from our equity issuance offsets the avoided interest expense in the current interest rate environment. We expect the impact to be approximately neutral to EPS for the full year as well based on the current outlook. Turning to Slide 14, this graph illustrates that our continued execution on capital investments, Both infrastructure projects and acquisitions are succeeding and growing regulated rate base at a long term rate of 8% to 9%. Rate based growth of course will drive earnings growth.

Speaker 5

We believe the high degree of visibility to our capital investment plan combined with the low risk nature of the plan, uniquely positions American Water in the utility sector and is fundamental to our investment thesis. Turning to Slide 15, you'll see that we continue to be set up for strong growth through acquisitions. We closed on 14 acquisitions totaling $36,000,000 across 6 states in the 1st 9 months of 2023, which demonstrates our continued ability to close deals in many states. We also had 32 transactions under agreement across 10 states through the end of September, totaling $611,000,000 2 of which we closed in early October, including 1 in West Virginia for $27,000,000 This total also includes both The Butler Area Sewer Authority Wastewater System in Pennsylvania and the Granite City Wastewater Treatment Plant in Illinois we previously announced. We expect the Butler acquisition to close later this year in Granite City around year end pending regulatory approvals for each and we look forward to serving those customers.

Speaker 5

Also included in our acquisitions under agreement is the Talamenson Township Wastewater System in Pennsylvania we expect to purchase for $104,000,000 as announced back in March. We expect to close this acquisition in late 2024 or early 2025 pending final regulatory approval and we look forward to serving those customers as well. Our outlook for future acquisitions remains very strong as we expect to have over $250,000,000 of acquisitions under agreement at the end of 2023 after the expected closings of Butler and Granite City. Of course, as we close on transactions, the work to build and refill the acquisition pipeline is continuous. Our pipeline of 1,300,000 customer connections is a strong leading indicator that supports this piece of our rate base growth outlook.

Speaker 5

On Slide 16, we provide some considerations regarding First, as you would expect, our growth will be driven by capital investment to serve our customers and earning a return on that investment. So we see that ramp up reflected in earnings in 2024 both from base rate increases and infrastructure mechanisms. As a reminder, approximately 45% of our CapEx is recoverable by infrastructure mechanisms, so it's a very meaningful driver of consistent earnings growth for us. Recent regulated acquisitions that are being incorporated into active or just completed rate cases will also drive growth next year. I'd like to note that our military services group does add incrementally to our earnings growth expectation as we have continued to show in our growth outlook.

Speaker 5

MSG's great work on the 18 military installations it serves has built trust and resulted in the U. S. Government allocating additional funds for improvement projects driving increased revenues. Just as critical to our growth strategy is our ability to prudently manage the Operating costs it takes to run the business, which goes to my final point on this slide. Because of our strong culture of operating efficiency and cost management, We expect only modest increases in O and M in 2024.

Speaker 5

These efforts go to the heart of the customer affordability construct We want to protect, which is closely aligned with the interests of regulators and ultimately investors in managing affordability of customer bills. Finally, related to pension, I'd simply remind you that our pension obligation remeasurement will be done at year end 2023 and that will drive the determination of our 2024 pension expense. Turning to Slide 17, I'll provide a total of $2,000,000,000 of equity financing need. We successfully issued $1,700,000,000 of the $2,000,000,000 earlier this year, leaving $300,000,000 of equity financing needed toward the end of that prior plan. Equity in our new plan is expected to be issued near the middle of the 2024 to 20 28 period subject to market conditions.

Speaker 5

The $700,000,000 increase in the anticipated external equity need is driven by the incremental $2,000,000,000 of CapEx in the new plan. As we've said many times now, we expect incremental CapEx to be funded roughly fifty-fifty Debt and Equity, which includes both external equity and cash flow from operations. Our financing plan design also takes into account the goal of maintaining a strong balance sheet and continuing to meet our long term debt to capital target of less than 60%. Another assumption inherent in our new plan is that we will continue to be a cash taxpayer, especially as we will likely become subject to the new corporate On Slide 18, we provide a summary of our continued strong financial condition. Our total debt to capital ratio as of September 30, net of the roughly $630,000,000 of cash on hand remains at 54%, which is comfortably within our long term target of less than 60%.

Speaker 5

As we are all aware, The current higher interest rate environment is challenging. We are however in a position of strength on a number of fronts in dealing with the challenge. Our strategy of issuing debt at the holding company level allows us to take advantage of our scale and pricing debt issuances. We remain confident that we will have strong access to capital for the long term. In fact, we just extended the maturity of our revolving credit facility to October 2028, which has a capacity of $2,750,000,000 Our diversified banking relationships with some of the largest and strongest banks in the world coupled with our fully regulated business model and strong credit ratings gives us great confidence around liquidity.

