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Executives

Terry D. Hildestad – President and Chief Executive Officer

Doran N. Schwartz – Chief Financial Officer and Vice President

MDU Resources Group, Inc. (MDU) Edison Electric Institute Financial Conference Call November 8, 2011 11:15 AM ET

Terry D. Hildestad

Good morning and thank you for coming to our presentation and hearing the MDU Resources story. I’m Terry Hildestad, I'm the President, Chief Executive Officer of MDU Resources and with me at the podium are Phyllis Rittenbach, our Director of Investor Relations and Doran Schwartz, our Vice President and Chief Financial Officer. Doran will join me at the podium in a little bit and cover the financials.

First of all, I would like to draw your attention to the forward-looking statements in your books and on the screen.

MDU Resources legacy dates back to 1924. We are a natural resource based company. We provide products and services that are essential to the infrastructure and energy sectors of America. Our company is asset based, and we focus on providing long-term value. When you take a look at our business mix, we have a foundation of regulated businesses that provide a predictable earnings and cash flow stream, and we combine that with our non-regulated businesses that provide for a more upside potential. On the slide you can see the breakout of earnings last year regulated 44%, E&P 36%, and our construction 20% of the earnings contribution.

Our strategy through the years has been very effective. We apply our expertise to grow our market share profitability and build shareholder value. We’re very opportunistic on growth. We grow both organically and through acquisitions. We expand in businesses where we have operating expertise; you won’t find us in a business line that we don’t have the operating expertise.

We’ve been very disciplined through the years. We have low access to capital and low cost capital, I should say, and we have the financing flexibility to take advantage of growth opportunities. Through the long-term, we provided our shareholders a very competitive dividend and good returns although, the one year returns have been impacted by the volatility in the market when you look over the 10-year period, our shareholder compounded annual return was 9%. That exceeded the performance of both the S&P 500 and the S&P 400.

Now I’ll move through a discussion on each of our business units and I’ll start with our regulated businesses. First segments here we have a regulated natural gas and electric utility and we have a FERC regulated pipeline and Energy Service Group.

And I’ll start off with electric and natural gas utility group. This is a strong foundation of earnings and cash flow for the corporation. It’s performing very well. Year-to-date our earnings are up 12% trailing 12 months earnings are running at $70 million; this has been a consistent growth engine for the corporation. We serve approximately 965,000 natural gas and liquid customers. We’re seeing growth in both electric and natural gas customer base. Of course electric customer base growth is related to the Bakken development in Western North Dakota, which is part of our service territory we own 564 megawatts of rate base generation it’s coal, gas, fired and renewable power. Our renewable is wind and also we have some lengthy generation.

So good base of regulated assets, we’re optimistic about the future of this business, it’s grown substantially over the last two years, we’re excited about the opportunities to grow our rate base going forward.

We expect an order in the first quarter of 2012 on our advanced determination of prudence filing in North Dakota that’s for an 88 megawatt gas fired generating station that will replace purchase power with own generation.

We’re also in the process of building a $20 million power line to move wind power out of South Eastern North Dakota that will be a FERC based return. In fact if you take a look at our capital investments in this business unit over the next five years we’re averaging $150 million a year, we have a depreciation rate of about 80. So we will continue to add to our rate based earnings, if you take look at our rate base historically since 2006 we have tripled our rate base.

Now that was driven in a number of areas but two significant areas is a natural gas, Cascade Natural Gas was purchased in 2007, in 2008 we purchased Intermountain Gas we’ve expanded our customer base with both of those purchases.

We continue to expect rate based growth going forward. The integration of those businesses has gone very well. So when you take a look at the outlook regulator electric and natural gas utility we’re excited about the future, I had mentioned power plant 88 megawatt power plant that’s about $85 million investment, we are seeing higher demand for natural gas certainly in agricultural side of the business, we’re adding industrial customers. We are looking forward to pursuing additional growth opportunities in this business line.

I will move on to the pipeline and energy service group, our FERC regulated pipeline consist of 3700 miles of pipeline capable of moving 750 million cubic feet a day. We offer our customers access to three natural gas storage fields actually one of them is the largest natural gas storage field in North America. In total we have a 193 building cubic feet in natural gas storage capacity.

Our non-regulated pipeline includes over 1900 miles of field gathering lines. We’re seeing growth in this pipeline business because we are located in the heart of the energy production associated with the Bakken field.

And as the chart on in your slides indicate with the surging activity oil related activity in the Bakken associated natural gas production continues to reach record highs August was another record high for natural gas production. This means opportunities, as we’re located in this area.

In fact if you take a look at the growth projects that we have underway now, we’ve added 2000 horse power of compression on one of our lines servicing that area that it’s a 30% increase at line now is capable of moving 120 to 130 million cubic feet a day.

