It was has been over six months since I originally wrote about MDU Resources (MDU). As I pointed out at that time, this is not just a gas and electric utility. In addition to its utility services, MDU has operations in construction materials, heavy construction, construction services, regulated and non-regulated natural gas pipelines, natural gas storage and oil and gas exploration and production. Since the time of my original article, the share price is up over 17%. While this is impressive when compared to many other utilities, it has underperformed several peers in both the construction materials and contracting businesses as well as the oil and gas industry. Considering this underperformance, I think it would be wise for management to, at the very least, consider the prospect of a spin-off.
Over the last year we have seen other situations in the utility and oil and gas industries where management has decided to split off the exploration and production operations. Questar Corporation (STR), a natural gas distribution, transportation and storage company, spun off its exploration and production unit QEP Resources, Inc. (QEP) on July 1, 2010. Since that time QEP shares are up over 40%. The performance of the utility business is not as impressive, but it is still up 15% since the split. In January of this year, Marathon Oil Corporation (MRO) announced its plans to split into two operating entities. The split would create a publicly-traded refinery operation and a publicly-traded exploration and production company. Since MRO announced its plans, shares are up 32%.
To help you better understand MDU and how a break up might be structured by the company, I have highlighted the major operations and touched on some of the company's 2010 results below.
Electric & Natural Gas Utilities
This segment provides electric and natural gas services to customers in eight northwestern states in the U.S. including Idaho, Washington, N. Dakota, Montana, Oregon, S. Dakota, Minnesota and Wyoming.
The utility segment of MDU had a successful year generating over $1.1 billion in revenue and saw earnings increase 20% compared to 2009, a result of higher electric rates, increased demand and an income tax benefit in the natural gas distribution unit. The company saw its electric customer base grow by 1.8% and its natural gas customer base grow by 1.3%. The company added 55 megawatts of additional generation which included 30 megawatts of renewable wind energy. The company sees additional growth in areas such as agriculture, increased industrial use of natural gas, the elevated oil drilling activity in western North Dakota and possible acquisitions.
Pipeline & Energy Services
This segment includes over 3,700 miles of regulated pipeline with a 750MMcf/d capacity as well as over 1,900 miles of non-regulated pipeline. In addition, the regulated pipeline has 11 interconnecting points and includes three storage fields with a capacity of 193 Bcf.
This segment generated nearly $330 million in revenue and earnings of $23.2 million. Earnings decreased 39% compared to 2009, primarily due to an arbitration settlement of $16.5 million, lower transportation and gathering volumes as well as higher operating and maintenance costs . These negatives were partially offset by record natural gas storage volumes in 2010. MDU is well positioned to take advantage of increased activity in the Bakken with its current natural gas pipeline. The company intends to expand its pipeline operation during 2011, further targeting opportunities in the Bakken. The company has also entered into an agreement to expand its Baker storage field deliverability. The expansion will add 125 MMcf/d firm deliverability and is expected to be in service by November 2011.
Oil & Gas Exploration & Production
The company's oil and gas properties are primarily located in the Rocky Mountain, Mid-Continent, and Gulf States region of the United States, with the Rocky Mountain region accounting for 74% of reserves. As with many exploration companies, MDU has been focusing its resources toward more oil and liquids-rich plays. At the end of 2010 the company's reserves were still mostly natural gas, which represented 69% of reserves. However, much of the 2010 budget will be directed towards oil and liquids plays in the Bakken of North Dakota, the Niobrara of Wyoming and to a lesser extent, the Heath Shale play in Montana. The company is also directing significant capital expenditures to its Texas properties, with a focus on areas showing a higher liquids potential. In October 2010, MDU announced that it had sold a 25% working interest in its Niobrara Shale play in Wyoming to a subsidiary of ITOCHU Corporation in an effort to manage risk.
This segment generated $85.6 million in earnings on revenues of $434.4 million. Revenues were down slightly compared to 2009, but earnings turned around a loss of $296.7 million in 2009. The loss in 2009 was primarily the result of a $384.4 million non-cash charge due to lower natural gas and oil prices. MDU expects to increase oil production by 5% to 10% in 2011 while natural gas production is expected to decline by 4% to 8%. This follows a 5% increase in oil production in 2010. The company is actively pursuing additional exploration and reserve acquisitions and has allocated $50 million of the 2011 capital expenditures to acquisitions.
