Description

MDU Resources is a "sleepy" utility based in ND that owns two large businesses that are leaders in their industries and should benefit from positive macro tailwinds in the near future. Due to a poor investor relations job from the company and a weak street coverage, the name has flown under the radar as many people still consider it a utility, which is not the case. Based on a sum of the parts valuation, the company presents a 30% upside and if the company is broken up there could be a 100%+ upside

MDU Resources was founded in 1924 as a utility and for the past 30 years it has expanded into other businesses. Since the '90s, the company has built two major businesses that today represent over 75% of the revenue and more than half of the EBITDA. These businesses are a Construction Materials business and a Construction Services business. Besides these two, MDU has two other divisions: a classic utility business and a gas pipeline business.  The company had about $5.7bn in revenue and $860mm in EBITDA for 2021, $5.5bn and $857mm in 2020 and $5.3bn and $753mm in 2019 respectively.

MDU's construction materials business main products are aggregates, asphalt and ready-mix concrete. The business operates under the Knife River brand (which might lead to people not thinking them as part of MDU) and has a large presence in the Pacific Northwest, the northern states of the Rockies, California and Texas. The business is one of the 10 largest aggregates producer in the US. Knife River is vertically integrated from mining all the way to final lay-down of concrete and asphalt. Despite being a cyclical industry the aggregates business has grown pricing at an average of 4.5% between 2005-2020 with minimal price decline during the financial crisis and right now is facing positive macro tailwinds due to the infrastructure bill passed in congress. This business generated $2.2bn in revenue (39% of total) and $290mm in EBITDA (34% of total) during 2021, $2.2bn of revenue and $304mm of EBITDA in 2020 and $2.2bn of revenue and $258mm of EBITDA in 2019.

The construction services business operates as a contractor with a main focus on electricity and utility infrastructure projects. Still, it is active in other major infrastructure initiatives like airports, data centers, pipelines, etc. The business is the 4th largest utility contractor in the US and has a roster of blue chip customers across the US. The services business should benefit massively from the new infrastructure bill's focus on clean energy, transmission and grid upgrades ($65bn committed for this as part of the plan). MDU Construction Services had revenue of $2.0bn (36% of total revenue) and $166mm of EBITDA (19% of total) in 2021, $2.1bn of revenue and $171mm of EBITDA in 2020 and $1.9bn of revenue and $143mm of EBITDA in 2019.

The utilities business serves over 1mm customers in the Dakotas, Montana, Minnesota, Wyoming, Idaho, Oregon and Washington. It owns about 765Mw of generation and has over 29,000 miles of electric and gas transmission distribution. The utility generates most of its electricity from gas, followed by coal and then renewables. The use of coal as a primary source of energy has decreased from 69% on 2013 to 46% in 2018 and it is forecasted to be 31% by 2023. The utility business generated $1.3bn in revenue (23% of total)  and $312mm in EBITDA (18% of total) in 2021, $1.2bn of revenue and $284mm of EBITDA in 2020 and $1.2bn of revenue in 2019 and $272mm of EBITDA in 2019.

Lastly, the company owns a small pipeline business that distributes all the utilities business gas (represents 23% of total gas transported) and owns over 3,700 miles of pipeline. The business operates as WBI Energy and it strategically located near five natural gas producing basins. Additionally, it owns the largest natural gas storage field in NA, which next to the Bakken play. The pipeline business generated $142mm in revenue (3% of total revenue) and $69mm of EBITDA (6% of total EBITDA) in 2021, $144mm of revenue and $71mm of EBITDA in 2020 and $140mm of revenue and $64mm of EBITDA in 2019.

This hodgepodge of business has led to the stock being misunderstood and a continual underperformer in every category. MDU Resources has underperformed vs. utility, construction materials and construction services comps for the past 3 and 5 years. This has led to some shareholders to bring the question of breaking up the company in the latest earnings call (4Q21). However, management still believes that this mix of business works and should be kept together. Thus, this seems to be prime for an activist to take a stake and shake things up.

If MDU were to be split up, the stock could see close to 30% upside to today's price if the business is valued as separate entities. Its utilities business could be worth about $3bn assuming a 13x EV/EBITDA multiple (average of midcap utility companies in the US), the pipeline business around $750mm at an 11x EV/EBITDA (and could be worth even more once two large projects come online), its construction materials business could be worth around $4.3bn at a 15x EV/EBITDA multiple (average of peers like Martin Marietta, Vulcan Materials, Eagle Materials, etc.) and the services business could fetch around $1.3bn at an 8x EV/EBITDA. This would bring the total potential EV to ~$9.7bn, minus net debt of $2.7bn and 203mm shares outstanding, this yields around a $35 share price.

Still, the major gains would come from a breakup and an increase in performance in its businesses. MDU's utility and construction materials margins underperform the industry average. The utility independent peers have EBITDA margins around 30%, while MDU has consistently been around 23% for the past 3 years. The construction materials peers average around 23% EBITDA margins, while MDU has averaged about 12% in the past few years, a 900 bps gap. More focused companies, with separate managements and incentives should help these divisions catch up with peers or get close enough. Assuming that MDU is able to match peer margins and is valued as separate business (as above), the stock could be a double, with $7 coming from pure multiple arbitrage and about $24 dollars from margin improvement for a total share price of $58 (a 110%+ return).

Assuming a break up doesn't occur, the company still trades at a low valuation of 9x EV/EBITDA (despite its largest businesses' peers trading in the low to mid teens). So, if we assume no multiple expansion and only a 4% revenue growth per year (lower than management's guidance of 5-8%) and no EBITDA margin improvement (15%) for an EBITDA of $970mm by year end '23, the company should be valued around the $30 range, a few bucks higher from today's price, providing some comfort in the downside.

In terms of leverage, the company has about 3.1x net leverage with upcoming maturities of $148mm in 2022, $78mm in 2023 and $283mm in 2024. Assuming that EBITDA stays around the $900mm level during the upcoming years (conservative assumption) and based on the company's capex estimates of around $700mm per year, the company should be able to generate ~$200mm of FCF (EBITDA - Capex) that could cover those maturities absent any refinancing of the debt (which is probably unlikely).

Catalyst

Activist involvement

Break up of company

Better ER coverage