We are in the construction phase of a 12 mile, 12 inch pipeline at takeaway capacity from the Garden Creek natural gas processing plant and we’re in the planning and early stages of construction of a 13 mile pipeline to take gas capacity away from the state line one and two natural gas processing plants, so good growth opportunities in this business line. We are evaluating other areas in the Rocky Mountain region, where we can add these types of services.

Now I'll move on to our E&P segment and talk about our approach to our oil and natural gas business. We take a very returns driven approach, production business is engaged in production, development, exploration and acquisition activities. We’re located in two primary regions as noted on the map, we’re in the Rocky Mountain region, we’re in the Mid-Continent/Gulf States region.

We have both operated and non-operated properties. We own 646 Bcf of proven reserves. It's our intent to grow this business significantly. We’re accelerating our drilling. We’re moving more towards a balance of oil and natural gas. Historically, we have been heavy on the natural gas side and lighter on the oil side, in fact, not too many years back, we were at 90% gas and 10% oil. At the end of last quarter, we were 33% oil; we’re moving more to a balanced natural gas and oil portfolio.

Our focus of course is in the Rocky's, Texas and Mid-Continent regions. As far as growth projects are concerned, we have a number of oil rich and liquid rich properties in fact we have a total of over 400,000 net acres in these type of plays combined. They have an estimated potential drilling locations about 900. So we certainly have a number of good opportunities to pursue in heavy liquids and oil. And of course that will require us ramping up our drilling program or deploying more drilling rigs as you can see on the chart.

This is ramping up quickly by year-end, we’ll have six rigs, by the end of 2012, we’re targeting 10 operated drilling rigs. Now I'll move through these by field and I'll start with our Bakken Holdings, as you can see on the slide, we have 90,000 net acres supports our strategy of increasing oil as a percent of our overall production.

We saw 15% increase quarter-over-quarter in oil production in the Bakken area. Really Bakken has broken down into three counties, we have about 16,000 acres in Montreal County that's certainly a development play.

We have about 50,000 acres in Stark County and another 20,000 acres in Montana and Richland County and I'll go through those. But this has been a great area for our company in fact, we have both operated and non-operated interests that we have netted out over three million barrels of oil in the last four years.

So you can see it's a great cash flow contributor to the corporation. This chart really talks about how the production rates in this area has increased for us and actually other operators in the region overtime. If we’ve increased the number of fracs, we’re up to most of our wells now are 30 stage fracs. As you can see the average 30-day rates and we think that that’s more of an accurate indication of the type of well you have is the 30-day rate that’s more than doubled since 2008.

So as many shale plays develop, as people continue to work in those areas the technology gets better, they understand the place better and certainly associated production increases with that.

Our Bakken Montreal County area with – we have 41 operated wells in that area and we hit a record last month in production 7,700 barrels oil out of our operated wells. Currently, we have one rig drilling there; we have five wells that are completed. Three of those are scheduled to be fraced this month. Certainly there is a demand for completion and fracing activities in that area. We have identified over 30 future drilling locations in this Montreal County, Middle Bakken and Three Forks area.

Now moving on to Stark County. Stark County is targeting the Three Forks formation. We have three wells completed in that area, we just moved our drilling rig down this month and we are testing the eastern most block of our Stark County acreage. It’s early in the valuation of this acreage position, but we’re very optimistic on this property as well.

And then more recently we leased up 20,000 acres in Richland County in Montana this is Bakken acreage as well. Adding to our existing base our property is located directly south of the Elm Coulee property that has been producing oil for many, many years. We’ve identified approximately 100 locations for drilling in this particular area. Our first praiser well will put in 2012.

Move on to the Niobrara oil play, we are very excited about the opportunities we see in the Niobrara. There has been a significant amount of oil activity through the years in the Niobrara area we hope 65,000 net acres total of four wells are planned during the next several months in this area.

If this play is successful, as we hope it is then we’ll go into an activity drilling program in the Niobrara.

Paradox Basin another oil area for our company 75,000 net acres in the Cane Creek Federal Unit in Utah. We’ve located our next well locations we’ll spot our next well in this area by year end. We also believe good potential exist in this Paradox Basin.

We also have approximately 80,000 acres in the Heath Shale play, and this again as the shale play its down drift from the Bakken its located in Central Montana we’ll drill two appraisal wells over the next six months. Our working interest in this area are very high.

And then our South Texas acres we’re targeting areas that have the potential for higher liquids. We’ve had great results in this area; our operated properties of exceeded our expectations, our production from last year third quarter more than doubled. So the outlook for the E&P business very well define strategy more balanced oil and natural gas again 400,000 net acres in oil and heavy liquids and up to 900 drilling well locations. We anticipate investing over $2 billion in this business line over the next five years. Great growth opportunity for the company.

