Otter Tail Corp (OTTR) 2018 Q4 法說會逐字稿

Good morning, and welcome to the Otter Tail Corporation's 2018 Year-End Earnings Conference Call. Today's conference call is being recorded. (Operator Instructions)

I'll now turn the call over to the company for their opening comments.

Good morning, everyone, and welcome to our call. My name is Loren Hanson, and I manage Otter Tail's Investor Relations area.

Last night, we announced our 2018 year-end results and our 2019 earnings per share guidance range. Our complete earnings release and slides accompanying this call are available on our website at ottertail.com. A replay of the call will be available on our website later today.

With me on the call today are Chuck MacFarlane, Otter Tail Corporation's President and CEO; and Kevin Moug, Otter Tail Corporation's Senior Vice President and Chief Financial Officer.

Before we begin, I want to remind you that we will be making forward-looking statements during this call. As noted on Slide 2, these statements represent our current judgment or opinion of what the future holds. They are subject to risks and uncertainties that may cause actual results to differ materially. So please be advised about placing undue reliance on any of these statements. Our forward-looking statements are described in more detail in our filings with the Securities and Exchange Commission, which we encourage you to review.

Otter Tail Corporation disclaims any duty to update or revise our forward-looking statements due to new information, future events, developments or otherwise.

For opening remarks, I will now turn the call over to Otter Tail Corporation's President and CEO, Mr. Chuck MacFarlane.

Thank you, Loren, and good morning, everyone. Last night, we released our 2018 results. Please refer to Slide 5 as I begin my comments.

Earnings per share were $2.06, which is above the midpoint of our updated 2018 earnings guidance of $2 to $2.10. Our stock performed well for the 3 years ending 2018, Otter Tail Corporation ranked #1 in total shareholder return in the EEI Index of investor-owned electric utilities. Total shareholder return has grown at a compound annual rate of 15.3% over the past 5 years. The dividend yield at year-end was 2.7%.

Some of Otter Tail Power's 2018 accomplishments include: the North Dakota Public Service Commission granted Otter Tail Power an overall revenue increase of $4.6 million or 3.1% with a return on equity of 9.77%. Final rates went into effect February 1, 2019. We implemented interim rates in South Dakota, interim rates, which are subject to a refund remain in place until the Public Utilities Commission makes a decision on our request to increase nonfuel rates by approximately $3.3 million or 10.1%. The commission will also decide on the second step in our request, which is an additional 1.7% to recover costs for the proposed Merricourt wind generation facility when it goes into service.

We completed stringing the Big Stone South to Ellendale 340 kV regional transmission project in 2018 and energized the line in early February of 2019. Our share of the cost for this project was $115 million because this is a MISO, Multi-Value Project, which allows cost recovery from all customers who benefit from the line, our customers will pay less than 1% of the project cost. In 2019, Otter Tail Power will also enhance transmission infrastructure in our Southeastern South Dakota service territory, providing an approximate $39 million investment that will improve reliability and provide increased capacity for customers in the southern end of our service territory.

In the fourth quarter and into 2019, we continue to work through the MISO Generator Interconnection process for the Merricourt wind generation project, which will be Otter Tail's largest capital investment at $270 million. We estimate the project construction will begin in July of 2019 with an expected commercial operation in the third quarter of 2020.

South Dakota Public Utilities Commission approved the site permit for $165 million Astoria station natural gas generation project. And the North Dakota PSC approved the project for rider recovery in our recent North Dakota rate case. We'll begin construction in 2019 and expect to be operational by March 2021. These and other investments will produce an annual growth rate of 8% in our rate base between 2018 and 2023 in a constructive regulatory environment.

Minnesota Public Utilities Commission approved a 1-year extension to June 1, 2020, for the filing of our next resource plan. Two key environmental regulations that may impact our modeling are the Regional Haze Rule and the proposed Affordable Clean Energy rule. Delaying our filing 1 year will allow us to consider the outcomes of these environmental regulations and develop a more informed resource plan.

In August, we published our ESG sustainability report, which gives investors and others insight into our environmental, social and governance commitments. On Slide 15 through 17, you'll see highlights from our report and a glimpse into how our electric utilities plants and service and resource mix are evolving due to significant investments in low-cost renewable energy and transmission that enables regional wind development.