Speaker 5

Our laddered approach to long term debt financings over the years is very important in environments like the current one to manage cash flows and minimize interest rate risk, which contributes to managing customer affordability. And our short duration between general rate cases allows us to minimize any lag we may experience related to recovery of debt costs. With that, I'll turn it back over to Susan for some closing thoughts. Susan?

Speaker 2

Thanks, John. To close on Slide 20, you've heard our latest strategic thinking today, and it should sound very familiar. It's all about execution at every level. As we continue to demonstrate our ability to consistently execute, we believe our industry leading EPS and dividend growth combined with our focus on affordability and ESG leadership will continue to be highly valued and rewarded by investors. We believe these aspects of our business and strategy separate us from all utilities.

Speaker 2

They are underpinned by our significant low risk capital investment plan, which includes our best in class execution on acquisitions and our excellent regulatory execution, all while maintaining a strong balance sheet with a well planned debt maturity profile and a differentiated affordability proposition. Through our consistent achievement of high operating standards, including our leading safety culture and water quality accolades, our team at American Water has raised the bar for success in the water and wastewater industry, and that includes the outstanding efforts by our military services group team to proudly serve the 18 military installations in our footprint. Our history of executing on our strategies has delivered a very competitive, Sustainable shareholder return. With this long term plan, we have full confidence in our ability to achieve the goals we talked about today and continue our track record of delivering superior shareholder value. And with that, let me turn the call back over to Chris to begin Q and A and take any questions you may have.

Operator

Thank you. We will now begin the question and answer session. Today's first question comes from Richard Sunderland with JPMorgan. Please proceed.

Speaker 6

Hi, good morning. Am I coming through clearly?

Speaker 2

You are, Rich. Good morning.

Speaker 6

Great. Thank you. Appreciate the details around the update here. I wanted to start with The CapEx revision and the bill outlook, looking back to 2021 when You first outlined the accelerated investment plan. You gave some details on the customer affordability angle, But I'm curious kind of bridging not back to last year, but back to 'twenty one.

Speaker 6

Is there anything different in that outlook now? Obviously, The CapEx is up significantly. Also curious if the 2% customer additions target and the language around there for M and A has factored into how you've crafted this new capital plan around the customer affordability angle as well.

Speaker 2

Okay, Rich. Yes, there's a lot in there. Let me start and then Sheryl and John can add to it. I would say our focus has Sharpened over the last number of years related to customer affordability. And that sharpened focus, I think, has really been around this sort of wallet share concept that Sheryl talked about.

Speaker 2

I think it's important for us to understand the communities that we operate in and the demographics of those Communities and what are the challenges of customers in those communities. And we've been able to do a lot of analysis at a very detailed level around around household income, around just economic impacts in the various communities that we serve and our focus has been, I think very clearly defined around our wallet share as a percentage of that household income. And we've been developing this concept here now for a number of years and I think that, our ability to confidently say this plan As we've continued to grow it, we'll continue to maintain our position of roughly 1% or less of a customer's bill in the communities that we serve specifically. And I think that focus has allowed us to really think about How to build this plan, how to continue to grow it, how to continue to grow rate base, while not Overburdening customers with our growth expectations. I think this plan fits very nicely in that concept.

Speaker 2

Cheryl, you want to add anything?

Speaker 3

Yes. I would just add Rich that, as Susan said, we look at all the communities that we serve, we look at the demographics and yet the capital investments are not that different from community to community and we need to make sure that we are investing at the right level in all of those communities. New regulations, like PFOS, but also the lead and copper rule that is driving a lot of capital investment across the board And so we have to continue to do that and we need to do that in all the communities. So these affordability calculations, the risk Priority model that we use, we think it's really the best balance to getting the right amount of infrastructure investment in all of the communities that we serve and as we grow the number of communities that we are serving that will continue to increase. But we think we are getting the right balance Because we have to treat all of our customers in a fair way.

Speaker 3

They all deserve clean, safe drinking water.

Speaker 2

And Cheryl, I might just add one additional comment. From a regulatory perspective, this is also a concept that we've been sharing very transparently with regulators. This affordability analysis that we've done and as we lay out in every jurisdiction, the The plan and the investments that we have made, we're right alongside it talking about impacts to customers and how we've thought about the plan and how it affects affordability for the customers in the service territory. So again, it's So concept and a view that we've taken that we think is differentiating here and I think regulators just as one party are certainly recognizing that.

