MDU Resources Group Inc. (MDU) is focused on energy services through its regulated gas and electric utilities, pipelines, exploration and production, and construction and materials units, with operations across the U.S. that are active in the energy sector.
The company is a conglomerate with wide holdings that include four regulated utilities (Montana-Dakota Utilities Co., Great Plains Natural Gas Co., Intermountain Gas Co. and Cascade Natural Gas), Fidelity Exploration & Production Company, WBI Energy (natural gas pipeline and related assets) and MDU Resources Group which focuses on construction materials and contracting.
Each of the company’s business segments is well positioned for growth, with about $1.3 billion in investments slated for 2013 as the U.S. energy market heats up. In parallel, MDU investors can expect steady and rising dividends in the years ahead. With shares near their 52-week peak, investors should consider options strategies for income.
Strong History of Paying and Increasing Dividends
MDU has a solid 76-year history of non-stop quarterly dividend payments and has increased dividends consecutively for the past 23 years, with dividends up 5% annually over the past ten years.
MDU recently announced a quarterly dividend of $0.1775 per share ($0.71 annualized, unchanged from the previous quarter) payable 7/1 to holders of record 6/12/14.
At $34.07 (close on 5//25), shares yield 2.10%.
Shares Handily Beat S&P 500 over Past 20 Years, Ripe for Options Strategies
Over the past 20 years, MDU shares have delivered a total annualized return of 11.5% (including dividends paid, not reinvested), well above the 7.4% return of the S&P 500 index. At $34.20 (market close on 5/14/14), shares are slightly below their all-time high of $36.05 after rising 28% over the past 12 months.
Shares trade at a P/E ratio of 23.3x trailing 12-month earnings of $1.47 per share, 17% below their 5-year average P/E of 28.6x, and at 1.43x TTM sales, 2.3x book value and about 10.5x cash flow.
Shares trade at 20.7x forward earnings, a 22% premium over their 5-y average forward P/E ratio average of 17, and at a forward PEG ratio of 3.1 which is a 27% premium to their 5-year average of 2.5.
At current levels, shares appear a little rich on valuation based on projected earnings growth of 6% to 7% and could correct a little on profit-taking and a broad market pull-down off recent highs.
Institutional shareholders hold about 56% of outstanding shares, reflecting a stable ownership base with high liquidity.
Wall Street has an average 12-month price target of $36.30 per share with a high of $42 and a low of $30, so shares could have some upside above current levels, or equally go slightly lower on profit taking, making MDU an ideal play for innovative options strategies. Three analysts rate MDU a Strong Buy, one rates it a Buy and five have this on a Hold rating.
Investment Thesis – Vertical Integration across 4 Segments, Organic Growth and M&A Opportunities in Each Segment
MDU Resources is a vertically-integrated play that offers key advantages such as the ability to leverage expertise across common customers, cost savings that strengthen its balance sheet and allow the company to re-direct cash flow into growth businesses. The company also has substantial organic growth opportunities in each of its business units.
I. Utilities Business Segment – Earnings up 3x Since 2006, Base Rate to go up 9% Annually
The company’s original business and name derives from Montana-Dakota Utilities Co. which morphed into MDU Resources Group as the company expanded. This unit, through its subsidiaries, provides electricity to 135,000 customers and gas to over 877,000 customers in eight states and 448 communities, and has steadily seen an increase in customers at 2.1% annually in 2013 as population grows in its communities.
And though many think utilities are boring, they have been a great source of stable revenue and growth for MDU with earnings that have increased over 200% since 2006 and a projected 9% annual increase in base rate expected over the next five years that will add to margins by leveraging the company’s existing infrastructure. As the graph below shows, the base rate increase is expected to outstrip increases in depreciation and capital expenditures.
Substantial Organic Growth Opportunities in Utilities Segment
MDU has substantial growth opportunities that it is actively pursuing in its utilities segment. The company plans to spend a record $300 million in capital expenditures in 2014, with $70 million targeted to accommodate growth in electric and natural gas demand from the Bakken shale field.
