MDU Resources Group, Inc. (MDU) Q2 2015 Earnings Report, Transcript and Summary

Good morning. My name is Angela and I will be your conference facilitator. At this time, I would like to welcome everyone to the MDU Resources Group's First Quarter 2015 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will a question-and-answer period. [Operator Instructions] This call will be available for replay beginning at 1:00 PM Eastern today through 11:59 PM Eastern on May 19th. The conference ID number for the replay is 12424597. Again, the conference ID number for the replay is 12424597. The number to dial for the replay is 1-855-859-2056 or 404-537-3406. I would now like to turn the conference over to Doran Schwartz, Vice President and Chief Financial Officer of MDU Resources Group. Thank you. Mr. Schwartz, you may begin your conference.

Thank you and good morning. Welcome to our earnings release conference call. This conference call is being broadcast live to the public over the Internet and slides will accompany our remarks. If you would like to view the slides, go to our website at www.mdu.com and follow the link to the conference call. Our earnings release is also available on our website. During the course of this presentation, we will make certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Although the company believes that its expectations and beliefs are based on reasonable assumptions, actual results may differ materially. For a discussion of factors that may cause actual results to differ, refer to Item 1A Risk Factors in our most recent Form 10-K and Form 10-Q and the Risk Factors section in our most recent Form 8-K. Our format today will include formal remarks by Dave Goodin, President and CEO of MDU Resources followed by a Q&A session. Other members of our management team who will be available to answer questions during the Q&A session of the conference call today are Dave Barney, President and CEO of Knife River Corporation; Steve Bietz, President and CEO of WBI Energy; Nicole Kivisto, President and CEO of Montana-Dakota, Great Plains Natural Gas, Cascade Natural Gas and Intermountain Natural Gas; Pat O’Bryan, President of Fidelity Exploration & Production; Jeff Thiede, President and CEO of MDU Construction Services Group; and Nathan Ring, Vice President, Controller and Chief Accounting Officer for MDU Resources. And with that, I'll turn the presentation over to Dave for his formal remarks. Dave?

