American Water Works Company, a cornerstone of the utility sector, recently held its first-quarter 2024 earnings call. While the company presented a picture of stability, a closer look reveals a potential regulatory storm brewing in Pennsylvania. This storm, centered around rate cases and revisions to the state's fair market value (FMV) law, could significantly impact American Water Works' future growth.

The Pennsylvania Rate Case: A Sign of Contention?

The company's Pennsylvania rate case, seeking to recover $1 billion in capital investments, has encountered resistance. A settlement appears unlikely, and the process has become more contentious than usual. The frequency of American Water Works' rate case filings and the allowed return on equity (ROE) are under scrutiny, signaling potential regulatory fatigue.

Act 12 Revisions: A Cap on Acquisitions?

Revisions to Pennsylvania's FMV law, Act 12, particularly the introduction of a 1.68x rate base cap on acquisition valuations, have raised concerns. While American Water Works remains committed to consolidation in Pennsylvania, the pace of regulatory approvals for acquisitions has slowed, introducing uncertainty into the company's growth strategy.

The Interconnectedness: A Shift in the Regulatory Landscape

The increased scrutiny on both rate cases and acquisitions suggests a potential shift in Pennsylvania's traditionally constructive regulatory environment. Regulators appear to be increasingly uneasy about the pace and scale of American Water Works' growth in the state.

The Potential Impact: A Threat to Growth Targets?

Pennsylvania is a crucial growth engine for American Water Works, accounting for a significant portion of its regulated customer base. A slowdown in Pennsylvania could jeopardize the company's ability to meet its 8% annual rate base growth target and cast a shadow over its long-term earnings and dividend growth targets of 7% to 9%.

Hypothetical Scenario:

Target Rate Base Growth in Pennsylvania: 8%

Organic Capital Investment Contribution: 6%

Acquisition Contribution: 2%

If Act 12 revisions hinder acquisitions, achieving the 8% target becomes challenging, potentially impacting overall earnings and long-term targets.

Annualized New Revenue in Rates

The chart below visualizes the annualized new revenue in rates for American Water Works since January 2023, illustrating the contributions from general rate cases, step increases, and infrastructure surcharges. It highlights the company's efforts to secure revenue and recover capital investments.

Conclusion: Navigating the Storm

The signals from Pennsylvania should not be ignored. While American Water Works has a history of navigating regulatory complexities, the potential for a less constructive regulatory environment in the state poses a real risk to its growth trajectory. Investors should closely monitor developments in Pennsylvania and assess the company's ability to adapt to this changing landscape.

"Fun Fact Pennsylvania is known as the "Keystone State" due to its central role in the formation of the United States. It was one of the original thirteen colonies and played a crucial role in the American Revolution."