THE FOLLOWING REPORT IS EXCERPTED FROM THE WALL STREET TRANSCRIPT COMPANY INTERVIEW
RON L. FLEMING
MIKE LIEBMAN
SECTOR — UTILITIES
(BEQ603) TWST: Can you describe the company, its history, and how it got started and how it’s evolved over the years?
Mr. Fleming: Yes, so the company was founded 20 years ago. In fact, we just had our 20-year anniversary in October. It was really founded focusing on two of the main issues in the industry, as our founders saw it at that time.
And those two issues were the fact that water scarcity is real and that we need to do a better job as utility managers to plan, build and design utilities in a way that dealt with that ultimate eventuality, and then also the fragmentation of the sector, which made that really hard to do. I mean, there are 150,000-plus water systems in the country, and that doesn’t even include wastewater systems.
So the idea was to aggregate water and wastewater utilities under one professional umbrella, then implement the program we’d created to deal with that water scarcity issue on more of a regional, consolidated basis.
And so, with that business plan, our founder said, you know a great place to do that is Arizona, because there are a lot of private utilities here, hundreds. I think there are still 400. And there’s been a lot consolidated over the 20 years — we’ve done a fair amount of that ourselves.
There’s also a lot of growth in Arizona, so it gave us the opportunity to really implement the way we, again, plan, design and construct our regional utilities that are integrated on the water, wastewater, recycled water side, in greenfield areas as well. Growth just keeps pushing out of metro Phoenix. That’s where most of our utilities and service areas are today, understanding that growth is coming. But because we got there early, when either the utilities were small or the communities were small, we had the chance to implement our vision early as the community has grown.
And so, all those things really just came together very well for us in the first 20 years, to the extent that some of our communities have been the fastest growing in the country during that time, but they’ve been well positioned from a water resource and sustainability and an infrastructure perspective, where lots of times communities are hindered by that if it’s not done in the right way.
So, with that, we’ve built a lot of support for what we do and how we do it. And sitting here right now, even though it was our 20th year, we really feel like we’re just getting going, because the opportunities that our communities are giving us, the opportunities that are happening in new areas outside of metro Phoenix, we’re being asked to come in and bring that solution.
And so, we’re really growing on all fronts and our model proved out to be what was needed in these areas in Arizona.
More recently, you’ve started to hear the term, “One Water.” So, One Water has become a thing in the industry, and it’s a very similar concept, which is, it’s always the same water, it just goes through a continuous cycle. And you have to think about it that way to properly manage it.
So we’ve been doing that since our inception in a way we think is unique and right, and we call that total water management, which is wherever we build utilities, our number-one priority is to reuse as much recycled water as possible.
So we provide our customers water, take back the waste water, treat it to a really high quality. It’s called Class A+ in Arizona, which means it can be used in common areas and at schools and at ballparks and on crops that are not meant for human consumption. It’s really clean effluent, treated wastewater. And we put purple pipe in the ground to send that resource back to all areas of our communities as they grow.
Now, using recycled water is not a novel concept. We certainly didn’t invent that, but most cities don’t do it that way, where, as I just described, each new community has to take that recycled water back through a second set of purple pipes and use it for all non-potable outdoor uses. So that allows you to conserve and protect your scarce potable water resources, because trees, grass and shrubs, they don’t need that potable water. They don’t need that river water or that aquifer water. Recycled water works just fine.
That’s the main point of TWM, but then we layer lots of things through it. We’re known for our technology. So we do a lot on the technology side as it pertains to conservation, and we have won many awards for our overall approach.
For example, we’ve implemented what’s called advanced metering infrastructure. So we read our customers’ meters continuously. It exists in the electric and gas space more, it’s not very prevalent in water. It’s starting to come there. But we’ve been doing it for 15 years. We were doing it when it was really new. We were on that leading edge. But that’s allowed us over 15 years to perfect that.
So we read our meters continuously. We do a lot with that data as the utility, and we give that data back to our customers. Our customers can log into a portal and see their uses hourly, daily, per home or per customer, depending on which metric you’re using, than really any other similar community in the state of Arizona.
And then we do all the outside irrigation with recycled water. And when you put all that together, we really are building sustainable communities. They’re beautiful because you can’t sacrifice that. They have amenities. We don’t restrict pools. We allow for those things, but we still do it on a very low water use footprint. And everything that goes into that is what we wrap up into what we call total water management.
