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Middlesex Water Company has a remarkably safe, growing dividend, with a current yield of over 3%. Using a constant dividend growth model, investors will find that the current stock price is slightly below the fair value. Investors looking for a safe utility company with a steady dividend should take a look at Middlesex Water Company. Middlesex Water Company (NASDAQ: MSEX ) could be one of the safest dividend stocks in the market. This is a water utility company operating in central and southern New Jersey, as well as Delaware and northeastern Pennsylvania, which include some of the highest-income areas in the nation. As a water utility company and a company whose customers are overwhelmingly wealthy, Middlesex Water Company is able to provide a remarkably safe dividend, with the current 3%+ yield representing a payout ratio of under 70%. Furthermore, recent developments in New Jersey (where Middlesex Water Company operates most of its business) should allow the company to grow earnings and maintain its healthy dividend. Governor Chris Christie recently signed into law the Water Infrastructure Protection Act , which allows municipalities to sell their water systems to water companies. So while utility companies have typically been seen as safe investments, in New Jersey they can be considered safe and also have the potential for growth. These developments show that the Middlesex Water Company’s dividend should be safe, and that earnings growth opportunities in the future could potentially provide an additional incentive to invest. If the under 70% payout ratio is not impressive as it is, the company has made a cash dividend payment every year for 102 years, even in the midst of the financial crises. Furthermore, Middlesex Water Company has raised its dividend every year for 42 years. (click to enlarge) This is a perfect case of a dividend stock, and a stock that many investors will only purchase for the safety of its dividend. Thus, we can safely use the dividend growth model to find its value. Excluding that one quarter blip, Middlesex Water Company has raised its dividend every four quarters by .25 cents, for an annual increase in its dividend of 1 cent. While this nominal growth rate is constant, in order to use the dividend growth model, we must come up with a percentage rate. The percentage rate will be declining year after year, even as the dividend growth remains at a steady 1 cent increase. For next year, the dividend growth rate is represented by .01/.77 = 1.3%. In about 25 years, we know this rate will decline to just under 1%, so we can split the different and use a rate of 1.15%. This assumes the investor will be holding the stock for a period of 25 years. For our required return rate, we will use the Weighted Average Cost of Capital for Middlesex Water Company. This can be calculated by finding the weighted average cost of equity, which we will find using the Capital Asset Pricing Model (CAPM), and the cost of debt multiplied by 1 minus the tax rate). The weights will be 71% equity and 29% debt, using market cap of equity and the book value of debt. The Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market – Risk-Free Rate of Return). The risk-free rate we will use is the 10-year Treasury, currently yielding about 2.05%. The beta we will use is .62, as calculated by YCharts, which uses data from BATS Exchange. The expected return of the market – the risk-free rate, otherwise known as market premium – is left up to much more interpretation. I will use a rate of 5%, which is slightly less than the average S&P performance minus the current risk free 10-year Treasury rate. I am using a slightly less-than-average S&P average because evidence suggests the market will not do as well as it has done the past few years, as news is coming out that people are pulling money out of the market and into other investments. For example, the return on cash now exceeds returns on stocks and bonds for the first time in 25 years . This model will assume that investors putting money in the market will receive a historically lower return than average. Plugging all these values in, we get a cost of equity of 5.15%. The cost of debt can be easily calculated as interest expense divided by book value of debt. In this case, using year-end data from 2014, we get $5.067 million divided by $162.2915, which equals 3.45%. Middlesex Water Company’s average tax rate for the past two years has been 34.57%, so we will multiply 3.45%*(1-.3457) to get 2.26%. Now, to weight them, it will come out to (.71)*(.0515) + (.29)*(.0226) = 4.31% Using the next annual dividend payout of $0.78 as well as all these values, we can use the dividend growth model to estimate the stock is worth approximately $24.69. At a current price of $23.75, it appears MSEX is undervalued by approximately 4%. For investors looking for a safe, growing dividend, Middlesex Water Company is worth a look. Scalper1 News
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