The company is spending $77 million on an 88-MW gas turbine in Mandan that is projected to enter service in the third quarter of 2014, $100 million on an environmental upgrade to its Big Stone Station, $62 million on a 30-mile pipeline to the Hanford nuclear waste remediation site that will be in-service in 2015 and $360 million on a proposed Midcontinent-ISO 345 Kv transmission line, in a 50/50 joint venture, with targeted completion timeframe of 2019.
Overall, MDU plans to invest about $1.3 billion in expansion projects over the next five years, expects to grow its rate base by about $700 million (9% CAGR) over the next five years from large growth projects and projects that accommodate rising agricultural and industrial demand.
In addition to its organic expansion, MDU has received regulatory approval for natural gas rate increases in North Dakota, South Dakota and Montana, and will recover some expenses on pipeline and constructions costs under government subsidies.
II. Pipeline and Energy Services – Adds to Utility Revenue, Provides Revenue Diversification
MDU operates 3,800 miles of regulated pipelines with over 1 billion cubic feet per day (Bcf/d) system capacity, with 13 interconnecting points and three storage fields with 193 Bcf capacity.
In addition, it operates 1,600 miles of non-regulated pipelines and provides energy services such as natural gas and oil gathering, natural gas processing and cathodic protection. The company is also currently constructing a diesel topping plant.
Bakken to Drive Revenues at Dakota Prairie Refinery (Under Construction)
At the Bakken shale fields, oil production is expected to triple and natural gas production is expected to quadruple over the next 10 years. And this explosion in production fits nicely with MDU’s construction of its new Dakota Prairie refinery which is under construction (50% complete) and is expected to produce 20,000 barrels/day of Bakken crude into diesel fuel, naptha and atmospheric tower bottoms. The refinery will cost $350 million, with costs evenly split with Calumet Specialty Products Partners (CLMT).
Dakota Prairie is expected to generate EBITDA of $70 – $90 million in its first year of operation, with earnings to be evenly split with Calumet.
Dakota Pipeline Project
To sate natural gas demand, MDU plans to build a 375-mile pipeline from western North Dakota to northwestern Minnesota, at a cost of $650 million, and is currently in open season where it is seeking capacity commitments. The 24-inch pipeline would have 400 MMcf/d carrying capacity, expandable to over 500 MMcf/d. Once capacity commitments, permits and regulatory approvals are in, the company plans to commence construction in 2016, with completion set for 2017.
III. Construction Materials & Services Business Segment
MDU Resources is currently in the Top 10 list of construction material producers, and sixth in the supply of sand and gravel, with high-quality aggregate reserves of 1.1 billion tons in key strategic locations close to demand points.
In the Construction Services segment, MDU is ranked #11 in the specialty contractors list and has developed a solid reputation for its highly skilled workforce and services.
Construction earnings were up 45% in 2013 on margin expansion and an 8% increase in revenues from volume expansion. The company’s backlog grew 25% to $915 million at year-end 2013. So the construction materials and services segment is also well positioned for revenue, margin and earnings growth.
IV. Exploration and Production
MDU is gradually strengthening its presence in Exploration and Production (E&P), and is targeting oil to maximize profitability while expanding its presence in key oil producing regions and exploring additional avenues for growth. In 2013, the company produced 28,000 barrels of oil equivalent per day of which 47% was oil, 8% was NGLs and 45% was natural gas. MDU has proved reserves of 81 million BOE (of which about 51% is estimated to be oil) and over 800,000 net leasehold acres. MDU’s E&P effort is supported by its technical expertise in horizontal drilling and completion and strong focus on disciplined execution.
MDU is focused on developing new wells in Bakken with $130 million in planned spending, Utah’s Paradox Basin ($170 million in 2014 capex) and the Powder River Basin where it recently acquired almost 25,000 net acres.
