MDU Resources Group's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: MDU Resources (MDU)

MDU Resources Group, Inc. (NYSE:MDU)

Q3 2011 Earnings Call

November 1, 2011 11:00 AM ET

Executives

Doran Schwartz – VP and CFO

Terry Hildestad – President and CEO

Bill Schneider – Co-Founder, Schneider & Schneider Mechanical, Inc.

Kent Wells – SVP, BP Plc

Analysts

Timm Schneider – Citigroup

Paul Ridzon – KeyBanc

Stephen Maresca – Morgan Stanley

Monroe Helm – Barrow

Operator

Good morning. My name is Kristin and I will be your conference facilitator. At this time, I would like to welcome everyone to the MDU Resources Group Third Quarter 2011 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator Instructions)

This call will be available for replay beginning at 2:00 PM Eastern Time today through 11:59 PM Eastern Time on November 15. The conference ID number for the replay is 12946239. Again, the conference ID number for the replay is 12946239. The number to dial for the replay is 1-800-642-1687 or 706-645-9291.

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.

Doran Schwartz

Good morning and welcome to the earnings release conference call. Before I turn the presentation over to Terry Hildestad, our President and Chief Executive Officer, I would like to mention that this conference call is being broadcast live to the public over the Internet and slides will accompany our remarks.

If you’d 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, as well as our Form 10-Q and the Risk Factor section of our most recent Form 8-K.

Our format today will include formal remarks by Terry 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 Steve Bietz, President and CEO of WBI Holdings; Dave Goodin, President and CEO of Montana-Dakota, Great Plains Natural Gas, Cascade Natural Gas and Intermountain Gas; John Harp, President and CEO of MDU Construction Services Group; Bill Schneider, President and CEO of Knife River Corporation; Kent Wells, President and CEO of Fidelity Exploration and Production; and Nicole Kivisto, Vice President, Controller and Chief Accounting Officer of MDU Resources Group.

And with that, I’ll turn the presentation over to Terry for his formal remarks. Terry?

Terry Hildestad

Thank you, Doran, and good morning. Thank you for joining us today to discuss third quarter results.

MDU Resources performed well this quarter demonstrating the value of our diversified business strategy. Business as continued to focus on operating economically and efficiently to offset the effects of the challenging economy. Our company has focused on growth. We’ve identified a number of projects we believe will generate earnings cash flow and additional value for our shareholders. We’re increasing liquids as a percentage of overall production at our natural gas and oil production business.

Our utility has several investment opportunities in natural gas distribution as well as electric generation and transmission that will lead to rate based growth. Pipeline is working on a number of capacity expansion projects centered on rising levels of associated natural gas produced by development and exploration activity in the Bakken area and our construction companies are green fielding operations in areas where growth and demand exist as well as adapting their skills to the needs of the market.

Over the next five years, we plan to invest approximately $3.5 billion into our company; this reflects a 27% increase over the five years prior. At MDU Resources, we are positioned to grow now and expect to be in a very competitive position as this economy strengthens.

Now I’ll move on to our operating companies and their results. We’re pleased to report that our E&P group showed a nice earnings improvement this quarter. Earnings improved 20% with oil production up 13% that was driven by our South Texas and Bakken areas. Our South Texas liquids production more than doubled from a year ago and we saw a 15% increase in our Bakken liquids production.

These improved results caused us to raise our forecasted liquids production increase to a range of 4% to 7% this year. On our Mountrail County acreage, record gross production of approximately 7,700 barrels of oil per day was achieved in August. During October, we spud a well in our Stark County acreage to test the eastern most block of our acreage. Additionally, we spud our first appraisal well on our Niobrara acreage. Location work is underway in the Paradox Basin, we anticipate spudding a well by yearend there.

In South Texas, new wells targeting liquids on our operated properties have met or exceeded our expectation. We are up to five rigs across our properties currently. We expect to be at six rigs by yearend and plan to have 10 rigs deployed by yearend 2012. All rigs are focused on oil or liquid rich plays. Our E&P business has a well defined strategy for long term growth. Our current strategic growth projects include an approximate 400,000 net acres of leaseholds with an estimated potential of up to 900 net well locations. We expect to continue to accelerate oil exploration activities to produce a more balanced portfolio while maximizing cash flow from existing properties. We are also focused on pursuing additional leaseholds. We intend to invest over $2 billion for exploration and development in the next five years, acquisition of producing properties would be incremental to this amount.