TWST: What challenges have you faced operating primarily in Arizona and other parts of the Southwest, where there’s an ongoing drought or drought-like conditions?
Mr. Fleming: It definitely keeps us busy. Definitely it’s a challenge, to use your word. But it was actually why we brought that utility model here. It was literally like, you can’t have this model in the Northwest where it rains more than any place else on earth, right? But in Arizona, it’s the right thing to do. And so, yes, there are challenges, but for us, we see it as the business opportunity to do it right and to get into more communities to continue to do it more.
But the actual challenges we’re dealing with — so, water is a regional issue and water is a local issue, and those two things aren’t always the same. Regionally, the Colorado River and the West are in their 28th year of what’s called a mega drought. Because of that, there’s been more and more restrictions on the river, more and more cooperation on the river on how to deal with the reduced flow in the Colorado River basin.
It got to its worst state just over a year ago, where they actually put in place what’s called a Tier 2 shortage declaration, which requires the states that use Colorado River to reduce their usage. But the good news is, over the last year not only have the states reduced their usage per the Tier 2 requirement, they actually did more.
And then last year, winter was one of the wettest winters in a long time. And when you combine those two together, we actually saw the lake levels in Mead and Powell go up enough that it actually reduced from a Tier 2 to a Tier 1 shortage declaration, which just reduces that obligation to conserve more.
All that means is, we know long term that the aridification is happening at some level, and we have to do more with less. But this has all led to where we bought a little bit of room because of what happened last year. But in the next couple of years, the states and the federal government and Mexico are going to have to decide how to reallocate the way the river works today versus the way it was a long time ago.
“You grow by rate cases — so going and processing the actual rate increases at our regulator, and our last one was completed in the back half of 2022. But really, most of the benefit came in place in 2023, so the financials are seeing that.”
But the good news is, when you switch from regional to local, it doesn’t actually impact our company and our communities today. Because if you think about the business plan that I described, all the big existing suburbs of Phoenix, they bought up all the Colorado River allocation long ago. There’s not more available for new areas. But what’s happening as growth moves out, it’s going to places that have been historically farmed.
There’s a lot of agriculture around Phoenix. People are surprised at how much there is. Well, the good news is when farms convert from agricultural to rooftops, they actually use like 10%, 20% of what the farm was using.
And there’s really good, large, high-quality local aquifers in this area because natural recharge has been happening for, obviously, thousands of years, but also the recharge from the farming activity.
We’re allowed, under state regulations, to pump the groundwater aquifers to a certain limit. You have to put in place what’s called an assured water supply. Arizona has got the most stringent groundwater rules in the country, which again is, you can call it a challenge, but for us, if you get really good at it, it’s the opportunity. So we’ve put big assured water supplies in place.
We can highlight our flagship utility which is the city of Maricopa. We bought those utilities 20 years ago. That was the first utility we bought, 2,000 people, today 72,000 people. And it’s not slowing down. But why can they do that? Well, we’ve put an assured water supply in place based off a groundwater portfolio that we’ve built over those years that shows that we can actually pump up to 23,000 acre-feet per year and not harm the aquifer. We’re only pumping 7,700 acre-feet per year, so we’re like a third into that.
Then you apply the total water management concept we just talked about and that gets stretched even farther. So it all comes together. So, sure, there are challenges, but we’ve created the solution to the challenge that is the business model.
TWST: Now, you described last year, 2023, as the best year ever for the company. Why was it such a good year? And what are you doing to keep that momentum going for 2024 and beyond?
Mr. Fleming: I’m going to take that at a high level, and then, Mike, I’m going to leave it to you to go over some of the financial highlights. I can say that from my view, it was our best year ever.
There are four ways this company grows. Organic growth, you’ve seen the data, almost 8% average over the last five years, way above the industry average. That’s happening. That’s going to continue to happen just based on where we’re physically located and what’s going on in Arizona.
We grow by acquisitions. Our biggest acquisition just closed in 2023 — the biggest we’ve done since before, really, the great recession. So we’re back to doing deals of size. We’ve done a lot of deals in between, but it’s a fairly material one for us.
