American States Water Company (AWR), the dividend aristocrat with a 69-year streak of consecutive annual dividend increases, has long been a haven for income-seeking investors. With a rock-solid track record and regulated utilities providing a steady stream of earnings, AWR has weathered market storms with remarkable consistency. But a silent threat lurks beneath the surface, one that could potentially disrupt this dividend dynasty: the looming specter of PFAS contamination.

Per- and polyfluoroalkyl substances (PFAS), often dubbed "forever chemicals," have emerged as a major environmental concern. Their widespread use in everyday products and their persistence in the environment have led to contamination of water sources across the country. And now, the EPA's recently announced final National Primary Drinking Water Regulation for PFAS has sent ripples of concern throughout the water utility sector.

While AWR's Q1 2024 earnings call focused on positive developments like new military base contracts and ongoing infrastructure investments, the PFAS regulation received only a fleeting mention. Yet, buried within the transcript lies a startling revelation: over 40 wells at Golden State Water Company, AWR's water utility subsidiary, have already exceeded the EPA's new maximum contaminant levels for PFAS.

The potential cost of remediation is staggering. AWR estimates that addressing PFAS contamination in these wells could require capital expenditures ranging from $80 million to a whopping $200 million, assuming a cost of $2 million to $5 million per well. This figure alone represents a significant financial burden for a company whose total annual capital expenditures at regulated utilities hover between $160 million and $200 million.

Potential Impact on AWR's Dividend Growth

Here's the alarming hypothesis: While AWR assures investors that the CPUC's rate-making process will allow for recovery of these costs, there's no guarantee of timely or full cost recovery. This uncertainty casts a shadow of doubt on AWR's ability to maintain its aggressive dividend growth trajectory.

Consider this: AWR's quarterly dividend rate has enjoyed a compound annual growth rate (CAGR) of 9.4% over the past five years. To put this in perspective, a $1,000 investment in AWR five years ago, with dividends reinvested, would now be worth over $1,600. This impressive growth has been fueled by a combination of robust earnings and a favorable regulatory environment. But the emergence of PFAS as a major cost factor could disrupt this delicate balance.

Even if AWR successfully recovers all PFAS remediation costs through rate increases, the timing of this recovery will be crucial. Delays in rate approvals could force the company to rely more heavily on debt financing, potentially pushing up its already rising interest expenses. A higher debt burden could, in turn, constrain the company's ability to fund future dividend increases, jeopardizing its long-held dividend growth policy.

Adding to the uncertainty is the potential for future PFAS contamination. AWR's initial estimate of 40 contaminated wells may just be the tip of the iceberg. As testing expands to cover all of Golden State Water's wells, the number of contaminated sites could rise significantly, driving up remediation costs even further.

AWR's Financial Performance

While AWR boasts a strong financial position and a history of constructive regulatory outcomes, the PFAS issue presents a unique challenge. Unlike routine infrastructure upgrades, PFAS remediation is an unanticipated expense with uncertain cost recovery implications.

Reference: AWR Financials

AWR's Capital Expenditures and Rate Base Growth

Reference: AWR Earnings Transcripts

The company's history, however, offers little guidance on navigating the PFAS conundrum. It's a new and evolving threat that demands a proactive and strategic approach. Investors would be wise to closely monitor AWR's progress in addressing PFAS contamination and its impact on the company's financial performance. The dividend dynasty, while impressive, may not be immune to the silent threat lurking in its wells.

"Fun Fact: AWR's history dates back to the late 19th century, with its earliest roots tracing back to the founding of the San Dimas Water Company in 1887, highlighting its deep connection to California's water infrastructure. Learn more about AWR's History"