Next, our pipeline of storage group, earnings continued to be effected by narrow seasonal natural gas basis differentials that resulted in lower transportation and storage related activity, this follows two consecutive years of record storage volumes. This group is focused on several expansion projects that are in the works in the heart of our pipeline system. Over 2,000 horsepower of compression was added at our Charbonneau station in northwestern North Dakota that can increase capacity of our existing natural gas pipeline by a total of about 27 million cubic feet a day. That’s a 30% increase in capacity. This pipeline is now capable of transporting approximately a 120 million to 130 million cubic feet a day.

Construction has begun on approximately 12 miles of pipeline providing takeaway capacity from our Garden Creek processing facility in northwestern North Dakota. Preparations are also underway for a 13 mile pipeline to provide takeaway capacity from the Stateline I and II processing facilities in the same area. These projects will more than triple our takeaway capacity for Bakken gas.

With the surging Bakken activity associated natural gas production reached another all time high in August. We are in a good position to continue to take advantage of energy development related pipeline expansion opportunities in the Rocky Mountain region.

Our utility continues to perform well. It reported a nominal natural gas operating loss in the third quarter, that’s a seasonal loss. On the electric side, we’re seeing robust growth in western North Dakota, it resulted in a 4% customer growth for that region compared to the year ago. On a year to date basis earnings for this group were 12% higher than the comparable period a year ago. With respect to the Montana electric case we filed last August, the Commission recently approved final rates at the interim rate increase level of $2.6 million annually or 6.3% for service rendered effective September 1st. You’ll recall, interim rates went into effect February 14 of last year.

We expect an order in the first quarter of 2012 on our advance determination of prudence filling in North Dakota related to the construction of an 88-megawatt natural gas turbine. This project is expected to be in service in 2015 with a projected cost of approximately $85 million. We have a contract to develop a $20 million power line to move wind power out of southeastern North Dakota to the grid. This project is expected to be complete in mid 2012. This business continues to focus on opportunities for rate based growth.

Now moving on to our construction materials business earnings were affected this quarter by the Minnesota state government shutdown in July as well as weather related delays early in the quarter. Lower margins including lower asphalt margins also impacted the earnings for the quarter. The good news is we are back to work in Minnesota as the projects were only temporarily delayed.

And in general, the weather has been cooperating in October. Our new Western Dakota, North Dakota operation is very busy. North Dakota now represents about 18% of our backlog, if you compare that to a year ago it was at 2%. Employees and equipment are being transferred to new locations from other areas of operations as the work demand continues to grow. Jobs in Western North Dakota includes subdivision site work, utility work, a new transload rail facility for crude oil, gas plant expansion projects and a $33 million highway project.

Another strong area for us is the Pacific region; work on the ports of Long Beach and L.A. is underway, utilizing rock from the quarry on Catalina Island. We anticipate a total of approximately 1.1 million tons of rock will be used for these harbor projects this year. Our new Cheyenne, Wyoming asphalt terminal is receiving oil, it’s expected to be fully operational by spring.

With this addition, our asphalt oil storage capacity has doubled since we entered this business in 2005. September 16th, the President signed an extension for the aviation highway and transit programs at the current funding level through March. We’re hopeful that a long-term federal highway bill will be passed prior to March expiration that includes at least level funding expenses. Our construction material businesses strong ability to adapt to market conditions has allowed us to remain profitable during this challenging economic cycle.

Next our Construction Service Group reported earnings of $5.1 million. This group is performing quite well this year with earnings up nearly $7 million on a year-to-date basis. Work backlog has been holding relatively steady over the past year with September 30 backlog numbers at $331 million.

Our Specialty Equipment division continues to excel and is on pace to have its strongest year ever. Considering that demand for our products, we are expanding these operations to another strategic location that should fully be operational by year end. In addition, we are opening an electrical supply distribution office in the booming northwestern North Dakota related to the Bakken fields. This group is working hard to find the right opportunities. It’s our practice to establish good relationships and to focus on maintaining long-term customers and by doing quality work and completing projects on time.

We recently committed more, completed more than $30 million of electrical work on a manufacturing facility in the West. Because of our team’s level of expertise and commitment to the project the general contractor recently awarded us two additional jobs. We’re optimistic as we look ahead many utilities are looking for increased transmission work, persistent reliability and to transport wind generation. In addition, we’re seeing some market improvement including the Cleveland and Las Vegas markets.

MDU Resources is positioned for growth, our businesses are operating well and more importantly they are keeping us financially strong. We have the balance sheet to support growth 66% total equity. We have $622 million and available credit and cash flows are healthy up 11% year-to-date. We have continued to provide shareholders a competitive dividend and a solid long-term return.

