MDU Resources Group, Inc.
Q2 2015 Earnings Call Transcript

Published: 4 Aug 2015

[Operator:]

Good morning. My name is Nicole, and I will be your conference facilitator. At this time, I would like to welcome everyone to the MDU Resources Group Second Quarter 2015 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. This call will be available for replay beginning at 1

[Doran N. Schwartz:]

Thank you and 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'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 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

[David L. Goodin:]

Thank you, Doran, and good morning, everyone. Thank you for joining us today. Before I begin with the discussion of our second quarter results, I would like to also introduce Martin Fritz. He joined our Pipeline and Energy Services team two weeks ago as President and Chief Executive Officer, replacing Steve Bietz, who retired on July 17 after 34 years with the company. Martin has extensive industry experience and a strong track record of business growth. We are confident he'll be able to lead our strong WBI Holdings team to accelerate our growth and transformation into a larger midstream business. We will provide you with opportunities to meet and visit with Martin at some point soon. Now, turning to our financial results. Our consolidated adjusted earnings for the second quarter totaled $29.1 million or $0.15 per share compared to $34.1 million or $0.18 per share in 2014. These results were highlighted by outstanding performance at our construction materials business, offset by delayed timing of backlog additions and lower margins at our Construction Services Group compared to the record pace that we had just a year ago, and by recent market dynamics related to the commodity prices that lowered margins at our refinery business as well as warmer winter weather at our utility. We have lowered our 2015 guidance for adjusted earnings to a range of $0.85 to $1 per share, down from $1.05 to $1.20 per share previously reported. Over the longer term, we remain confident that our assets and the underlying strengths of our businesses provide attractive growth opportunities and support our record capital investment in both our utility and our pipeline businesses. Turning to our individual business unit updates. Our construction businesses reported combined earnings of $27.1 million, up from $24.9 million in 2014. Construction materials continues to perform very well and had their best second quarter since pre-recession 2007. Here, we saw earnings for the quarter at (05

[Operator:]

Your first question comes from the line of Matt Tucker.

[Matt Tucker:]

Hi. Good morning.

[Doran N. Schwartz:]

Good morning, Matt.

[David L. Goodin:]

Good morning, Matt.

[Matt Tucker:]

First question. Good morning. Can you hear me?

[David L. Goodin:]

Yes. I can. Good morning, Matt.

[Matt Tucker:]

Okay. Great. Good morning. Thanks. Just first question on the refinery. Was the operating loss in the quarter solely due to market conditions, or are there other issues there related to starting and ramping up the facility that contributed to the loss? And then could you comment on what the revised guidance assumes in terms of the refinery's contribution to the second half?

[David L. Goodin:]

Yeah. So just playing that back a little bit, Matt. We announced back in early May that we produced our first amount of diesel out of the refinery. And about mid-May, we announced that we actually started making some sales on the refinery. So we're in the process of, I'll say, commissioning the plant as we go through a ramp-up period. So part of the quarter would see a ramping up of the facility. We are pleased with the operation of the facility. At this point in time, we feel that – I'll say operationally, we've still got some acceptance testing to go through, as one might expect, major industrial facility like this. But the primary reason to the economics really are the market conditions that we're currently experiencing. We saw Bakken differentials in the – oh, I'll say double digits early part of the year. That those have narrowed considerably, more in May and June, which is when we brought the plant online. And we're also seeing price for the diesel and naphtha in particular, due to over-supply in the marketplace, is softer than what we've historically seen, too. So it's really commodity driven. That's a long way of answering your question, but I think it's important to understand that we're still commissioning the plant, ramping up. We feel good about that. The facility's a great facility. We do plan to showcase it at our Analyst Day here in September. Yet, marketing conditions are such that they are. Then one might ask, well why didn't you hedge for that? Well, until we could get the plant up and running along with I'll say a steady supply of inventory, it would've been imprudent to enter into any hedges where we could physically cover them on the production side. So long answer but I think it needs a long answer, given the – I'll say the timing of it and the market that we have associated with it.