Now I’ll move on to the last segment our construction group and that’s made up of construction materials and contracting and our Construction Service Group. I’ll start out with our construction materials and contracting, its just our 20 year of operation in this aggregate base business we have 1.1 billion tons of reserve these results are valuable it’s a depleting resources difficult to permit. We have a strong market position. We’re number one, number two and many of our markets. We perform work in 17 states. We've grown to be a large producer. We are the fifth largest sand and gravel producer, ninth largest overall aggregate producer, ninth largest ready-mixed producer in the country.

Our vertical integration separates us from many of our peers. Our performance, we’ve been solidly profitable during this challenged economic environment that we've had over the last few years. Our core business line revolves around aggregate and then we add value to that aggregate up the chain. We produce asphalt, we produce ready-mixed concrete, we sell liquid asphalt to our sales and other producers, and we actually in some of our markets lay that product down.

The market certainly has changed on the slide in 2006. We had about 40% of our backlog was related to private work. And currently, the private work has slowed down significantly and it makes above 9% of our backlog, now although our backlog is holding solid, we have $448 million worth of backlog currently that's above where it was last year at this time. The mix is changing slightly. The last time I reported this, our private work was at about 6%. So now it's moving to 9%. Some of our markets are performing well. We have some strong markets I don’t want to talk about those.

One of them is in the Port of Long Beach in the Port of LA, the work there is underway. We have the quarry on Catalina Island. This year, we’ll supply about 1.1 million tons of rock to this project; this is a very good project. Another area that’s been very strong for this business line and it's driven our returns in this economy is Western North Dakota that area now makes up about 18% of our backlog. We have green fielded an operation in Williston, North Dakota kind of about 150 people in Williston doing work in that market and we plan to significantly grow that next year. This past quarter contributed our first profit from this growing market again, we moved in with a nice green field operation we’ve set up, we are running, we’re earning money there.

Another area that we are growing that has been very successful for us is our liquid asphalt business. We just completed a green field asphalt terminal near Cheyenne, Wyoming that is now completed it’s taking an asphalt will be ready for next year’s construction season with this market.

So the overall outlook on this business as noted on this slide, we’ve adapted very well to a challenged market. We’ve remained profitable during this slow down in the economy. We are very well positioned for a turn around, our SG&A cost since 2006 kind of the peak of the market, this business unit earned $86 million in 2006 were down 40% in SG&A cost. So as the economy recovers we are certainly leveraged well for that recovery.

Why the $5.5 billion (inaudible) is Hawaii is ongoing that is a good market for us as well and giving us some opportunities for this business. Long term we are positioned well.

Now, I’ll move on to our Construction Service Group. Our last group before I turn it over to Doran you can see the breakdown of the type of work we do in this business we have variety of markets, we have variety of customers, geographic locations, certainly provides diversity and mitigates the risk, this business unit is performing well are up $7 million year-to-date over the last year.

Their work force is the key. They’ve enabled to show flexibility they’ve remain very profitable over this time. A couple of division that are performing very well is the specialty supply distribution business were at a record pace in that business unit. It’s our practice to work hard to establish good customer relations we have recently completed a $30 million electrical project for one customer they went out and we picked to additional contracts with that customers so they do a great job and service and customer they are performing well in a challenged market.

As far as the outlook there we’ve again cut our cost, SG&A cost are down from 2008 about 30% many utilities are increasing transmission work for system reliability we are doing work in wind, generation, we are seeing some pick up now in a couple other markets one of them is Los Vegas and other one is Cleveland are seeing some pick up in both of those markets. And again performing well rely in our people in this business unit significantly.

We are defiantly committed to excellence our vision statement state that well, (inaudible) well integrality creating superior shareholder value while we take care of our employees providing a very safe work environment. This guides our overall strategy.

And with that I will the mike over to Doran cover our financial results.

Doran N. Schwartz

Thank you Terry and welcome everybody. Thanks for spending some time with us today here at EEI hope you are enjoy the conference. I will start with the first slide and cover of on our results on a year-to-date basis, see our earnings are about $151 million that’s comparable to the same time period from 2010, I think it really reflects the value of our diversified group of companies. To Terry’s point, we got our construction companies that are operating profitably in a very challenging environment. We've got a growing utility that is providing a stable base of earnings and cash flows, and we had a good quarter from the oil and gas business with liquids-based production up 13%, we are up 15% in the Bakken alone and we increased our liquids-based production guidance for 2011 as well. So a good quarter for the oil and gas business.

This is an interesting slide, I think it really talks about the frame of mind, we were in growth mode from 2000 to 2008, you can see we are growing our earnings about 17% per year, we were investing heavily in our businesses and it showed through in our stock price and we increased our dividends along the way. But in 2009, we made a conscious decision with uncertainty in the capital markets and uncertainty with the economy to pull back and live within our cash flows. And that was the right decision, we actually strengthened our balance sheet, we built up cash, we enhanced our liquidity, we positioned ourselves for the recovery.