Last, but certainly not least, February 4, 2019, marked the official go-live beat for our new Customer Information System. This 37-month project is our biggest system upgrade in a generation. I'm proud of the project team for its resolve throughout the project and for executing a seamless cutover plan to help ensure continued customer satisfaction.

I'd also like to give special recognition to Coyote Station in North Dakota for achieving 2 milestones. By year-end, the plant exceeded 3 million megawatt hours produced, the second highest yearly generation amount in the plant's 38-year history, and crossed over the 3 million man-hours without a lost time incident. The plant's last lost time incident occurred 18 years ago. Congratulations to Coyote Station employees for these significant accomplishments, and thank you to all of our employees for continuing to put safety first.

Our Manufacturing companies also experienced noble accomplishments in 2018. BTD, our contract metal fabricator and the largest manufacturing business, increased sales by 19% in 2018 and the Georgia location was profitable in the last half of the year. The company achieved this while reporting its lowest OSHA rate and highest on-time delivery in history.

T.O. Plastics celebrated its 70th anniversary in 2018 and achieved 6% overall sales growth and a 29% increase in earnings, driven mostly by lower income tax rates. The company's horticulture segment continues to grow through key account relationships and new product launches.

Northern Pipe Products and Vinyltech had an exceptional year supported by strong market demand and prices and continued excellent operating performance. They positively contributed to earnings, while remaining highly competitive. Both companies continue to improve in the markets they serve by demonstrating flexibility and responsiveness to customer needs. We're targeting additional organic volume growth in these companies in 2019.

Employees across our organization are aligned with our growth strategy, which includes capital investment, continued improvement in operations and talent development. It's with much appreciation when I congratulate them on a job well done in 2018. In 2019, we will continue to execute on utility rate base growth and create additional organic growth in the Manufacturing businesses.

Now I'll turn it over to Kevin for the financial perspective.

Well, thank you, Chuck, and good morning, everyone. I will cover the following items: Our 2018 financial results, our liquidity position, strength of the balance sheet and corporate credit ratings, the increase in our 2019 indicated annual dividend, our 5-year capital expenditure plan and our 2019 business outlook.

We are pleased with our strong 2018 financial performance. Revenues grew approximately 8% and earnings grew approximately 14% with all our reporting segments showing year-over-year increases in revenues and earnings. We earned $2.06 per share, which compare with $1.82 per share last year. Our 2018 return on equity was 11.5% on an equity ratio of 54.5%. Our 2-platform strategy continues to deliver higher returns on equity on a higher equity layer when compared to holding company peers.

Let me now provide an overview of 2018 earnings by segment as shown on slides 20 and 21. Electric segment net earnings increased $5 million year-over-year. Key drivers include: increased revenues due to more favorable weather, year-over-year earnings improved by $0.11 a share due to the weather, and compared to normal, weather was favorable by $0.07 a share; increased revenues due to interim rates associated with our North Dakota general rate case net of estimated refunds, which was implemented in January of 2018; interim rates associated with our South Dakota rate case went into effect in October of 2018; increased renewable resource rider revenues in Minnesota and North Dakota and increased Minnesota SIP revenues.

These items were partially offset by the $9.6 million reduction in revenues related to a provision for refunds to recognize at current retail rates in our service area and FERC approved transmission tariffs or recovering federal income taxes in excess of lower rates under tax reform; lower North Dakota environmental cost recovery rider revenue due to the impact from lower tax rates; a reduction in the return on equity component of the rider and the lower investment balance subject to recovery from depreciation; further North Dakota and South Dakota transmission cost recovery riders due to the impact of lower tax rate and reduced transmission costs.

Other items impacting the segment's earnings were higher operating and maintenance, property tax and depreciation expenses. We did have a scheduled maintenance outage in 2018 at our Big Stone Plant that cost $2.9 million. We don't have any planned maintenance outages in 2019. And income tax expense is lower in 2018, mainly due to the reduction in federal corporate tax rates from 35% to 21% and the reversal of excess deferred taxes.

Net earnings for the Manufacturing segment increased $1.8 million year-over-year. Key elements of this improvement are as follows: BTD's revenues increased $36.8 million, of which $33.8 million came from increased product sales to all its major end markets. $12.7 million of this increase relates to higher material costs that were passed through to customers with the balance due to increased sales and improved pricing.