[Matt Tucker:]

Thanks, Dave. That's helpful. And I guess just to be more specific, if and when the plant is kind of fully ramped up, fully commissioned, would it still be generating an operating loss based on current market conditions? And are you assuming an operating profit contribution in the second half?

[David L. Goodin:]

Well, we do see – looking at the market, we believe it will slowly start to improve as we look through the remainder of 2015. We're not anticipating a sudden change in that market that would be in our favor. So that is all included as we put together our remaining-year guidance as we thought about the combined consolidated guidance.

[Matt Tucker:]

Got it. Thanks. And then moving on, have you given any thought to delaying the sale of Fidelity again, given the recent pull back in oil prices?

[David L. Goodin:]

I'll ask Pat O'Bryan to touch base with that.

[Patrick L. O'Bryan:]

Yeah, Matt. Obviously, the fall in crude prices, the timing of it's poor. I'm not going to get into whether we will or we won't here on the call, but I will say we will do what is best to maximize shareholder value as we go forward with it.

[Matt Tucker:]

Thanks. And then I guess rather than or in addition to arguably selling Fidelity, potentially, at a low, have you given any thought to selling a business like construction materials, which is performing very well, where the publicly-traded comps have pretty healthy multiples and arguably selling a business like that at what could be high?

[David L. Goodin:]

Yeah, Matt. This is Dave. I would say we need to continue with our Fidelity process, as Pat has outlined. And for competitive reasons, Pat didn't want to give you a long and detailed answer just for competitive reasons as we go through that process. We need to complete that. As we've indicated, we believe – we anticipate that for planning purposes by the end of the year. To your other question, I think it's an ongoing conversation we have with our Board of Directors as to our business mix, how we allocate capital, what businesses should we be in? What businesses should we expand and grow? Which businesses should we consider divestiture of? And clearly, we do that as an ongoing part of our meeting with our Board of Directors. One of the outcomes last year was our oil and gas business. And so I would say conversation always needs to be around strategy, allocation of capital and how to maximize shareholder value. So I would say that's an ongoing conversation.

[Matt Tucker:]

Great. Thanks. And just one last one. It's nice to see the healthy backlog build at construction services. Are you having to sacrifice your bidding margins at all in this environment? Or would you say that the backlog margins are similar to what you've been seeing over the past several quarters?

[Jeffrey S. Thiede:]

Hi, Matt. This is Jeff. Thanks for your question. A couple of years ago, we started to see some of our backlog decrease, and we sharpened our pencil and our pricing levels were less than desired. And we've offset that with some operational excellence initiatives. We have seen recently with projects we've been able to secure a slight increase in margins. And in that increase of $108 million of backlog, we see that we're getting on board early with about six projects in pre-construction. And these projects, I think, will have a better impact to our financials. And we're looking forward to a better second half of the year than a first half.

[Matt Tucker:]

Great. Thanks, Jeff, Dave and Pat. I'll jump back in the queue.

[David L. Goodin:]

Okay. Thank you, Matt.

[Operator:]

And your next question comes from the line of Paul Patterson with Glenrock Associates.

[Paul Patterson:]

Good morning.

[David L. Goodin:]

Good morning, Paul.

[Paul Patterson:]

Just to follow up on the refining. If we look to 2016 and you look at the Ford – the price for Ford products, how much of a uplift are you expecting, I guess, in 2016 based on what you're seeing in the markets locally there?

[David L. Goodin:]

Well, when we think about the – we've provided previously our EBITDA projections for the plant between $60 million and $80 million, which we've characterized in the past – and I'll reinforce that today – we believe that's over the long term from a pricing perspective. So clearly, it will be dependent on what the markets do. But it would be – we'll update you into the future as we see that more near term. But over the long term, I'd just like to reinforce that we believe that $60 million to $80 million is a valid number. But that is obviously based on current market conditions that we'll need to update as we get closer to 2016.

