MDU Resources: Low Risk Bet On An Infrastructure Boom
Year to date returns from MDU Resources (MDU) have disappointed, in the red more than 9 percent and lagging the Dow Jones Utility Average by about 12 percentage points.
Five-year annualized returns are considerably better at 12.6 percent, topping the DJUA’s 12.1 percent. But the 10-year’s are far less than stellar: 5.3 percent including dividends and less than half the DJUA’s yearly return.
MDU also yields less than the average DJUA stock. Is historical dividend growth rate—after a 2.4 percent boost last month—is less than half. And while the utility’s credit rating of BBB+ is relatively high, S&P rates the outlook negative.
At first glance, that’s a fairly discouraging investment profile. But there are three very good reasons to expect much better in the next 12 months.
- MDU is a far more focused company than it’s ever been, with much less real cyclical exposure than in previous years.
- The company is uniquely positioned to profit from an increase in US infrastructure spending, something Republicans and Democrats are increasingly likely to agree on in 2021.
- MDU currently has a very low profile with the big investors who drive stock prices. That’s now starting to change as interest grows for companies tapped into infrastructure spending.
Five years ago, MDU was struggling to unload money-losing oil and gas production operations. The resulting five separate selling agreements wrapped up in April 2016 for $450 million in proceeds. They strengthened the balance sheet and cut operating risk, but only after nearly $800 million in non-cash writeoffs stretched out over three quarters in 2015.
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MDU funds its dividend solely with earnings from its regulated utility and infrastructure units. So management was able to continue raising the annualized rate by two cents per share, as it’s done every year since 2010. And it preserved the BBB+ credit rating as well, even after writing off an additional $160 million related to the sale of refining operations in June 2016.
Nonetheless, the steady drip of writeoffs dropped MDU shares from a mid-30s trading range in mid- 2014 to a low of $15 and change by early 2016. And selling production and refining operations was a bitter pill to swallow for management, which had envisioned life as a multi-service provider in the Bakken shale region of the US upper Midwest.
The silver lining is the company has effectively doubled down on its most profitable and promising operations, while shedding assets that would otherwise still be hammering earnings. And the benefits of those moves showed up this week in spades.
Specifically, MDU raised the mid-point of its 2020 earnings guidance range to $1.97 per share from the previous $1.85. The key drivers: Successful cost controls and asset expansion at the regulated utilities and pipelines units, along with robust order backlog of $564 million for construction materials and $1.24 billion for construction services.
Management promised to initiate fiscal year 2021 guidance in “early February.” When it does, we’ll see more detail on the $3 billion of planned capital spending through 2025, including for 5 percent annual regulated utility rate base growth. But the most interesting color will concern the construction units, which together contributed 89.5 percent of overall company profits in Q3.
Their full-year contribution will be somewhat lower, since the summer quarter brings seasonal weakness for MDU’s gas and electric utilities. But the construction units’ combined 21.9 percent earnings boost in the first nine months of 2020 clearly shows their importance to overall company prospects.
MDU’s Investor Presentation this month noted that the core of the construction business is public sector projects now seeing “increased demand visibility” as well as higher volumes. Management highlighted major opportunities in surface transportation, airports and rail infrastructure, all likely to garner significant funding from any federal infrastructure legislation.
MDU cites sources projecting $2 trillion plus in US surface transportation needs through 2025, with a current $1.1 trillion funding gap. Airports’ $157 billion is underfunded by $42 billion, while rails at $154 billion need an additional $42 billion capital influx.
The company is well positioned to capitalize when that money starts flowing. MDU’s construction service operations now span 42 states with 7,800 “peak” employees. Construction materials employs almost 6,000 over 15 states, focused on California, Texas and the entire upper half of the US from Minnesota to the Pacific Coast, as well as Alaska and Hawaii.
One of the surprising hallmarks of these businesses is how steady revenue has been over the past 30 years, especially considering that sector’s well-deserved reputation for cyclicality. Since management started ramping up activity in the early 1990s, the only significant year-over-year sales drop was 2008-09. And in the decade plus since, revenue has steadily wended its way higher, hitting new highs this year thanks to successful acquisitions and expanding relationships.
As a result, the operating capability of MDU’s construction units is reaching new heights at what looks like precisely the right time for the infrastructure business. And for shareholders the implications going forward are every bit as positive as the company’s past push into oil and gas proved negative.
Only three research houses currently cover MDU, in part because of the company’s dual nature as a utility. So it’s likely other engineering, procurement and construction companies will receive more attention at least initially, following passage of federal infrastructure legislation.
But as one of North America’s larger EPCs, MDU is hardly an unknown either. And with 525 institutional shareholders and membership in 167 stock indexes, just a little more attention could go a long way toward closing its valuation gap with other utilities, from a price of just 13.4 times expected next 12 months earnings.
MDU’s all-time high is $36 and change, first hit in mid-2008 and revisited in mid-2014 following strength in oil prices. Rapid growth of construction operations makes that price a reasonable upside target for the next 12 months. Buy up to 27.