BTD's scrap metal revenues also increased due to higher volumes and higher scrap sales prices. These increases were offset in part by higher cost of goods sold and operating expenses, and higher income taxes due to the elimination of the Section 199 deduction, which was eliminated in 2018 and the write-down of deferred tax liabilities in 2017, which lowered last year's income tax expense. These items resulted in a $1.2 million increase in BTD's year-over-year earnings.

T.O. Plastics revenues improved $1.9 million, mainly due to increased sales of horticultural containers. The increased revenues were partially offset by higher cost of goods sold, labor, freight and operating expenses. Earnings before taxes increased slightly year-over-year, however, due to a lower tax rate, earnings improved $600,000 at T.O. Plastics.

Our Plastics segment's earnings increased $2.1 million year-over-year as a result of a 9.4% increase in PVC prices on a 2.3% decrease in pounds of pipes sold. The increase in sales prices more than offset higher cost of goods per pound and lower sales volumes. The net impact of these items resulted in 11.3% improvement in gross margins.

Sales volumes were lower in the last 4 months of 2018 compared with the same time period in 2017, primarily due to the increased sales from hurricane-related impacts in the Gulf Coast region. Those dynamics favorably impacted earnings by an estimated $0.09 a share in 2017. And the favorable variance due to tax reform was offset by the loss of the Section 199 deduction in 2018. We had lower tax expense in 2017 from a $3.3 million reduction in deferred tax liabilities due to tax reform.

Our corporate expenses before taxes increased $4 million year-over-year, primarily due to an increase in charitable contributions due to the establishment of the Otter Tail Corporation charitable foundation in 2018, the increase in employee benefit costs and in other corporate costs. We realized a $5 million net increase in tax savings in the corporate cost center in 2018, primarily due to the write-down of deferred tax assets in 2017 from tax reform. This was offset by an increase in tax expense, mostly related to uncertain tax positions and the establishment of a valuation allowance on the recoverability of certain state net operating losses. And we experienced a reduction in tax savings as a result of the federal tax rate change. The net result of all these items was a $1 million year-over-year reduction in corporate expense.

Moving to Slide 22, let's review our financial condition and liquidity. Last year, we had no equity financing activity and don't expect any equity issuances in 2019. Our 2 credit agreements are in place until October 31 of 2023 between expected cash flow generated from 2019 operating activities and these credit facilities. We have the appropriate levels of liquidity to support both of our business platforms. We currently expect to do a private placement of debt at Otter Tail Power company in the range of $150 million to $170 million during the last half of 2019 in connection with our rate base growth. And in 2018, all 3 rating agencies affirmed Otter Tail Corporation and Otter Tail Power's ratings and outlook and we remain committed to maintaining investment grade credit ratings and we'll manage our operations to reflect that commitment.

As shown on Slide 24, the Board of Directors increased our indicated annualized dividend rate from $1.34 per share to $1.40 per share. This 4.5% increase is a result of our solid 2018 performance and our 2019 outlook. The company's strong balance sheet, liquidity, cash generation profile and our commitment to enhancing shareholder returns. We expect future dividend increases to be in line with earnings growth while maintaining a targeted payout ratio in the range of 60% to 70%. And we have paid dividends on our stock for 80 years or 321 consecutive quarters.

Slide 25 highlights our capital expenditure plans for the 2019 through 2023 time frame. We expect capital expenditures for 2019 to be $203 million, planned expenditures for this year includes $61 million for the Merricourt Wind Project and $40 million for the Astoria Station natural gas-fired plant. These investments will continue to positively impact the corporation's earnings and returns on capital. The 5-year capital plan calls for approximately $973 million in utility projects, 45% of this capital spend will be recovered through riders. The plan also includes $97 million for the Manufacturing and Plastics businesses. And our updated compounded annual growth rate in rate base over the 2018 through 2023 time frame is projected to be 8% using 2018 as the base year.

Slide 26 reflects our 2019 consolidated earnings per share guidance of $2.10 to $2.25. This guidance includes our strategies for improving future results, the cyclical nature of the manufacturing businesses as well as current regulatory factors facing our Electric segment.

Our Electric segment's 2019 net income is expected to be higher than 2018 based on constructive outcome in the South Dakota rate case, increased AFUDC for planned capital projects, including Merricourt Wind Project and the Astoria natural gas plant along with increased revenues from the North Dakota generation cost recovery rider on the Astoria Station; increased revenues from the completion of the Big Stone South to Ellendale project and additional transmission investments related to our South Dakota transmission reliability project; decreased operating and maintenance expenses due to a decrease in pension, medical workers composition and retiree medical benefits, the discount rate is increasing in 2019 to 4.5% from 3.9% driven by the increasing interest rate environment. These items are offset by normal weather, weather favorably impacted our 2018 earnings per share by $0.07 compared to normal, higher property tax and depreciation expense due to larger transmission projects being put into service.