[Paul Patterson:]

Okay. But I mean I guess what I'm wondering is, is that because it's sort of a localized market and you've got some very specific characteristics associated with it. I mean I'm just wondering if you could give us a little bit of a flavor as to what you see the difference in – if you could just give us some sort of sense as to sort of where – how much of an improvement you see in 2016, given just where the markets are. Do you see what I'm saying? I mean in other words, you seem to suggest that you guys could do hedging when you guys were operationally further along and what have you. That would suggest that you have some visibility as to where margins are to a certain degree, I would assume, going out to 2016. And I guess what I'm trying to get a sense is, how much are we – should we be thinking about as being potentially happening in 2016 in terms of spreads or in terms of margin or anything you can tell us?

[David L. Goodin:]

Sure. So let me try to give you some thoughts in that regard. We do see that the markets, I believe, will, I'll say, slowly recover. Part of this is going through – even from a national perspective, from a diesel supply that's being produced – co-produced from gasoline at the moment. So that's more from a national perspective. So when I say slowly recovering, I think that diesel inventory will get worked down. To the other part of your question, though, Paul, is on a local market, we still see oil activity. There're 70 some rigs operating out in the Bakken. Clearly, we're going to have full harvest here that will help from a diesel – I'll say consumption perspective. Working with some experts, we believe that there'll probably be a demand off on diesel in the States, so maybe 10,000 to 15,000 barrels per day. That's from a peak of 60-some thousand. But that still points us very much in an under-supplied local market position. Again, there's only one other refinery in North Dakota, produces about 22,000 barrels a day. Our plant will be 7,000 to 8,000 a day, so that's 30,000 in total. So we're probably 20,000 to 25,000 barrels a day under-supplied in North Dakota, which is very much a local market for us. So we still see that bearing fruit. Yet at the same time, just with the local differential that's narrowed to near-historic lows because a variety of, I'll say demand factors for Bakken crude, we believe that will widen some to more, I'll say traditional or our past run rates we've seen back in 2013 and 2014.

[Paul Patterson:]

Okay. When do you think you'll feel comfortable in hedging, and how might that take place? Just what are your thoughts? If you could just expand a little bit more on that.

[David L. Goodin:]

Yeah. I'd say...

[Paul Patterson:]

And you say that you couldn't do it up to date. But I'm just wondering going forward, when do you think you might begin to get into that?

[David L. Goodin:]

Yeah. So a combination of things there as we continue to go through our – say, our acceptance testing for the plants, we want to have assurance there that we've got a steady supply of product day in and day out. And we're doing that today, again, going through the final acceptance plans from the ramp up period. That will be one component. The other component will be as we look into the forward markets at that point in time. And so it's a combination of what's naphtha doing? What's diesel doing along? Along with crude acquisition. And so we're putting that together, and we'll share that with you in the future as we put that together.

[Paul Patterson:]

Okay. And then just on this – to put this to bed – the weather discussion I believe about expanding or doing an expansion of the refinery. And just what are your thoughts about that today, given the results and what have you? Has that changed?

[David L. Goodin:]

When you say expansion, are you talking about de-bottlenecking this plant, or are you talking about considering a second refinery?

[Paul Patterson:]

I'm talking about considering a second refinery.

[David L. Goodin:]

Yeah. I would say right now, our WBI team is very focused on working on the final acceptance testing for the first unit and looking to optimize that asset along with de-bottlenecking it or finding ways to improve actually the throughput on it. And we certainly haven't dismissed the idea of a second refinery at this point; yet, I'll say our efforts and focus right now near term are very much on the first refinery.

[Paul Patterson:]

Okay. And just finally on the – you mentioned that because of – there might be some sort of change or some sort of – with respect to the 11% utility compound annual rate base growth that, that could be somewhat altered associated with what's been happening in the Bakken. Could you elaborate a little bit on that? And also, could you give us just a sense as to what the rate impact we might see customers impacting – what some customers or I guess the most – the highest rate increases that we might see across the system associated with your plans?

[David L. Goodin:]

Sure. I'll ask Nicole Kivisto to talk about both CapEx and rate impacts.