Diversifying E&P with Gas Production
While oil is key to earnings, MDU is not ignoring natural gas production. The company’s gas assets include the Baker and Bowdoin fields in Montana and the Shiloh field in Texas, with net current production of 62 MMCF/d of low cost, high margin production at Baker and Bowdoin, and horizontal drilling potential in the Shiloh field.
Overall, its E&P segment has NPV10 of $1.34 billion with MDU focused on driving value creation over reserve volume growth, while increasing its higher-margin liquid-to-gas ratio.
Well Diversified Revenues across Growing Business Segments
MDU has a good mix between regulated and non-regulated businesses, and each of its four businesses contributes substantially to earnings with 30% from its regulated utilities, pipeline and energy services segments combined, 36% from construction materials and services and 34% from exploration and production.
Experienced Management, Dedicated CEOs for Each Business Unit
MDU has a well-rounded management team which is essential for the conglomerate nature of its holdings. The Group is led by President and CEO David L. Goodin who was formerly the CEO of Montana-Dakota Utilities Co. and has extensive experience with gas/electric utilities. Under him, Goodin has CEOs for each primary business segment.
J. Kent Wells is the President and CEO of Fidelity Exploration & Production Co., David C. Barney heads the company’s construction materials and services business (which operates as Knife River Corp.), Steven L. Bietz heads the company’s WBI Energy subsidiary for energy and pipeline services and K. Frank Morehouse heads the company’s gas utilities (Montana-Dakota Utilities Co., Great Plains Natural Gas Co., Cascade Natural Gas Corp. and Intermountain Gas Co.)
Doran N. Schwartz serves as CFO and has extensive financial accounting experience in the energy sector.
Q1 2014 Results – Adjusted EBITDA up 57%
For its first quarter ended March 31, 2014, MDU announced adjusted earnings of $60.8 million, marginally above $60.1 million in the year-ago quarter. Adjusted EPS was flat at $0.32 per share, and one cent below Wall Street estimates.
The construction services segment had a strong quarter with a record 42% increase in earnings and the highest backlog since 2007, reflecting project delays after a harsh winter and ongoing strength in the energy sector. Oil production was up 14% at the company’s Fidelity E&P subsidiary with a 121% increase in production at the Paradox Basin, a 3% increase in Bakken despite the weather, and acquisition of oil assets in Wyoming’s Powder River Basin. Midstream demand almost doubled earnings at the pipeline and energy services segment and electricity revenues were up 10% on demand growth in the Bakken area. Overall, results reflected strength in all business lines.
MDU also upped 2014 EPS guidance to $1.50 – $1.65, up from $1.45 – $1.60, on new projects expected to come online in 2014 and rate increases in the utility business.
On a consolidated GAAP basis, MDU earned $56.5 million ($0.30 per common share), marginally above Q1 2013’s $56.3 million.
On a consolidated basis, the company had operating revenues of $1.04 billion, up 11%, operating income of $102.9 million, down 1.5% on higher operating and maintenance expenses for the utilities segment and seasonal slowdown in outdoor construction projects.
The company ended the quarter with $15.34 in book value per share (vs. a market price of $33.84 per share). Total debt increased 15% to $2.1 billion on borrowings related to capital intensive projects. The company had a debt/equity ratio of 0.7 and a debt/assets ratio of 0.28.
MDU Resources Group is a well-diversified conglomerate with complementary operations, each with strong growth potential. The company has steadily increased dividends over the past 23 years, and is expected to increase dividends by 5% annually. It also plans to make sizable investments in organic growth projects which will translate into higher earnings while expanding the company’s platform for future growth. MDU is well capitalized and has manageable debt ratios that allow the company to tap the capital markets if needed. With shares near their all-time high, there is limited near-term upside but solid long-term growth potential, so MDU shares are ripe for lucrative options strategies.