We expect increased earnings from our Manufacturing segment in 2019 due to increased sales at BTD and the recreational vehicle, lawn and garden and agricultural end markets. Also, increased scrap revenues due to stronger sales volumes. The increased earnings at T.O. Plastics, primarily driven by increased sales in horticultural, life science and industrial end markets. The backlog for this segment is approximately $211 million for 2019 compared with $166 million a year ago. We expect Plastics' 2019 net income to be lower than 2018. We are expecting lower operating margins due to increasing resin prices and slightly higher sales volume compared to last year. And corporate costs, net of tax are expected to be lower in 2019.

Our current earnings guidance for 2019 reflects 68% of earnings from our Electric segment and 32% of our earnings from our Manufacturing and Plastics segments. This compares with 66% and 34%, respectively, in 2018. The increase in the Electric earnings mix is being driven by the rate base growth related to Merricourt, Astoria and South Dakota reliability projects. We expect the long-term earnings mix to continue to move back in line with 75% of earnings from our Electric segment and 25% of our Manufacturing and Plastics segments net of unallocated corporate costs. This will be driven by the capital plan, which calls for approximately 91% of our capital spend over the 2019 through 2023 time frame to be in the Electric segment.

We believe our 2019 guidance further positions us to achieve a 5 to 7 compounded -- 5% to 7% compounded annual growth rate in earnings per share using 2018's $2.06 per share. Our 2019 guidance is dependent on the business and the economic challenges our 2 platforms will face this year. For the utility, key drivers include constructive outcome in the South Dakota rate case and successful execution of our rate base growth projects. For BTD, key drivers include continued operational improvements across all locations to further improve our return on sales margins. And while earnings are expected to decline in 2019 for Plastics, this segment continues to be a strong complement to our portfolio by providing strong earnings, cash flows to support our dividend and returns on invested capital.

We're now ready to take your questions.

(Operator Instructions) Our first question comes from Paul Ridzon with KeyBanc.

Could you give just some background on this charitable contribution and what we should look for going forward?

Sure, Paul. I appreciate the question. We have for a number of years been considering establishing the foundation through our -- both Otter Tail Corporation and then we also have established one for the Otter Tail Power Company as well. And we wanted to in 2018 certainly help get the foundations off on the right foot with the -- a good commitment to fund those organizations going forward. And so you see a, probably a much healthier contribution made for the Otter Tail Power -- I'm sorry, the Otter Tail Corporation Foundation in that $2 million amount the power company is $0.5 million. As we kind of look forward, I would tell you that future contributions are ultimately subject to the success -- the financial success that we're having at both of the entities. But in the utility, if you're looking for a future kind of range, I would say in that $200,000 to $500,000 range on a go-forward basis, and at the parent company depending on results, you could see I suppose in a range of $300,000 to $600,000 a year.

So '18 was just kind of getting this to critical mass?

Yes.

And then, relative to your EEI deck, it looks like some CapEx moved from '19 to '20? Can you give a little more detail there?

The movement Paul relates to the Astoria -- Merricourt, I keep flipping those, sorry. The movement is the Merricourt Project in terms of what we saw at EEI and then what we see now, we've seen a bit of a push back in the timing of the Merricourt Project -- and so we're basically -- the project isn't going away, it's just a movement of dollars from '19 into '20.

Got it. Okay. So fundamentally it's still the same, just the timing here?

Yes.

And then, I know I ask this every call, but pressures you're seeing maybe from the benefit of tax reform being competitively reduced in the Manufacturing segment?

Paul, we just haven't seen that in a couple of our -- as we talk about in the press release and in my comments, we were actually -- we saw price uplift from some of our customers in 2019, both in kind of across the board at BTD and T.O. Plastics, we were able to get price increases in place with customers where we thought it was appropriate and needed. We haven't had any pushback from customers looking for kind of a reduction in pricing because of the tax savings we're picking up in the Manufacturing businesses, doesn't mean that it couldn't happen, but we certainly aren't seeing any of that. And of course, we actually have -- we could be looking for the same things on our supply-side as well when we negotiate our prices with our supply base, and given the PVC commodity nature of that business, prices were up in 2018 in the PVC business and that was really a reflective of market conditions. We're seeing some softening of prices. We saw that in the fourth quarter and as we head into '19, but it's really more a market driven than it is having anything to do with tax reform.

