Could Federal Spending On Infrastructure Revive This Sleepy Utility?

September 21, 2010

MDU Resources Group, Inc. (NYSE: MDU) is a diversified natural resources company whose primary segments include regulated electric and gas utilities, oil and gas exploration and production, and construction materials and services. This diversification led to each segment supplying about a third of the bottom line in 2009 when a non-cash charge in the oil and gas segment is excluded.

MDU has certainly felt the strain of a poor economy. As expected, the economy took its worst toll on the construction materials and services segment. The regulated utility segment put a floor under the stock price with some recent help from strong oil prices. The stock also got pressured by the British Petroleum oil spill in the Gulf Of Mexico. I believe this is not relevant to the company as all of the interests in the Gulf are non-operated and most are located in the shallow waters off the coasts of Texas and Louisiana. In addition, only a small percentage of the net production comes from the Gulf interests.

While the utility segment provides steady earnings and the oil and gas segment can produce huge profits, it may be the beaten down construction materials and services segment that provides the catalyst to move this stock higher. The Federal Government is spending on infrastructure projects from highways to renewable energy and all fall within the expertise of MDU.

So you can better understand MDU I have given a brief breakdown of each segment below and saved the potential catalyst for last.

Electric & Natural Gas Utilities
This segments operations are primarily in the north central and northwest United States. It operates in 8 states distributing natural gas and electricity to approximately 955,000 customers providing reliable cash flows. The utility segment also includes pipeline and energy services which boasts nearly 5,700 miles of regulated and non-regulated pipeline as well as 3 storage fields with 193 Bcf of working storage capacity including the largest storage field in North America. MDU intends to expand its natural gas pipeline in the Bakken area which should contribute to earnings in the future.

The natural gas and electricity utilities segment should continue to grow as MDU seeks to increase rates and add capacity to the existing pipeline infrastructure. In addition, MDU continues to explore renewable energy opportunities such as wind generation and landfill methane gas recovery. MDU announced earlier this year that two new wind projects were in commercial operation.

Oil & Gas Exploration and Production
This segment is geographically diversified with operations throughout the Rocky Mountain and Mid-Continent regions all the way down to the Gulf states of Texas, Alabama, and Louisiana. It was the star performer in the second quarter of 2010 providing nearly half of the earnings. MDU has continued to add acreage in the prolific Bakken area by acquiring an additional 40,000 acres. MDU also acquired 80,000 exploratory acres in the Niobrara oil play as well as producing natural gas properties in the Green River Basin.

Currently the oil & gas reserves of MDU are primarily natural gas (69%), but if MDU is successful in the oil shale plays of Bakken and Niobrara that balance should begin to shift. This shift should increase profitability and if natural gas prices recover, earnings for this segment could explode.

Construction Material and Services
This segment has taken the brunt of the sluggish economy over the last couple of years, but its fortunes may be about to change. Earnings were down in the second quarter of 2010, but still profitable. MDU has been actively trimming cost in this segment giving it a low cost basis to work from as new projects begin to roll in the door. According to MDU, 59% of Federal stimulus funding in the Company’s states of operation have yet to be spent. The Feds have also approved stimulus funding for renewable energy and electric power transmission projects.

The Company’s construction materials subsidiary, Knife River was recently awarded $41 million in new highway construction work. Knife River should continue to benefit as states receive funds to improve highways throughout the country. Knife River is currently bidding on a $150 million Long Beach Harbor project, a Texas Army base project, and a light rail project in Hawaii. Knife River continues to pursue energy related projects as well including wind towers, transmission projects, geothermal, and refineries. The services division operates in nearly all 50 states and has been involved in projects from Wright-Patterson Air Force Base near Dayton, Ohio to Arrowhead Stadium in Kansas City, Missouri. Any additional stimulus spending for renewable energy, electrical transmission, broadband, or building improvements should benefit the top and bottom line.

The strength of MDU is clearly its diversity. The reliability of the regulated utility and the potential of huge profits in discovering the next big oil or gas well is certainly enough to make me want to own MDU at this level. Throw in the construction materials and services and I think that gives this stock what it needs to go to the next level. I should also mention that MDU has raised its dividend every year for the last 10 years and currently yields 3.2%. If you are looking for a higher yield and willing to forgo some appreciation you can buy the 4.5 percent Series Preferred (MDURP) which is currently yielding 6.1%. The preferred is thinly traded so be careful and set your limit orders appropriately. However, at under $20 per share, I prefer the common to get the appreciation plus a decent dividend.

Disclosure: The author holds a long position in MDU Resources Group, Inc. (MDU) at the time of this article.

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