Our total shareholder return on a ten year basis was 9% exceeding the performance of the S&P 500 and the S&P 400 indices. MDU Resources has a long history of operational strength. We have solid expertise in our business lines, our financial discipline is second to none, it has is very well positioned, we remain committed to operating with integrity and creating shareholder value. For all these reasons, we’re excited about our future as we look at the abundant growth possibilities within reach for MDU Resources.

And with that, we’ll open the lines up for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Timm Schneider with Citigroup.

Timm Schneider – Citigroup

Hey guys, how is it going?

Doran Schwartz

Good. Good morning, Timm.

Timm Schneider – Citigroup

Hey, on the construction material side, I see overall volumes are up kind of 5% year-over-year but operating income is down 16%, so it seems like there was a slight uptick in relative O&M expense but is it fair to assume that pricing maybe wasn’t as robust as it had been before?

Bill Schneider

Timm, good morning, Bill Schneider here, Timm that’s of a part of the story but the other two big issues really were the winter fuel cost for asphalt oil in the Midwest area was higher than we’ve seen in the past, that had a big impact. And then the other thing is Timm as our diesel costs are up about $13 million year-over-year so those two really were the major factors.

Timm Schneider – Citigroup

Got it. And then how much of your backlog right now is tied to kind of the Bakken buildup?

Bill Schneider

Right now is that I can’t give you the specific percentage, Terry mentioned to you is that we have 18% of the total backlog right now but I will tell you this Timm is we are lining up our work for next few year that number will continue to rise what has happened Timm is besides our traditional materials and constructions for the public arena we are doing more and more work for the oil patch and that’s of course at much greater margin so next year and the years after that really look good for us.

Timm Schneider – Citigroup

All right thanks and then just switching to the E&P side real quick. With respect to Niobrara the four exploration wells are you expecting to get any of those started before Q4 here or before the end of the year I should say?

Kent Wells

Actually Timm, it’s Kent. We’ve already spudded our first well. We’re actually setting casing getting ready to drill the horizontal lateral so we’ll have finished that well and started the second maybe even the third before the end of the year.

Timm Schneider – Citigroup

Got it, so we should have results by Q4 or in the Q4 call I should say?

Kent Wells

We’ll certainly share the results with you as soon as we have them.

Timm Schneider – Citigroup

All right thank you. And then just can you remind me what your average working interest is in Stark County?

Kent Wells

In Stark County it varies we have everything from 100% working interest down to gee, I don’t know what it is on the bottom end may be 25%.

Timm Schneider – Citigroup

Okay got it then just real quick on the cost side. I saw D&A ticked up sequentially is that kind of a good run rate assumption given the shift towards more oil directed drilling?

Kent Wells

Well that’s clearly what we are seeing today of course as it changes going forward it’s all that what rate are we adding reserves at what cost and we’re very focused on what I call our finding & development cost driving that down as we ramp up our activities.

Timm Schneider – Citigroup

Okay and then the sequential decline in LOE costs anything that was driving that.

Kent Wells

No I think there is clearly pressure in the system on cost but I think we’re doing a good job of controlling that and we’ll see that bounce around a little bit but I think the team does an exceptionally good job of managing our cost.

Timm Schneider – Citigroup

All right thanks guys.

Bill Schneider

Thank you Timm.

Operator

(Operator Instructions) Your next question is from the line of Paul Ridzon with KeyBanc.

Paul Ridzon – KeyBanc

Good morning.

Bill Schneider

Good morning Paul.

Paul Ridzon – KeyBanc

The number of wells, potential wells in the Niobrara and Bakken went up pretty sharply, what drives that.

Kent Wells

Paul this is Kent. It depends whether you’re talking about end of year or total potential where is your question?

Paul Ridzon – KeyBanc

Just comparing this release to the second quarter release for instance Niobrara, I’ve said in the second quarter 100 potential future gross wells and now that’s switched to 200.

Kent Wells

Yeah I think just as we’ve continued to work on the play and as we’ve got seismic results and seeing what other operators have done, we’ve just updated our estimate on what we see there. I think as you’re well aware we’ve got about 65,000 acres there in three different blocks. We’ve just started drilling and we’ll know more over the next six months as we appraise that acreage.

Paul Ridzon – KeyBanc

Okay thank you very much.

Bill Schneider

Thanks Paul.

Operator

Next question comes from the line of James Bellessa with DA Davidson.