Thank you Doran and good morning everyone. We appreciate you joining us today to discuss our first quarter results. We are positive about our long-term growth potential despite challenges we experienced during this first quarter. We have record capital investment opportunities at our utility and pipeline businesses, a refinery that is now in production and clear momentum at our construction materials business as well. Along with increasing bidding opportunities at our construction service business with a combined backlog between both construction materials and services now approaching 1 billion. Several factors negatively affected our results for this quarter. Some of the warmest winter weather on record affected utility earnings by approximately 6.6 million. Although the pipeline bid benefit from last year's rate case, the company incurred higher start cost for our Dakota Prairie refinery as the time neared to commencing operations impacting this year's first quarter by about 1.9 million. The Construction Service Group sold underperforming non-strategic assets in the first quarter recording an expense of 1.4 million and our Construction Materials Group had a true-up of a multi-employer pension plan withdraw liability of 1.5 million related to the same plan for which an estimate was recorded in the fourth quarter of 2014. These items on a combined basis totaled 11.4 million or [$0.066] per share of a negative impact to the first quarter earnings compared with last year. So including these items consolidated adjusted earnings for the first quarter totaled 22.8 million or $0.12 per share compared with 35.6 million or $0.19 per share in 2014. On a consolidated GAAP basis which includes our exploration and production business, we reported a loss of 306.1 million or $1.57 per share reflecting a 315.3 million after tax non-cash write down of oil and natural gas properties pertaining to the quarterly ceiling test. Turning to business unit results and operational updates. Our utility businesses reported earnings of 29.8 million. Earnings were positively affected by the implementation of the environmental cost recovery rider and the electric generation resource recovery rider in North Dakota. And we continue to see strong current growth in the Bakken area with increases of 4.4% in electric customer accounts and 3.6% in natural customers in the first quarter compared to a year ago. More than offsetting these items were significantly warmer winter weather across our service territory resulting in a $6.6 million earnings effect with the natural gas sales decline of 14% along with a slight decrease in electric sales. While we do have weather normalization in North Dakota, South Dakota and Oregon, we do not have natural gas weather normalization in our remaining five states of operation. Higher O&M cost largely as a result of a planned outage Big Stone generating plant also impacted earnings quarter-over-quarter. Even the substantial growth in investment of our utility timely regulatory recovery is a primary focus. We have pending natural gas rate increases cases in Wyoming, North Dakota, Oregon and just last week we received PSD approval for 2.5 million annually on our Montana gas phase. We have filed in North Dakota for advanced determination of prudence for the Thunder Spirit Wind project as well as an update to the environmental cost recovery rider as well. We expect to file electric rate cases in Montana, South Dakota and Wyoming and natural gas cases in Washington, Minnesota and South Dakota with most of these cases expected to be filed this year. We continue to expect this business to grow substantially over time with the investment opportunities ahead. Rate base growth is projected at 11% compounded annually over the next five years including plans for a record 1.8 billion gross capital investment program. New electric generation and transmission and electric and natural gas distribution investments are planned to serve the growing customer demand and to enhance reliability along with system integrity. Specifically three projects completed this year include the $200 million Thunder Spirit Wind project to be built here in Western North Dakota, a $385 million upgrade to our Big Stone generating plant of which our share is approximately 90 million and the addition of 19 megawatts of natural gas fire generation near our Lewis & Clark Station in Sidney, Montana. In addition we are working on a $340 million 345 KV transmission line that is MISO multi-value project expected to be completed in 2019 with our share being one half. Our utility is really in a great position focused on timeliness of regulatory recovery along with our planned investment in executing on the substantial [identified] projects as I just recently laid out. Next at our Pipeline Group, earnings were 4 million including that 1.9 million after tax increase in our portion of the startup cost related to the refinery. Absent these costs, earnings would have been up 1.6 million or 33% quarter-over-quarter. This corresponds to transportation volumes which were 30% higher driven by strong growth of off-system transportation volumes. Also benefiting earnings were increased rates from that favorable rate case settlement we had May of 2014. Gathering and processing volumes also increased at our Pronghorn facility but were largely offset by lower processing rates. And as we announced yesterday along with Calumet, our partner on the project, the Dakota Prairie refinery, the greenfield refinery built in the U.S. in nearly 40 years has commenced operations. With more than two-thirds of North Dakota's diesel fuel currently imported into the state, the refinery is well positioned to meet strong regional demand and additionally local produce supplies of diesel fuel. We expect to begin sales of diesel fuel as the plant ramps up during the month of May. Construction of the facility began just back in March 26 of 2013 and it is located 4 miles west of Dickinson, North Dakota. We had more than 800 workers that were on site at peak construction and the plant was constructed with zero loss time accidents over the 2.1 million man hours worked to build the facility. The facility is designed to process some 20,000 barrels per day of locally sourced Bakken crude and the production slate includes up to 7,000 barrels per day of diesel, approximately 6,500 barrels per day of naphtha and about 6,000 barrels per day of atmospheric tower bottoms or ATBs. Naphtha will be used as a diluent to transport heavy oil by pipeline or as a feedstock in natural gas production and ATBs can be used as feedstock for lubricating oils and other refined products as well. We continue projecting EBITDA contribution for the first full year of operation of the refinery to be in the range of 60 million to 80 million and this will be shared equally by our partner Calumet. As we look