Speaker 5

And Rich, I'll pick up on the 2% part of your question. As Susan mentioned in her commentary, 2% is a metric that we think is good to think about as a long term metric given just the short term Variability around acquisitions, but you're right to point it out in this context, as you know, that 8% to 9% Rate based growth is what drives the 7% to 9% earnings growth, but being able to spread that 8% to 9% rate base growth over A larger customer base is a healthy element of our growth.

Speaker 6

Great. That was very helpful color there. Thanks for laying all of that out. And then separately turning to the financing plan here, you're clear on the drivers around the equity relative to the Thanks. I'm curious on the operating cash flow side, it looks like a significant step up 24% to 20% versus 23% to 20 7%.

Speaker 6

Is that just Normal course kind of rate recovery, any discrete items in there, just how to think about prior versus new?

Speaker 5

Yes, it's a good question, Rich. Really there is a big step up if you think about the increase in our capital plan as we go back from 2021, 2022, 2023 and forward, it's such a significant step up that when you drop 23 out of the plan and you bring 28 into the plan, the accumulation of the capital spend through that period accounts for a very significant portion of that operating cash flow step up. And then as you would also intuitively think, There is increased cash flow in the interim years as well, just given the increase in capital plan.

Operator

Our next question is from Paul Zimbardo with Bank of America. Please proceed.

Speaker 7

Hi, good morning team. Good morning. And just to clarify that last line, confirm my understanding. So there's effectively no change in Growth triangle, as you call it, it's just kind of a re presentation?

Speaker 2

Yes, I think that's Fair. We want to continue to emphasize that rate based growth is the driver. Rate based investment, which includes acquisitions, is the driver. What we are trying to do here, I think, is just give Some clarity around or maybe a better view as to how you can measure our progress toward Growth through acquisition by giving you that sort of metric around customer additions. The investment that we'll continue to make in Just rolls into rate base, which it always has.

Speaker 2

So no real change in that. I just think it's a better view potentially for investors To be able to see progress we're making around the acquisition strategy.

Speaker 7

Okay. Understood. That's what I thought. And then shifting to the financing plan. So if I understand it right and correct me if I'm wrong, it doesn't assume any Litigation proceeds, state funding, federal funding for PFAS.

Speaker 7

Just is there any sense of what that kind of offset could be to help out on customer bills?

Speaker 2

Yes, it's a good question. Obviously, the numbers that we have laid out here, as Cheryl outlined, continue to be our best estimates of the cost necessary to Meet the current proposed rule. Obviously, we don't have a rule yet. So finalizing those numbers will occur once we have a final rule. And we do participate in the ongoing litigation around this whole issue.

Speaker 2

We've laid all that out in the queue, so you can look at that There and probably won't talk much more about it than that since it is ongoing litigation. I think it is fair to say that our estimates today are the costs we would We have to see how the litigation ultimately works out, to see what impact that may have. And I think Cheryl covered this Well, we do believe as by virtue of our participation in the litigation that polluters It should be our first line here of responsibility. So we are quite involved in that to make sure that that is Properly executed.

Speaker 7

Okay. So to make sure, it does have an assumption around kind of getting external Funding or it does not?

Speaker 2

It does not at this point. No.

Speaker 7

It's

Speaker 2

just the cost estimates that we have developed so far.

Operator

The next question comes from Will Granger with Mizuho. Please proceed.

Speaker 8

Hi, good morning everybody. Good morning. Thanks for taking my question. Just wanted to ask On the PFOS $1,000,000,000 that you've outlined today, how should we be thinking about the makeup Of that over your service territories, is it pretty ratable or yes, if you could unpack the underlying assumptions there, that'd be Yes.

Speaker 2

I will ask Sheryl to comment on that. We hit on I think pretty high level, but Sheryl you might want to just reemphasize that. Yes. We, as we have looked at this, Our

Speaker 3

as I mentioned in my comments earlier, we expect the bulk of the spend to be in our states where we have a larger footprint of customers, New Jersey for example and the reason for that driver of that being the largest amount of spend is that there is more contamination There in general, but also these are large surface water plants that are very costly to add treatment to. We have Pennsylvania is a larger state, numerous locations there, but we really haven't outlined everywhere that we're going to add treatment, but anywhere that it's a Surface water plant as opposed to a groundwater source is going to be a lot more costly to add that treatment. And so New Jersey is our biggest dollar state for sure.

Speaker 8

Got it. That's helpful. And then maybe just on the equity for your plan, Is that the incremental equity is just $700,000,000 if I've got my math right, the $300,000,000 that You're still planning to issue now an incremental $700,000,000 or is it an incremental $1,000,000,000 You've

Speaker 5

got it right, Will. It's an incremental $700,000,000

Speaker 8

Okay. And we should expect the timing of that to come in towards the back half of your plan or would that Be issued like as an ATM and just kind of pretty ratable.