Construction Materials and Contracting
This segment has most of its operations west of the Mississippi River and includes Alaska and Hawaii. These operations include aggregates, cement sales, ready-mix concrete, asphalt oil, asphalt production, building materials and contracting.
This segment produced $1.45 billion in revenue, but only $29.61 million in earnings which was down over 37%. Both revenue and earnings trailed 2009 numbers due to a slow economic recovery. The backlog was approximately $420 million at the end of 2010 compared to $459 million at the end of 2009 of which 94% was for public projects. The company estimates aggregate reserves to be slightly in excess of 1.1 billion tons. The company has continued to pare SG&A expenses, so any uptick in orders should provide for very good upside in earnings. The existing stimulus bill as well as any additional government spending on transportation infrastructure should benefit the materials industry as a whole.
This segment is currently focused on expanding its presence in high-voltage transmission and substation construction, renewable resource projects, government contracts, refinery projects, healthcare and utility service work. In addition, this segment provides inside contracting such as electrical and plumbing, outside contracting services such as excavation, industrial contracting such as wastewater treatment facilities as well as equipment rental and sales. The company has offices in several Western and Midwest U.S. states and is authorized to conduct its business in nearly every state, barring a few states in the Northeast.
This segment has seen revenue and earnings decline sharply over the last three years. In 2010, revenues fell to $789 million from $819 million in 2009 and earnings dropped nearly 30% to just under $18 million.
The weak economy continued to take its toll on this segment. However, there are signs that the markets for its services are beginning to stabilize. Backlog at the end of 2010 was $373 million, which is in line with the backlog at the end of 2009. As with the materials segment, the company has been managing its SG&A expenses closely, so the upside could be big when the projects start flowing at higher rates. MDU should also benefit from government spending as a result of a comprehensive energy plan. Any plan will most likely require major upgrades to the transmission and distribution infrastructure.
I am not aware of any plans by management to break up the company in any way and I personally like the assets MDU has assembled. However, this is a shareholder-friendly consideration that management should routinely analyze.
Currently, the utility and energy segments are performing well and the energy segment should really drive earnings as they execute on their exploration plan to produce more oil and liquids. It is obvious the materials and contracting segments are holding this stock back. However, even with the positive performance of the utility and energy segments, the stock has still underperformed many of its peers in both the materials and construction industries. This, along with the stock's overall underperformance of its peer group and recent underperformance to the S&P 500 Index, should make shareholders and management at least ask the question if these segments would provide better investment returns as independent companies.
The management of MDU refers to the company having three primary businesses:
Utility Services/Regulated - This includes the electric and natural gas utilities and the pipeline and energy services business.
Energy/E&P - This includes all of the company's natural gas and oil acquisition, exploration, development and production activities.
Construction - This includes the construction materials and contracting activities as well as the construction services business.
It would seem that this break down might lend itself to how the company might break up. It would give investors a regulated utility with nearly $1.5 billion in revenue, a full service construction and materials company pushing $1.5 billion in revenue and a pure play oil and natural gas exploration and production company. It is also a company with 646 Bcfe of proven natural gas and oil reserves, with attractive exploration properties. While the above structure seems to be how the management is grouping the operations for reporting, it is important to note that the energy business and the pipeline business currently make up WBI Holdings, Inc. which is a wholly owned subsidiary of MDU.
There are certainly no guarantees that a break up would result in the performance seen by QEP or MRO, but it should be a consideration that management puts on the table for analysis. Even without a split, I believe MDU has many positive factors in its favor. The recovery, albeit slow, should start to benefit the construction business. In addition, the U.S. will need to spend money on its energy and transportation infrastructure to support new and existing energy programs which will come with or without an improving economy. However, some of this could be delayed due to budgetary constraints being proposed by Congress. The utility and pipelines should also see increased demand with an improving economy. Lastly, strong oil prices and additional demand for natural gas should give the energy segment plenty of fuel to drive strong earnings.
Disclosure: I am long MDU.