[Nicole A. Kivisto:]

Sure. Yeah. I'll take that question, Paul. When you look at the news release, we did disclose in 2015 approximately $60 million of expenditures related to the Bakken area. That number has stayed static as a lot of those projects were committed and underway for things such as transmission upgrades for reliability and such. So don't see any near-term impact in 2015. Now as you look beyond 2015, we've got about $20 million per year in the forecast related to customer additions in the Bakken area on an annual basis. So $20 million relative to the $1.7 billion we're disclosing, pretty small piece of the overall growth there. In terms of rate increases, those are ranging across the board. You see each of the filings in our news release, and so kind of hard to give a general statement there. In South Dakota, in Montana, they're around 20%.

[Paul Patterson:]

Okay. Over the five-year period you're projecting? Is that right?

[Nicole A. Kivisto:]

No. That's the current case we have on file.

[Paul Patterson:]

That's the (32

[Nicole A. Kivisto:]

Correct.

[Paul Patterson:]

Okay. And that obviously could increase as well as more capital's deployed in those areas? Is that correct?

[Nicole A. Kivisto:]

Yeah. As we look ahead, we'll have to balance what we do in terms of growth additions on the customer side with the incremental investment.

[Paul Patterson:]

Okay. Thanks so much.

[Nicole A. Kivisto:]

So, it's (32

[Operator:]

Okay. And your next question comes from the line of Timm Schneider with Evercore.

[Timm Schneider:]

Hey. Good morning. On the new guidance, I was wondering if you guys can just walk us through which or how much of an impact each of these moving pieces had. So you got a benefit, I believe, from construction materials and then some headwinds from the refinery and construction services and warmer weather. Just wondered if you could quantify that.

[Doran N. Schwartz:]

Timm, this is Doran. Good morning. Yeah. Let me walk you through as our guidance change and we laid out in the press release, I think, at a higher level, some the reasons behind that by business unit. From a lowering guidance perspective, you start with the utility. We did talk a bit about the weather in the first quarter. We quantified there was about $6.6 million of delta year-over-year in the first quarter. Second quarter, we had some additional weather impact. That's probably the primary driving reason that we're behind last year's results. You can see year-over-year where we're at. So the utility then, I guess, would be largely described by that $7 million. Then you move onto the pipeline. You go to the income statement at the back, Timm, there's a line item there for non-controlling interest, essentially what that is. Remember, we consolidate the pipeline. That represents Calumet's share of the economics of the refinery plus the interest that they pay on the debt at the JV level. And so on a flipside of that, that would be our share of the economics. Probably a little bit smaller number because we're not paying the interest on the JV. We had originally forecasted based on our assumptions, operating income and net income at the plant. So that would be, probably directionally, give you an idea of the impact from the refinery for the year. Although to Dave's point, we are forecasting based on third-party information, a slow recovery here as we go through the rest of the year. So probably a moderated run rate there as we get towards the end of 2015. The Construction Services Group, you saw we updated our revenue guidance. We just didn't see the backlog come in as quickly as we had originally planned. The revenue guidance now is $850 million to $950 million as opposed to the original guidance of $1.1 billion to $1.3 billion. And so – but to Jeff's point, some of those projects are in – either have landed in the second quarter with backlog increases or we are working on pre-construction on other contracts that we believe later in the year will be added to backlog as the construction contracts come in behind pre-construction. And you could see the delta there year-over-year at the Construction Services Group is $30 million last year and about $13 million on an adjusted basis this year. So that gives you a feel for some of the effects of the timing that we saw from last year to this year. And then that was partially offset by what we're seeing at the construction materials group where you've got record backlog; you've got revenues that are up; you got margins that are up; you've got volumes that are up on a year-to-date basis for all product lines doing very, very well and it's really broad based. And so you can see that they're up about $20 million, so – on a year-to-date basis, six months. So again, just trying to give you some feel, Timm, on the impact there that we saw from the utility, from the refinery, from Construction Services Group and then partially offset, year-to-date, which should give you kind of an indicator, I guess, for how we're thinking about the year, at least directionally, as it's reflected in the adjusted guidance.

[Timm Schneider:]

Okay. Perfect. No, that's really helpful. The other question I had, I know you didn't explicitly disclose it in the release, but do you guys have a gross margin per barrel on the refinery?