You grow by rate cases — so going and processing the actual rate increases at our regulator, and our last one was completed in the back half of 2022. But really, most of the benefit came in place in 2023, so the financials are seeing that.
And then you can get new service area. That’s where we’re literally asked to go out to a brand new area and start a utility from the ground up, which a lot of utilities stay away from because it’s hard to do, to be honest. But we’re doing a fair amount of it. We signed a bunch of contracts in 2022 that led to a lot of progress on new areas in 2023.
So, when you put that all together, it really was the first time ever that all four areas of growth were occurring at the same time, because even over those 20 years, there were always reasons why we were picking and choosing one priority versus the other. All four areas of growth went very well, and it’s evidenced in the successes that we had and in the financial numbers of last year. So that’s the way I would describe that. Mike?
Mr. Liebman: Thanks, Ron. What I would say is, I think in the trailing 12 months, we’ve surpassed $50 million in revenue, $25 million in EBITDA, so near 50% EBITDA margin.
But really what’s happening is, because of all the activity, one, we’re obviously in Phoenix, where there’s a lot of people moving, there’s been a lot of buzz around all the semiconductor manufacturing that’s coming here between Taiwan Semiconductor, Intel also, which is just 20 miles up the road from us, is doing a couple of plant fabrication expansions. And so that’s driving a lot of people to move to Phoenix.
And in addition to that, the areas that we’re in — Ron mentioned the flagship assets that we have in the city of Maricopa — it’s about a 25% discount from a home affordability perspective. So we have a lot of things going for us, the economic driver plus the home building element.
And what you’re seeing and what we’ve sustained over the last five years or so, our connection growth is averaged about 7.7%, where the peers are at 1.5% connection growth, all the other publicly traded water utilities. And so, we’re going at a five times clip of the peer group and that’s going to continue based on all the growth that has and is continuing to happen here in the metro Phoenix area and beyond, in addition to the other elements Ron mentioned, new areas, acquisition opportunities, etc. So we’re going to carry that momentum and keep going.
TWST: And you touched on this, but how has your acquisition strategy been integral to your growth and expansion?
Mr. Liebman: Yes, so we’ve acquired twelve utilities over the last, I’ll call it, six years or so. As Ron mentioned, there’s over 300, almost 400 independently owned utilities. And there’s actually been an incentive down from our corporation commission to continue that consolidation. And so those opportunities exist. We continue to have those conversations.
“But because we have that organic growth that’s so strong and robust, it allows us to be disciplined on the acquisition front. And so we make sure we have the right fit and we’re paying the right price and we’re not just out there buying utilities at overvalued prices from our perspective.”
But to put some numbers around it, it’s about 7,700 connections that we’ve added to our portfolio, 61 square miles, as well as about $4.4 million of revenue. And so, it’s been pretty instrumental. It’s an element of our growth story, but organic growth alone is still a significant element of what we do.
And so those acquisition opportunities are there. But because we have that organic growth that’s so strong and robust, it allows us to be disciplined on the acquisition front. And so we make sure we have the right fit and we’re paying the right price and we’re not just out there buying utilities at overvalued prices from our perspective.
TWST: And what should readers and investors understand about your revenue model? And how is that part of your broader business strategy?
Mr. Fleming: Look, we’re still relatively young. Another reason we say we had our best year ever and we’re just getting going. When you look at the average age of our publicly traded peers, it’s over 100 years — the closest one to us is, I think between 40 and 50, and that’s San Jose Water. Most are 100 years old.
But what’s happening right now, which you can see in our financials, and it goes back to your question, is it is expensive and it is difficult to start new utilities. And so your investment and then the revenue return you get on it lags a bit more than normal. So, we’re starting to get to a point where you can see in our financials that that is a lot more healthy and balanced.
And when you wrap it into the regulatory program that we have here on going back and getting rate increases more frequently to recover those capital investments that we have to make to keep up with this constant growth, we’re doing better and better at that and on shorter intervals.
So, all of that is to say, we’re no different than the other regulated utilities. You’re driving revenue and you’re driving, really, earnings by the investments you make and getting a return on those investments. It’s just we’re getting to a size and scale and a maturity that it becomes more predictable than maybe it did in the past, with a bunch of upsides. So that’s the important point, the upsides.