Speaker 5

What we said is we'll issue it in the middle of our New 2024 to 2028 plan, subject to market conditions, obviously.

Operator

Our next question is from Jonathan Reeder with Wells Fargo. Please proceed.

Speaker 9

Hey, good morning team. Just kind of following up a little bit on that last question. Despite the higher operating cash flows, It looks like the external capital needs increased more than the $2,000,000,000 CapEx increase. You got the $700,000,000 equity and then I think it's $1,700,000,000 of debt. Anything unique going on there?

Speaker 5

Jonathan, we really lead this analysis by looking at our credit metrics. And so a lot of it just goes back to what we've said in the past where incremental CapEx will fund it fifty-fifty debt and equity. As we think about equity there, it's internally generated funds as well as new issuance. I think we think of it as lining up in that regard.

Speaker 9

Okay. No, I was just thinking the debt portion was a little higher than I would have thought.

Speaker 5

Yes, that's just a function of the capital spend as well as the maturity schedule.

Speaker 9

Okay. Yes, maybe the maturity settled. Okay. So Cheryl, I know you said that California filed on 10.16 to increase, the 24 allowed ROE. Has there been any opposition filed to this request?

Speaker 9

I think there's like a 30 day Comment period which probably ended maybe yesterday?

Speaker 3

Yes, there is that 30 day period and, Jonathan, I am unaware of any kind of Intervention or any kind of concern over that?

Speaker 10

Okay.

Speaker 2

It's pretty formulaic, Jonathan. I mean, Yes, we don't expect there to be any issue with that. It really just follows the formula.

Speaker 9

Yes. No, I mean, I think Investor concern is more on the electric side, whether you'll see some intervention than the water, but monitor both. I think the 10 year CapEx plan, you bumped up the M and A placeholder by $1,000,000,000 Is there anything specific driving that or is that just kind of Passage of time more than anything.

Speaker 5

Yes, I'd say, Jonathan, it's certainly passage of time is part of it. We are investing in our capability across the system, Starting with originations and as well as due diligence and integrations. As we look at What happens when we make acquisitions and just our standards as a best in class operator relative to the systems that we acquire, We just continue to think that there's a lot of momentum there and a lot of strength in us continuing this program. So It is a capability that we're investing significantly in. And yes, as you pointed out, as we We look forward in time, we expect those numbers to become bigger to maintain that relative level of contribution.

Speaker 5

Okay.

Speaker 9

And then last, you mentioned the pension costs for 'twenty four and figuring that out. But do you have much exposure on that? Or do most of your key states now have tracking mechanisms for pension?

Speaker 5

We have trackers and deferral accounts in certain states, Jonathan, we can go through that with you in detail. So there's a mix there of what we pick up already and what would need to be picked up in the future.

Operator

The next question comes from Greg Orrill with UBS. Please proceed.

Speaker 10

Yes. Hi. Thank you.

Speaker 1

Good morning, Greg.

Speaker 10

Good morning. I think you mentioned You're working on an acquisition in Pennsylvania of $104,000,000 to close in late 'twenty four, 'twenty five. How do you think about when you go into acquisitions sort of the Reasonable timeline for getting approvals. How do you think about that?

Speaker 2

Don, you want to comment on that? I think the one you're referring to in particular, it's a little more complicated. I wouldn't say it's Sort of a traditional process, the Tal Minson acquisition. I recall we stepped into That arrangement when NextEra decided to exit the opportunity. So that was just a little more complicated.

Speaker 2

John, you want to talk sort of typically how we think about the process around acquisitions?

Speaker 5

Sure. Yes. And Greg, it varies state to State, but since you mentioned Pennsylvania, there's a process you go through to file an application. The application has to be deemed complete And then that starts the statutory clock. And so in the case of Pennsylvania, there's a 6 month statutory clock that runs through.

Speaker 5

And then either you're settling your approval or you're litigating your approval, but all within that 6 month statutory timetable.

Speaker 10

And so what's different about this situation?

Speaker 5

Well, Tom mentioned it's one where There's opportunity based on precedent in Pennsylvania. We'll see how Well, the post PUC approval plays out, but we're just allowing a little bit of latitude in the event that there's Any follow-up to the PUC approval from intervenors?

Operator

The next question comes from Aditya Gandhi with Wolfe Research. Please proceed.

Speaker 4

Good morning, Susan, Sheryl and John. Can you hear me?

