Companies operating in multiple businesses frequently trade at a “conglomerate discount” to more focused rivals, explains Roger Conrad, editor of Conrad's Utility Investor.
This month, Aggressive Holding MDU Resources (MDU) became the latest utility to simplify — announcing a tax-free spinoff to shareholders of its Knife River construction materials division.
After 12 acquisitions in four years, Knife River more than a billion tons of aggregates reserves in the western, central and southern US. It operates 110 ready-mix plants, 50 asphalt plants and a combined 410,000 tons of liquid asphalt and cement storage. And contracting services include construction of roads, bridges, residential properties, schools, shopping centers, office buildings and industrial parks.
When the spinoff closes next year, Knife River will be an instant takeover target, even as management continues its own growth-through-acquisitions strategy. End Q2 backlog was a record $1.13 billion, up 24 percent over the past year. And 2022 revenue guidance is $2.45 to $2.65 billion, with inflation expected to hold margins slightly lower than in 2021.
Remaining MDU will serve 1.2 million electric and natural gas utility customers in 8 states, with a five-year, $1.6 billion CAPEX plan driving growth. Its 98 percent-regulated natural gas pipeline and underground storage system serves the Rocky Mountains and northern Great Plains. And its construction services group of 16 local operators is the fourth largest US electrical contractor.
New MDU will generate 70% of post-spinoff EBITDA from regulated businesses. That’s plenty of earnings power to support the current dividend policy, with Knife River expected to offer a modest payout as well.
MDU’s Q2 earnings per share dropped -30 percent, forcing management to cut the mid-point of 2022 guidance by nearly -10 percent. The main reason for the shortfall: The -36.6 percent drop in Knife’s profits, rising construction materials and operating costs more than offset a 12 percent revenue increase.
Such cyclicality comes with the territory in a commodity-driven business. But post-spinoff that volatility will be a thing of the past, which should ultimately earn the utility a much higher valuation than its discounted 13.4 times expected next 12 months earnings. I ultimately expect the sum of the parts to be near $40 a share. Buy MDU at 35 or less.