forward we have a number of additional growth opportunities at our Pipeline Group that are included in our five year record capital expenditure program which totals 1.1 billion. A $120 million Wind Ridge pipeline project is a 95 mile natural pipeline designed to deliver approximately 90 million cubic feet per day off of northern border system and deliver to near Spiritwood, North Dakota where an announced fertilizer facility will be built. We are continuing work on acquiring [indiscernible] as well as filing an application on the project. Potential really also exists for expansion of the pipeline to serve communities in growing markets in Eastern North Dakota. Our projected in service date for the Wind Ridge project is in 2017. In addition our Pipeline Group has an agreement with an anchored shipper to construct the pipeline to connect the Demicks Lake gas processing plant in Northwestern North Dakota to deliver natural gas into a new interconnection with the northern border pipeline. Project costs are estimated to be in the $50 million to $60 million range and we are also continuing our evaluation of a potential development of a second diesel refinery here in North Dakota. We are encouraged by the growth potential we see for our Pipeline Group as it continues to pursue new opportunities and expansion of the existing facilities and services offered to our customers. Now I'd like to move on to our construction businesses. Here we reported a combined loss of 9.8 million for the quarter. Our construction materials business had its best first quarter since 2007 narrowing our seasonal loss by 38% compared to the first quarter last year. Favorable weather was a positive for this business in the first quarter allowing us to get out an earlier start on the construction season this year. We are pleased that our construction materials business is really gaining momentum. Trialing 12 month earnings net of the withdrawal liability recorded for that multi-employer pension plan is now at 70.3 million, up from annual earnings of 26.4 million just back in 2011 which was the low point during the great recession. Returns on capital have more than doubled over that time period as we continue trending with higher margins with that lower cost structure now in place. We have seen an increase in volumes of aggregate and asphalt sales up 26%, ready-mix concrete volumes up nearly 16%, however levels are still approximately only 60% of peak volumes, so we still have capacity to handle more work in our markets without requiring a significant amount of near term capital. Backlog also continues to trend up, now at 664 million as of March 31st and the bidding environment continues to be strong with incremental work being secured in a number of our markets. At our construction service businesses, workloads declined in the first quarter compared to last year's all time record quarterly earnings, largely as a result of the closing out of several stronger margin large projects a year ago. And although we are seeing strong bidding opportunities the timing of new project awards did not allow us to offset or replace those workloads. First quarter also reflects a $1.4 million expense after tax associated with the sale of certain non-strategic and underperforming assets. Backlog is lower this year than the prior year, however it is up from year end. We are pursuing opportunities that we believe will be reflected in the backlog and workloads later this year. For example, we are a finalist on a substantial transmission project that is expected to be awarded within the next month. With regard electric and mechanical work, we have been verbally awarded a sizable institutional project that we are pursing another with an expected award date later this year. We also have been awarded a pre-construction service base on a project with the construction phase expected to be awarded again later this year. And we are awaiting contract award for another sizable project to be in construction in the second half of 2015. Along with this and on the industrial side the level of maintenance work has increased and we are in the planning stages on several larger projects for upcoming turnarounds. Overall, bidding opportunities are increasing with an improvement of securing work with actually better margins. There are pending project opportunities in all of our regions and equipment sales and rentals do remain very strong. We believe these projects and others that we are pursing will have a significant positive impact to the backlog revenue along with margin at construction services. With our lower cost structure, improving economies and our highly skilled operations teams in our Construction Group we continue to be economic about the long-term growth for our construction businesses. Now I would like to move on to our Exploration and Production Company, Fidelity. From an operational standpoint, we are living within cash flows and we have recently added some hedges to reduce that volatility of cash flows for the near term. Our focus on lowering the cost structure has resulted in a 15% reduction in lease operating expenses that we plan to continue to pursue additional reductions. Our general and administrative expenses have also been reduced. We are moving forward with plans to maximize the value of reserves with recent positive well results in both the Paradox along with East Texas. We are pleased with the production levels of our assets noting the majority of our production decreases are due to prior year asset sales with some additional impact from lower capital levels. We certainly like the stability that we have seen in oil prices as of late. And we will pursue the marketing and sale of our E&P business as we determine appropriate. So I would like to wrap things up. As we continue to be excited about the future of MDU Resources Group, we have substantial investment opportunities that underlie a record 3.9 billion five year capital investment program. We expect to fund our $755 million in planned gross capital expenditures for this year largely with cash flow from operations. Our balance sheet remains strong. Our credit ratings are solid at BBB+ stable and our liquidity position from our various credit lines [netback] our low cost commercial paper programs is extensive. And we have continued to track our record of paying dividends for now 77 straight years and increasing it for the past 24 years. We are only one of a handful of companies that can really say the same. So I am confident that we are well positioned to produce significant long-term value as we execute on our business plans and the opportunities we have right in front of us for the benefit of our shareholders. I appreciate your interest and commitment to MDU Resources organization and I would certainly be happy to open up the lines to questions that you may have at this time. Operator?