And so the question then is that at what point in time do you turn back to the same frame of mind going from offense to defense and back to offense. And we’re saying at that time is right now as you can see from the next slide, the CapEx in our forecast for the five-year period through 2015 is up 27% from our CapEx been through the five-year period 2010. The CapEx is targeted towards our utility operation, Terry talked about some of the regulated opportunities that we have to invest organically in rate-based generation as well as environmental upgrades to our Big Stone I facility and certain transmission opportunities as well that the utility will be pursuing. Oil and gas, over $2 billion of our $3.5 billion focused on our oil and gas business as we pursue a more balanced commodity production profile, already making headway there, 33% liquids production in the third quarter that’s up from 10% just a few years ago. So were on our way towards that strategy with a more balanced commodity production profile and got opportunities to continue to invest in the business to moving them closer to parity on that.

As we take a look at the cash flows within the forecast relative to the CapEx; one of the things that we want to do is not only grow but we want to grow accretively and we think that we can finance this financing plan with cash flows and not have to go to the market for external equity. So we are looking to grow and grow accretively, and when you take a look at our balance sheet, I think one other nice things is we don’t have to fix the balance as we think about growth.

Again we made conscious decisions to strengthen the balance sheet and we are well positioned as we move back to office. And we are at 34% debt to capital, that’s stronger balance sheet as you can see on the slide, we’ve had here recently and so. We feel very well positioned as we think about the future.

As it relates to our balance, we’ve also got liquidity. We got over $620 million of available liquidity on our various lines of credit, what does that mean as working capital is required to take advantage of opportunities as they arise across our opportunity or across our business units whether that be oil and gas drilling opportunities, construction contract opportunities, pipeline opportunities, utility opportunities, we’ve got the capital available to fund those working capital requirements.

Talk a little bit about our dividend also; when you think about our dividend, our yield right now is right in the 3% range that compares pretty favorably against some of the long-term fixed income options you might have to invest in certainly north of a 10-year US Treasury. So as you think about our stock, you earn a 3% yield on our dividend, which we’ve grown for the last 20 straight years. We paid for 74 straight years, it’s been important to us in the past, it will be important to us in the future. But you also get the upside potential to Terry’s point going through each of our business units as we pursue our growth program, as it relates to our stock prices we grow earnings and cash flows by investing in our businesses going forward.

So our dividend has been important in the past as a way return value to shareholders, it will be important to us in the future. So in conclusion, it’s time to grow, we’ve got opportunities to grow and we’re going to do that as we have in the past in a financially disciplined way. We’re going to look out for the best interest of our shareholders, as we continue to pursue the value creation that we’ve had in the past, as we look to our future.

So with that, we would open it up for questions and answers from the audience. Thank you very much.

Question-and-Answer Session

Unidentified Analyst

I think you get lost sometimes when you talk about shareholder value. Can you give a little color; I think it was one on the first slides where you talked about using different cost of capital to look at your business segments? How that fits into your capital allocation programs and your discipline on cash?

Terry D. Hildestad

It’s a good question; we are opportunistic as when we look at growth opportunities. We have corporate development teams at each one of the business units and obviously, we have cost of capital at each business unit, our regulated businesses have a lower cost of capital, our non-regulated businesses in general, have a higher cost of capital. So if they find a project that meets a number of criteria that aren’t financial, environmentally sound, good management teams, good locations, but if they find a project that meet those specifications and hit and exceed their cost of capital, risk adjusted cost of capital, we’ll fund that. So our approach to adding value isn’t we just want to grow this segment or another segment, we’ll grow any segment that we can add value in our business lines where they will exceed their cost of capital, they each have their own individual cost of capital.

Doran N. Schwartz

And we would – even within each business line, as we take a look at the cost of capital, we would expect different return rates for different types of projects. For example, on the oil and gas business. First of all, we’re a returns-based company. We’ve already made the decision not to invest as much on natural gas and to invest more on the liquid side. We could spend more money in natural gas and push production. But it wouldn’t get you as an investor much in terms of earnings.

So we’re going to leave that natural gas in the ground and produce it later to higher price points that will get you earnings while we focus on the liquid side. So we’re already reallocating capital more towards the liquid side of the business. Within E&P for example, if we’re going to pursue more of a proved up type property with production associated with it, we’ll probably look for and accept a lower IRRs as it relates to the that lower risk type project. If it’s more exploratory in nature on unproved properties, they are going to probably have to provide a higher IRR to reflect the risk associated with that project. So it would be similar considerations that we have as it relates to capital allocation.

Are there questions?

Terry D. Hildestad

Okay. Well, thank you all for taking your time and attending.

Doran N. Schwartz

Thank you for your interest in MDU.

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Source: MDU Resources Group's Edison Electric Institute Financial Conference Call Transcript
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