[Doran N. Schwartz:]

Yeah. We don't, Timm. What I would tell you, though, just directionally, as we think about margins at the refinery, again to Dave's point. There's a variety of different factors which he described in the press release as to the changes in the recent market dynamics we've seen around not only the oil prices in terms of our purchases but then the sales prices of the products we produce. And so we have definitely seen margins come in as a result of the shrinking differentials that we saw on the second quarter, much lower than what we saw for the first part of the year. And again, based on third-party information, we would anticipate that those basis differentials would widen out to more normalized levels slowly throughout the second half of the year. And then again, the margins from the diesel certainly came in, in the second quarter from what we had seen historically but certainly in the first quarter. And we'd – again, third-party information, expect those to recover. But we'll have to update you I think on those key assumptions here as we go through the year. To Dave's point, he indicated in his script that these conditions have been fluctuating. And so I think as we go through the remainder of 2015, we'll be in a better position to – Paul Patterson asked earlier about 2016 guidance – be able to give some 2016 guidance as some of these markets normalize from what we've seen over the last couple months.

[Timm Schneider:]

Got it. And then last one for me is just real quick on E&P. I'm assuming it's still your goal to sell this as the Fidelity business and not piecemeal it at this point?

[Patrick L. O'Bryan:]

Timm. This is Pat. That is correct.

[Timm Schneider:]

Okay, guys. Thank you.

[Doran N. Schwartz:]

Thank you, Timm.

[Operator:]

Our next question comes from the line of Christine Cho with Barclays.

[Christine Cho:]

Hi. So most of my questions have been answered. But while I have you guys on the line, I was wondering if you could quantify what the operating loss from the refinery was during the quarter.

[Doran N. Schwartz:]

Yep. Christine, this is Doran. What I would recommend is going to page 20 of the press release. And there's a line item on the income statement and it's net loss attributable to non-controlling interest. And essentially, what that represent again is the 50%...

[Christine Cho:]

50%.

[Doran N. Schwartz:]

Ownership of the economics on the Calumet side plus the interest that they pay on the $75 million of JV debt at the JV level. They service that debt. So our share of the net loss year-to-date would be slightly less than 50% of the amount that you see in the income statement year-to-date.

[Christine Cho:]

Okay. And then just on your – the comments that you gave to Timm about – I know you guys rely on third-party data for this. But I guess in the data, what was their rationale for margins widening out the second half of this year?

[Doran N. Schwartz:]

Well I think you have a lot of factors there again that will play out here in the second half of the year. But some of the things that we heard about would be, for example, some seasonal factors as you think about diesel demand. For example, in the summer season, a lot of demand right now for gasoline. And gasoline margins have been quite strong and so refiners are producing a lot of gasoline. And then there's associated diesel with gasoline runs, and so that's in the driving season here as we see the summer season. And then obviously, in locally here, we get in at agricultural season for harvest later in the year, which should drive up demand as it relates to diesel here locally. I think other factors that were perhaps maybe more seasonal when you take a look at some of the forest fires that we read so much about in the second quarter in Canada. That disrupted production of Canadian crude; that affected the prices and demand for key commodities coming out of the plant like naphtha. It also, in part, increased – along with gasoline demand by refiners to produce gasoline – increased the demand for Bakken crude. That decreased the differential in part, which, also affected the price that we pay for crude. So a lot of those factors I think we view as certainly need probably a little bit more time as we go through 2015 to get a better feel for how they normalize out. But they were framed up as perhaps being a bit more seasonal or temporary in nature.

[Christine Cho:]

Okay. Great. Thank you.

[David L. Goodin:]

Thank you, Christine.

[Operator:]

There are no further questions at this time. I would like to turn the call over to Dave Goodin for final thoughts.

[David L. Goodin:]

Thank you. Our utility pipeline and construction businesses are positioned for growth, and we are focused on creating long-term value for MDU Resources shareholders by focusing on opportunities at these businesses. We will inform you when a sale of the exploration and production business is finalized. And we do appreciate your participation on our call today. And thank you for your continued interest in MDU Resources. Thank you very much.