[Operator Instructions] Your first question comes from the line of Matt Tucker with KeyBanc Capital.

Congrats on the refinery start up. I wanted to ask is the guidance for the refinery, [if you look at that] is being based on current market conditions or is that more of a long-term average run rate?

Matt I will take a shot at that, Steve is in the room here as well. I appreciate the congratulations, it's been quite a project and effort in just 25 months we were able to complete that project from groundbreaking to now start up. So I want to provide also hats off to Steve and the team over there. I would say it's more a long-term as we look at differentials as we give that guidance of that 60 million to 80 million in EBITDA, we know differentials widen and they will narrow but we're going to be very transportation advantaged with the sizing or the location of this plant given we'll capture that crude price going out and being processed out of state and then refined product being brought in. So again I would look at it over the longer term and it's not a point in time.

Thanks, should we assume that there is some ramp up period here before you can kind of get to the full run rate?

Yeah Matt, this is Steve, you know as we sit here today and as we kind of design the startup, we've been right around 10,000 barrels a day. And I think as you think about the refinery typically would look to ramp that up to the maximum in a fairly short period of time kind of a matter of days given this is a newly commissioned equipment and facility, we're doing that on more measured approach ensuring safety and just kind of bringing things up as we go. As I think about I, our objective here is to continue to move that up and expect, if there's any big issues as we go we would be up to our 20,000 barrels a day say by the end of this month, somewhere around there.

Great, thanks Steve. And then one just with respect to a potential second refinery, you've indicated you'll probably spend most of this year analyzing that. You know on paper based on the cost from the guidance for the first one, the supply demand situation, it would seem like it makes sense, so could you just talk a little bit more about you know what factors that you have to consider or in any other, anything else that prevents you from moving ahead more quickly with that?

Well I think [indiscernible] to get the first one up and running so that was really where our focus was at. So we put this on the shelf a little better and at least on the back burner. We have been doing some work associated with the second refinery from a [citing] perspective as well as some of the engineering work. So we're making some progress there and we've got some meetings planned over the next couple of months relative to some of the equipments so forth for a second refinery. We want to understand also the market, the crude oil acquisition market that where we're buying crude and the market for diesel in several locations. So those are all factors that we're studying. I guess, I think the good news here is that we've got our first one up and running and can now shift our attention over to spend more time on the second one and certainly apply the lessons learned if you will from the construction of the first one where there is opportunities to do a better job to reduce cost and make a second plant actually more efficient so.

Thanks a lot. And then just one on shifting gears to the potential sale of Fidelity, I know you don’t want to show your hand too much but is there any more color you can give us in terms of what you are looking for in order to start marketing that, have you had any conversations, any sense you could give us for potential timing or what you are looking for from oil prices before you begin that process?

Yeah, Matt I will take that one. You know we're going to certainly pursue the marketing and sale of our E&P to maximize shareholder value as you might expect. I noted in my comments we are encouraged by the stabilized oil pricing environment that we're seeing and we look at other various factors, rig count, supply demand, what's happening internationally, how much M&A activity is there, what's happening on what might be some acquires balance sheet so far as debt and equity. So we kind of roll that all in and we will make the decision at the appropriate time. I think you answered during question, at the onset of your question, we won't play a lot of cards here but we are encouraged I will say by some local indicators, more recent indicators I will say. Okay, thank you Matt.

Your next question comes from the line of Brent Thielman with DA Davidson.

One more on the refinery. Is the guidance embedding a similar level of startup cost into Q2 or is that mostly behind at this stage?

Yes, Brent as you think about the start-up cost, those are some I'll say typical expenses that we've got at the refinery, we've got north of 70 employees out there and while some of those costs we're able to capitalize, many of those costs we got expensed. So we've got leases for railway and different things. So those are more typical expenses if you will. And as you think about going forward, in the first quarter we didn’t have revenues to really offset those, so as we go forward you're going to see revenues coming in and some of the costs certainly that were capitalizing will move over to the O&M side.

