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The Last Shall Be First

By Ari Charney on November 23, 2016

Utilities are going back to basics. And that means selling non-utility assets in order to focus more on businesses that generate stable, regulated returns.

Some CEOs have derided the sector’s retreat into fully regulated fortresses. But some utilities got burned in recent years by risky bets on merchant power and energy production.

Perhaps one of the best examples is what happened to North Dakota-based MDU Resources Group Inc. (NYSE: MDU).

Shareholders of the $5.4 billion utility holding company have been on a wild ride in recent years. In terms of share-price performance, MDU has gone from first place to last place, and now back to first: The stock has gained 51.4% on a year-to-date basis.

Until earlier this year, MDU’s diverse operations included an oil and gas production segment. At the height of the energy boom, this business drove growth in MDU’s earnings and its share price.

In 2013, for instance, when the firm’s stodgier utility peers returned 13.1%, MDU delivered a total return of 47.1%. That year, MDU’s energy production segment accounted for nearly a third of operating income.

But as the energy crash accelerated during the second half of 2014, investor sentiment swiftly turned. From MDU’s peak in late April of 2014 to its trough last January, the stock dropped 55.4%.

During that tumultuous two-year period, MDU’s adjusted earnings per share dropped nearly 40%. On a GAAP basis, the firm’s performance was even worse, with a loss of $7.16 per share in 2015.

Nevertheless, we held on anyway. We knew that the stock was being punished out of all proportion to its energy stake.

Beyond that, toward the end of 2014, management announced that it was putting its production unit up for sale in order to de-risk its operating profile.

While that was hardly the most opportune time to unload such assets, we knew there would be better days ahead once the firm completed these sales, which it did earlier this year. Proceeds from the divestitures totaled around $500 million.

Equally important, ditching this unit would not only remove a serious drag on earnings, it would also provide greater long-term earnings visibility.

In fact, Wall Street’s consensus forecasts show that MDU now boasts the highest medium-term growth estimates among its sector peers. MDU is expected to grow adjusted earnings per share by 8.4% annually over the next few years, compared to a sector average of 5.2%.

To that end, on Tuesday the firm’s management unveiled a $2.2 billion capital spending plan for the next five years, with nearly three-quarters of spending allocated toward growing its regulated businesses.

As CEO David Goodin noted, “After completing recent sales of our exploration and production and refining businesses, our more streamlined business operations are focused on the growth opportunities at the regulated energy delivery and construction materials and services businesses. These businesses provide opportunities for growth with a lower business-risk profile that is now much less exposed to commodity prices.”

Of course, analyst estimates of future growth are coming off of a low base. And MDU is hardly retreating into a purely regulated utility fortress.

You probably noticed that Goodin mentioned the firm’s non-utility divisions, which accounted for about two-thirds of revenue last year.

While the construction businesses in these segments offer exposure to the utilities infrastructure buildout, they also entail greater exposure to the business cycle than a fully regulated utility would.

So it’s important to keep that risk in mind. MDU may be lumped in with utilities, but it’s a bit different than its peers.

Despite the stock’s strong rebound this year, it’s still almost 23% off its all-time high. But it’s getting there.

Of course, eventually there will be a new cycle of risk-taking. But in terms of operations, at least, utilities are increasingly playing it safe, as is MDU.

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