What's driving that softening in market?

Well, I think that -- as we went through '18, we saw much stronger prices than we expected. Now as we head into the -- we completed the fourth quarter, we saw some uplift in our resin cost, and we think saw some pullback in market pricing as it relates to just demand and competition. And as we move into '19, we're seeing similar -- there's some announced resin price increases here in the first quarter, we will see if they stick fully. But we expect it -- some of it's going to stick and we have seen some softening in sales prices that started in the fourth quarter and is really kind of market related that's what's driving it.

Our next question comes from Chris Ellinghaus with Williams Capital.

Can you talk about Georgia? You had mentioned it was profitable in the second half of the year. Are you expecting that trend to continue?

Thanks for the question, Chris. Yes we are, we saw more like a 30% increase in volume year-over-year in Georgia. So we've got some leverage there and we continue to see a good backlog at that site. We've continued to improve operationally, they've improved dramatically on their on-time delivery and work for the number of customers on pricing. So we anticipate similar or better results as we head in the last 6 months of '18 going forward in '19.

Does that mean BTD had some pretty strong revenue growth? Are you expecting particularly the way the backlog look are you expecting another really good revenue year there?

We're definitely expecting an increase. I would say in the backlog, 35% of the product price or 35% to 40% is metal, and a lot of these prices that are in the backlog assume metal prices that were probably based on 2018 final quarter and we're seeing that drop a little. So the metal impact in the '19 backlog is likely overstated a little bit. But we do anticipate good growth in all segments. Some of those segments that you're not going to see that kind of growth, we have been awarded programs in the ag sector that are new to us, meaning, it's just not how your volume or the same product we are making. We are going to be making products that we weren't in previous years. So it's a market share growth there.

Okay. Kevin, the foundation donations that you were talking about, would you anticipate that those would likely stay sort of fourth quarter kind of event?

Yes.

Okay. And lastly, you talked the competition increasing in Plastics a little bit? Is there -- was there a lot of slack in capacity that some of your competitors may have been trying to utilize to get utilization higher? Where is that competition coming from?

Yes. I think that they're in a lot of the -- some of the larger competition certainly has capacity out there in their plants. Some of that competition is also vertically integrated in that they're resin manufacturers and there is always some potential or where they want to have their profits occur, whether it's at their resin plants or their PVC businesses. And so we did see some of that happen, and there has been, at least looks to be continuing into the first quarter. We're only 1.5 months into the year so far, but we have seen sales prices kind of continue at those little bit reduced levels from -- that were in the fourth quarter.

Our next question is a follow-up question from Paul Ridzon with KeyBanc.

Just back to the last question, at BTD the decrease in metal prices will impact revenues, but shouldn't impact net income?

Correct. The metal prices are pass-throughs to the customer, but they do show up in the backlog as far as total product prices.

And Kevin, you talked about the '19 electric utility outlook. You said something about O&M pension, I kind of missed that. Could you quickly review what you said?

Sure. I mean, we expect in large part lower O&M at the utility in part because our discount rate went up on the pension plan and our other benefit programs. We had a discount rate of 3.9%, Paul, in 2000 -- that we use for 2018 and then on in 2019 given where interest rates moved kind of that last half of the year, our discount rate went up to 4.5%.

And should we also look for a decrease in O&M because of the planned outage rollouts?

Yes.

So the O&M line in the total should be down, correct? Is that fair to say?

Yes.

And I'm not showing any further question on the phone lines.

Well, thank you for your questions and support to Otter Tail Corporation. We're continuing execution on the utility growth projects with some strong operational performance in our Manufacturing segment. We remain confident in our ability to deliver shareholder value.

In 2019, we will focus on continuing to improve BTD profitability and we will further refine our long-term growth strategy for Northern Pipe and Vinyltech and T.O. Plastics. And we will continue to execute on Otter Tail Power's major generation and technology projects. We believe this will allow us to deliver on our 2019 guidance of $2.10 to $2.25 a share. Thank you for joining our call. We appreciate your interest in Otter Tail Corporation and we look forward to a successful 2019.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.