Speaker 2

We can. Good morning. Good morning.

Speaker 4

Good morning. Thanks for taking my questions. I just wanted to of water systems from any PFOS related financial liability under Circular. Do you see risk if a final rule is released And it doesn't contain any protections. And then the second topic is, can you maybe give some color on what portion of the $50,000,000 additional annual O and M sort of qualifies for trackers or expense mechanisms?

Speaker 3

I can take those questions. This is Sheryl. As far as protections around the CERCLA, We have been really engaged in that process and we have been pushing really hard to ensure that water and wastewater utilities are protected in that space. And so we are going to continue to fight that battle. Right now, you are right, there is a little bit of vulnerability out there, but But we feel pretty confident that we're going to be able to manage through that and that we're going to be able to impact, how we're treated in that space.

Speaker 3

So more to come on that, but rest assured we are going to fight like crazy to make sure that we are protected there. And as far as the 50,000,000 I don't have an exact breakdown and we haven't talked about an exact breakdown from state to state, but whether or not that would be recovered through mechanisms just Depends on the type of mechanisms that a state would have. So if they have a mechanism that would allow them to recover their production costs, Any kind of tracker in that space would be really helpful in those costs. In some cases, we have environmental writers that include Capital improvements, some of them include capital and operating improvements, so that would allow them to recover those costs as well. So there's going to be a portion that we're going to be able to recover right upfront, but the rest of them will just recover through a general rate case with very little lag I would anticipate as far as those costs are concerned.

Speaker 2

Yes. And the only thing I would add to that is, where we don't have An existing mechanism or an approach to ensure timely recovery, We're going to work to design 1. Our view here is that these are federally mandated costs, and we are Taking care of a problem created by someone else and because of that federal mandate and the federal rule behind it, we think we will have A great argument to make around recovery and timely recovery. So we will be looking for where we don't have existing solutions, we will be looking to create New opportunity to do that. So there will be a lot on the regulatory front here to do once we have a final rule and I know how this plays out.

Speaker 3

Yes, Susan, I would just add that that 3 year implementation period that we have to put treatment in place gives us time to do those Kinds of things and make those regulatory improvements. Right.

Speaker 4

Got it. That's super helpful color. Thank you. And just One question for John. On the equity needs, you've mentioned it's in the middle of your new 2024 through 2018 plan.

Speaker 4

So Sort of in the 'twenty six timeframe, you're also going to have proceeds from the HOS note come in. I believe they're due at the end of 2020 6. Just can you add a little bit more color on timing and the form of equity? Is this just going to be like a straight block or is this going to be some sort of forward where you'll maybe draw down on the forward Over a couple of years, how should we think about that?

Speaker 5

Yes, Deja, I would say that we haven't We're not close enough yet in terms of time to have made the decision on the exact form of equity. You're right on the timing of the HOS, No proceeds, but as we approach the more immediate timing, then we'll develop our thinking Closer to that point, but certainly we're we'll look and do what's best for shareholders there. I'd say that You've seen us issue the straight equity as we did this year with the $1,700,000,000 We issued the convert this year for $1,000,000,000 And so we're willing to look at everything, but I'd say that's a decision we'll make as that time approaches.

Speaker 4

Okay, got it. And just one follow-up. Can you just clarify The point you made on your cash taxpayer status. And I just wanted to confirm, is there a base for your 7% to 9% EPS CAGR At all, I couldn't find that in the slides or the earnings release.

Speaker 5

Yes. So, and let me just clarify on the equity That we've talked about, to be clear, it will be equity, not another instrument To replace the equity. With regards to our cash taxpayer status, With the Inflation Reduction Act, we do expect that we'll become subject to the corporate alternative minimum tax in the coming years. Those regulations are not finalized at this point, and there are certain elements that are in play that will dictate the precise timing for when we would become subject to the AMT, But we are expecting that to be the case for us. With regards to 7% to 9% and a base year.

Speaker 5

I'd say on that, this is a target that we think of as a long term target. You're aware that over the last few years we reset the capital plan with the sale of HOS and the sale of New York and we needed time to redeploy those proceeds and which was the case in '22 and 'twenty three. And as Susan pointed out, our 'twenty four guidance reflects an 8% EPS CAGR at the midpoint. So we really think of 7% to 9% as a long term target driven by the long term 8% to 9% rate based growth CAGR.

Speaker 4

Got it. That's super helpful. Thanks for taking all my questions.

Operator

At this time, we are showing no further questioners in the queue. And this does conclude our question and answer session as well as our conference. Thank you for attending today's presentation and you may now disconnect.

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Earnings Conference Call
American Water Works Q3 2023
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