Got it. And then Dave, we're starting to see some other construction material suppliers out there showing some really solid pricing momentum and I know you don’t break it out and your geographic footprint is a little different from others, but can you talk through your expectations and initiatives for materials pricing for Knife River?

Yes, Brent to get margin improvements on materials and our construction backlog and as we continue to see [there is also] recover we expect that trend to continue in the near future. So it's definite positive and our volumes continue to grow, as our volumes continue to grow we expect margins continue to follow that trend.

Your next question comes from Paul Patterson with Glenrock Associates.

Just on the construction business, favorable weather. Does that take, does that impact your earnings in the other quarters, does it take any business from other quarters or it's just additive?

Paul as your question more of a, did we work ahead some work as opposed to a wet spring or how does it impact the backlog, is that more of a way you're looking at?

Yes, yes you got it, does it pull any work from future periods?

Paul this is Dave Barney, yes, that definitely is going to pull a little of work from probably April we might see a little low but we have a good backlog, we've picked up quite a bit of work in April and we expect the volumes to continue to increase and like I said margins continue to increase, we don’t see a big drop off for the rest of the year.

Okay, great. And then on the pension expense, I think you guys had this last quarter and is it just sort of a catch up or sort of fine tuning it or is there something else going on?

Hi Paul, this is Doran. I think you characterized it the right way, we made an estimate at the end of the year, we had some new information that allowed us to true-up that estimate here in the first quarter. So that's essentially what's you are seeing.

Your next question comes from the line of Matt Tucker with KeyBanc Capital.

Hi, got a couple of follows ups. I noticed you saw pretty nice customer growth on a year-on-year basis in the Bakken region, can you comment on kind of more recent trends, are you continuing to see growth on may be a quarter-to-quarter month-over-month basis, so if you can just provide kind of an update on how you view the economy in that region?

Certainly Matt, this is Nicole, I will answer your question. As Dave alluded to in his remarks, we did see electric customer growth in the Bakken at 4.4% quarter-over-quarter, on the gas side we saw 3%, 3.6% growth rate. Really when you look at year-on-year, we added around 20,000 customers and about 3,400 of those came from the Bakken. So you can see that although the Bakken activity is clearly exceeding national averages in terms of growth rates, we're seeing growth across really our entire system. On an overall basis we had customer growth around 2%. And then if you are getting to the question on what's the run rate going forward, that's really hard to predict, it has come up a little bit from the historic levels but we still anticipate strong growth out there in the Bakken and quite frankly across our entire territory.

Okay, great. And I just wanted to ask on the construction services side, could you provide a little more color on the non-strategic [indiscernible] assets that you sold and do you expect to continue with that type of activity this year?

Matt thanks for the question, this is Jeff. We sold our electrical supply and distribution business which was based in Las Vegas, head office is in New Mexico, Texas and North Dakota, this was not a strategic part of our business and we do not anticipate any other moves like that, that we're looking, we're actively looking at strategic acquisitions across the country.

[Operator Instructions]. This marks the last call for questions. [Operator Instructions]. This call will be available for replay, beginning at 1:00 PM Eastern today through 11:59 PM Eastern on May 19th. The conference ID number for the replay is 12424597. Again, the conference ID number for the replay is 12424597. At this time there are no further questions. I would now like to turn the conference back over to management for closing remarks.

Thank you operator. In closing I would like to make sure everyone understands it. We believe our utility pipeline and construction businesses are really very well positioned for growth and we intend to continue develop them to maximize shareholder value. We expect to create greater long-term value for MDU Resource shareholders by focusing on the successful growth businesses. And when I think about our Utility Group, the 1.8 billion of investment over the next five years, Nicole noted the higher than national average growth in customer. When I think of our Pipeline and the Refining Group now, we call it a Refining Group now that we have a refinery online, the first one in America in almost 40 years and you heard between our construction businesses having about 1 billion in backlog between materials and services, I think we're well positioned as we think about this year and beyond. And as noted earlier we will pursue the marketing and sale of the Fidelity when we believe the time is appropriate. We appreciate your participation on our call today and again, thank you for your interest in MDU resources. Operator?

This concludes today's MDU Resources Group conference call. Thank you for your participation. You may now disconnect.