Bill Schneider

Good morning, Jim.

Operator

Hello James, your line is open. And I believe that question has been withdrawn. Your next question is from the line of Stephen Maresca with Morgan Stanley.

Stephen Maresca – Morgan Stanley

Hello. Yeah, good morning guys, how are you?

Bill Schneider

Good Stephen, good morning.

Stephen Maresca – Morgan Stanley

I just have a question, and you talked a little bit about acquisition opportunities and I would just ask where geography wise do you think you would be focused, what size you feel comfortable with and then and sort of what line of business do you think this would be in more? Is it more on the E&P side than some others?

Bill Schneider

Stephen, I will take a shot at that. We have business development teams at all of our business units exploring opportunities to grow their business. Certainly the oil and gas team is looking for new leaseholds and producing properties that we’ve evaluated a number and we continue to do that.

Our construction materials company and our Construction Service Group, as I had noted in our transcript formal remarks there, they are green fielding new operations. We’ve got our asphalt terminal up running now in Wyoming and we have our expansion into North Dakota at the construction materials and at the construction services expanding into North Dakota as well and expanding our manufacturing group because that’s been so. But they continue to look at opportunities as well. They all have their own cost to capital and they are looking at growth opportunities as far as acquisitions.

The utilities, got a team working and although right now primarily we are looking at organic growth with expansion of our gas plant and our environmental upgrades and some piping improvements. We continue to look for acquisition opportunities there as well. As we are in the pipeline, now on the pipeline, we have three projects going now, they are looking for acquisition opportunities as well. So opportunistic, I think the thing to remember there is we will be very financially disciplined as we go forward with all these business lines.

Stephen Maresca – Morgan Stanley

Okay. Thank you very much.

Bill Schneider

Thank you.

Operator

This marks the last call for questions. (Operator Instructions) This call will be available for replay beginning at 2:00 PM Eastern Time today through 11:59 PM Eastern Time on November 15th. The conference ID number for the replay is 12946239. Again, the conference ID number for the replay is 12946239. Your next question is from the line of Monroe Helm with Barrow, Hanley.

Monroe Helm – Barrow

Thanks. Sort of jumping here at the end of the call. I was wondering if you could give us any color on – your thoughts on CapEx for 2012 relative to 2011 in particular in the E&P space, and in that particular subsector, how they are kept spending amount related to their cash flow?

Bill Schneider

Yeah. We can do that Monroe, do you want to cover it Kent or?

Kent Wells

Yeah. I think Monroe as we shared at the Investor Day in August, we’re continuing ahead with that plan as we’ve laid out. We’re ramping upper activity. We expect to be at six rigs by the end of the year, and then continuously adding throughout 2012. If you remember the appraisal programs that we set out for all our major assets depending on how those go we expect to see significant liquids growth going forward and we’ll be cheering that 2012 guidance I think in February.

Monroe Helm – Barrow

Okay, so at that point, tell me you’ll talk about your production goals for 2012 or related to the 2011?

Kent Wells

Yes.

Monroe Helm – Barrow

Okay, great.

Kent Wells

Great.

Doran Schwartz

Monroe, Monroe excuse this is Doran. Just to provide a little bit more color commentary again on the capital, again overall I think as you’ve heard, Kent’s business is really in growth mode and that’s requiring some capital and as far as your question on cash flows at that particular business we’re probably going to spend more in capital than what we generate in cash flows in the early years as we look forward here.

But I think that’s one of the benefits of being a part of a diversified group of companies where cash flows that are, are kicked off from all of our business units come together to make up that difference essentially. And as we communicated in the past, our current version of our forecast about $3.5 billion we’re not forecasting to having to issue any equity as it relates to that, we’ll again update that here at the yearend call.

But it’s great to be in a position I think where you’ve got growth opportunities you’ve got a strong balance sheet, you’ve got a great credit rating, you’ve got cash on the balance sheet and you’ve got excellent liquidity off your lines of credit. So we feel like we’re really in a great position from an investment perspective.

Monroe Helm – Barrow

Okay, well congratulations on making good progress and look forward to better results down the road.

Bill Schneider

Thank you Monroe.

Operator

At this time there are no further questions. I would now like to turn the conference back over to management for closing remarks.

Bill Schneider

Okay, well we appreciate all of your participation on the call today and we look forward to seeing you soon. Again, we will be at the EI next week, hopefully we’ll see some of you there. And as mentioned just a minute ago, our plans for providing guidance for 2012 we’ll do that with our yearend earnings report in early February. So thank you again 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.

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