And the upside is that organic growth rate. I mean, it gives us a lot of flexibility on when we process rate cases and when we make acquisitions, like Mike was talking about. And so, we think we’ve built the foundation here.
And it’s more than an idea. You’ve seen it in the numbers over the last five years that Mike was describing, and this growth can go on for decades. It’s probably true that the areas we’re in, if you study the local demographics, if you study the local job growth and just the transportation corridors, growth is coming to our areas. It has come and it will continue.
And we have decades of runway of that type of organic growth. And that’s almost not replicable anywhere else in the country, in my opinion, not on the scale that we’ve secured here outside of metro Phoenix.
TWST: Are you feeling any effects from microeconomic or geopolitical factors right now?
Mr. Fleming: I would say, I thought we would have felt it more. The steepest slope to inflation and interest rates in more than 50 years last year, actually leading back to middle of 2022. All the supply chain issues that have been a problem coming out of COVID and just the demographic factors that we talked about, we just thought that housing and growth would slow more in Arizona, in our areas. And we were just wrong, to the positive.
The number of jobs like industrial, manufacturing, commercial, medical, university, projects that continue to come into the metro Phoenix area is just unprecedented. There’s a slide in our deck that shows the actual numbers. And we’re outperforming the history of Arizona by a factor of five. And so that’s just overcoming the bigger global geopolitical and economic factors right now for us.
Mr. Liebman: Yes. If I could add to that concern, I would just say that we obviously track permits at every city where we have our utilities because that’s a good leading indicator to future home growth for single family homes. And it seemed to have bottomed the middle of last year. And it started an upward trajectory.
So even our annualized organic growth through September was over 3%, a lot more than we were expecting, as Ron mentioned. But it seemed to have bottomed out. And we’re seeing some upward momentum. So it’s nice to see that continue.
TWST: And as you look ahead, what are some of your biggest concerns going forward over the next few years?
Mr. Fleming: Obviously we’d like to see, just like the rest of the world, the U.S. get this inflation under control. I mean, it’s trending in the right direction, which has been helpful for us here this year, but I don’t think we’re out of the woods on that yet. And so, I do think that inflation is obviously difficult for regulated utilities to manage just due to the increasing costs that we have to go to a regulator to get recovered in rates.
And then obviously the cost of capital component, because we’re capital intensive, and also high interest rates has a bit of an inverse effect on valuation. But I think we held up pretty well during that. And so I don’t see it becoming a bigger issue for us that would impact our business more to the negative side than it already did. But I would still say that that’s one of the top things on my list. The concern is just to see that continue to get under control and back to historical steady state type numbers.
On the water front, there is more going on in Arizona on the water policy and legislation side, tied to both local groundwater rules and laws, but also how we’re going to deal with the Colorado River issue that we talked about earlier. And so, I do think there’s the potential for both good and bad to come out of that level of activity.
The good is, I guess I would say it this way, the amount of interest is also a positive because that means there’s a lot of people focused on it and interested in it, and that’s what it takes to actually get things done on the water side. And so, while certainly it keeps us busy and some negative things could come out of it, ultimately, I look at it as a positive.
So, it’s less of a concern. But again, I think it’s really more of an opportunity for our state to take this focus, take the momentum, take the fact that we have to solve the Colorado issue with the other states by 2027, or at least agree to a new plan to do some meaningful things in Arizona that we haven’t done really since the 1970s and ’80s. We’ve been relying on the Groundwater Management Act of 1980. We’ve been relying on the central Arizona project that was built even earlier in that, but really started getting the full allocation of the Colorado River to different parts of the states, not until the ’80s and ’90s.
So, we’ve done a lot of great work. Arizona’s positioned themselves well, but it’s time to take the next big steps on either augmentation, like what’s the next solution and/or rewriting of some of those laws and policies.
Frankly, we think they should make everybody do what we do, as it pertains to maximizing reuse, smart metering and innovative rate programs. We already do it. It’s not in law. But if they’re going to enforce more conservation, more mandates around the things that we do, fantastic. We already do them.
TWST: Thank you. (CJ)
RON L. FLEMING
Chairman, President & CEO
MIKE LIEBMAN
Senior Vice President & Chief Financial Officer
Global Water Resources Inc.
21410 N 19th Avenue, Suite 220
Phoenix, AZ 85027
(480) 360-7775