MDU Resources Group, Inc. — Q2 2016 Form 10-Q
Business context and period: This unaudited filing covers the three and six months ended June 30, 2016. MDU operates regulated electric and natural gas utilities, pipelines and midstream assets, and construction materials, contracting, and construction services businesses. It completed the sale of Dakota Prairie Refining on June 27, 2016, and completed sales of Fidelity’s marketed oil and gas assets between October 2015 and April 2016; both businesses are reported in discontinued operations, with certain related corporate costs remaining in continuing operations.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $1.044 billion | $938.0 million | $1.904 billion | $1.799 billion |
| Operating income | $89.0 million | $59.7 million | $151.0 million | $110.0 million |
| Income from continuing operations | $46.3 million | $26.1 million | $78.2 million | $46.6 million |
| Loss attributable to common stock | $109.3 million | $229.8 million | $84.6 million | $535.9 million |
| Basic diluted EPS | $(0.56) | $(1.18) | $(0.43) | $(2.75) |
| Operating margin | 8.5% | 6.4% | 7.9% | 6.1% |
Revenue rose approximately 11% in Q2 and 6% for the first half. The common-stock losses reflect discontinued operations, including a $251.9 million pretax ($156.7 million after-tax) Dakota Prairie Refining impairment in Q2 2016. Continuing-operations earnings per share were $0.24 for Q2 and $0.40 for the first half, versus $0.13 and $0.24, respectively, in 2015. The quarterly common dividend declared was $0.1875 per share.
Cash flow and investment: First-half operating cash flow was $102.6 million, down from $194.3 million; continuing-operations operating cash flow increased to $128.2 million from $120.2 million, while discontinued operations used $25.5 million. Investing activities used $177.5 million, compared with $402.4 million in 2015. Continuing-operations capital expenditures were $199.0 million for the first half. Financing activities provided $76.1 million, including $387.6 million of long-term debt issuance and $196.8 million of repayments.
Balance sheet and liquidity: At June 30, cash was $85.1 million. Long-term debt, including amounts due within one year, was approximately $1.987 billion; total equity was $2.238 billion. Available capacity under company and subsidiary credit facilities was $496.0 million. Total equity was 53% of total capitalization, compared with 54% a year earlier. Management said it expects to meet debt maturities within one year using internal funds, credit facilities, and long-term debt issuance.
Material changes and segment trends
- Construction materials and contracting earnings increased to $33.7 million in Q2 from $20.1 million, supported by greater construction activity and stronger asphalt and ready-mixed concrete margins and volumes. First-half earnings were $19.2 million versus $5.5 million.
- Construction services Q2 earnings were $7.0 million, unchanged year over year; first-half earnings rose to $13.0 million from $11.8 million.
- Electric earnings increased to $8.0 million in Q2 and $19.2 million for the first half, aided by regulatory recovery trackers and production tax credits. First-half electric sales volumes declined 4%.
- Natural gas distribution had a seasonal Q2 loss of $7.8 million, compared with $5.4 million a year earlier, as warmer weather reduced sales volumes; first-half earnings increased to $17.5 million from $16.1 million.
- Pipeline and midstream earnings increased to $6.3 million in Q2 and $11.6 million for the first half. Lower operating costs and higher storage activity were partly offset by lower gathering volumes and earnings.
- The 2015 comparative periods included substantial Fidelity impairments and an oil-and-gas property write-down. Their absence in 2016 partly explains the much smaller first-half consolidated loss. The new refinery impairment partially offset that improvement.
Outlook, risks, and unusual items
- Management projected regulated electric and natural gas rate base growth of approximately 7% annually over five years, including an approximately $1.5 billion capital investment program. Estimated 2016 capital expenditures from continuing operations were approximately $389 million.
- Construction materials and contracting projected 2016 revenue of $1.85–$1.95 billion and slightly higher margins than in 2015; backlog was approximately $805 million at June 30, 2016, 93% public work.
- Construction services projected 2016 revenue of $1.0–$1.1 billion and slightly lower margins than in 2015; backlog was approximately $508 million.
- Management cited continued growth opportunities in utility infrastructure, pipeline expansions, and construction markets. The proposed Valley Expansion pipeline was estimated to cost approximately $50 million, subject to adequate shipper commitments, permits, and approvals. A separate Demicks Lake connection project was delayed by the plant owner.
- Regulatory proceedings remain material: rate cases and recovery mechanisms were pending in several states. North Dakota electric and Idaho natural gas rate cases were expected to be filed in Q3 2016. South Dakota interim utility rates exceeded final approved increases, requiring customer refunds with interest by October 1, 2016.
- Major risks include commodity prices and basis differentials affecting pipeline and midstream activity; regulation and recovery of infrastructure and environmental costs; potential greenhouse-gas requirements; seasonal and competitive construction markets; and multiemployer pension obligations. The Clean Power Plan was stayed pending litigation, leaving compliance requirements and costs uncertain.
- Contingencies include an estimated $16.4 million withdrawal liability for a Wyoming multiemployer pension plan, disputed additional contribution claims, environmental remediation accruals, and the company’s continued $66 million guarantee of refinery debt. Tesoro agreed to indemnify the company for losses and litigation expenses arising from that guarantee. Management stated that other probable or reasonably possible losses, beyond accrued amounts, were not expected to materially affect financial position, results, or cash flows.
- The refinery sale reduced commodity-price exposure, but the company remains exposed to certain pre-sale liabilities and indemnification obligations. The refinery impairment and Fidelity asset-sale and exit costs are unusual items affecting comparability.
Investor verification priorities
- Review the refinery sale terms, the $251.9 million impairment, retained liabilities, the $66 million debt guarantee, and the scope of Tesoro’s indemnity.
- Separate continuing-operations performance and cash generation from discontinued operations and one-time impairments when assessing earnings trends.
- Track utility rate-case outcomes, interim-rate refunds, and whether approved rates provide timely recovery of capital and operating costs.
- Assess the sustainability of construction segment margins and backlogs, and the effect of seasonal working-capital needs on cash flow.
- Monitor debt, credit-facility availability, planned capital spending, and exposure to environmental rules and multiemployer pension liabilities.