MDU - MDU Resources: A Dividend Aristocrat With Upside Potential

2023-07-21 08:05:00 ET

Summary

• MDU Resources, a diversified utility and pipeline company, has a strong track record of growing dividends and is attractively valued.
• The company's utility and natural gas businesses are expected to benefit from record temperatures across the US, increasing demand for indoor cooling, and the growth of electric vehicles.
• Despite potential risks such as inflation and higher project costs, MDU remains a solid investment due to its strong balance sheet, healthy 4.1% dividend yield, and a positive outlook.

One can do well in the market simply by not speculating on trend stocks in hopes of getting rich quick. At its best, frequently trading in and out of stocks results in frictional costs such as federal and state taxes, which can go largely unnoticed until after the year ends, and short-term capital gains can take a big bite out of one’s hard won capital gains.

At its worst, frequent trading can result in sub-par performance compared to the market index, and in the words of Warren Buffett, investing is like a bar of soap, the more you handle it, the smaller it gets.

Buying and holding a basket of strong dividend payers at the right price can be the best ticket to sleeping well at night. This brings me to MDU Resources ( MDU ), which I last covered here in August of last year, highlighting its diversified nature and long track record of growing the dividend.

The stock has given investors a 13% total return since then, handily beating the 9% tech-fueled rise of the S&P 500 ( SPY ) over the same time. In this article, I provide an update and discuss why the stock remains attractively priced for income and growth.

Why MDU?

MDU Resources is a member of the S&P MidCap 400 and is a dividend aristocrat, having raised its dividend for 31 consecutive years. It was founded nearly 100 years ago and operates a diversified utility and pipeline company. The utility-side serves Montana, North and South Dakota, while the natural gas distribution side serves Idaho, Minnesota, Oregon, and Washington.

MDU has a fairly strong track record of top-line growth. As shown below, its revenue has grown at a solid pace over the past 10 years, landing at $7.3 billion for the trailing 12-reported months. Notably, MDU recently split off its construction services side through the Knife Rivers spin-off, thereby simplifying the business and making it easier to value with less cyclicality.

MDU’s remaining business segments have demonstrated resiliency, as reflected by their strong performance. This includes the combined utility (electric and gas) earnings growing by 17% YoY during the first quarter to $55.5 million, driven by interim rate relief in North Dakota and Montana and lower O&M (operation and maintenance) costs associated with the closure of 2 coal-fired generating units.

Moreover, MDU is seeing respectable growth in the pipeline business, which saw earnings grow by 14% YoY to $8.3 million, driven by the North Bakken expansion project as well as increased contracted volume commitments from customers, resulting in record transportation volumes during the first quarter.

Looking ahead, MDU should see fairly steady growth, considering that it operates in constructive rate-setting environments, and management expects rate base annual growth between 6% and 7% compounded over the next 5 years. This is supported by a pending rate case with FERC (Federal Energy Regulatory Commission), with new rates slated to take effect on August 1 ^st pending approval.

Plus, MDU expects to be near term growth may also be supported by 3 natural gas pipeline expansion projects that commenced in Q2 and are anticipated to be in service later this year. These three projects will add around 300 million cubic feet of incremental capacity. This makes MDU well-positioned to capitalize natural gas as a reliable power-generation fuel source for increasing numbers of electric vehicles on the road, all of which depend on electricity from the power grid.

MDU’s utility and natural gas businesses may also benefit in Q2 and Q3 from record temperatures across much of the United States, as demand for indoor cooling may soar. For example, Montana, a service territory for MDU, has experienced triple-digit temperatures this month.

Meanwhile, MDU maintains a strong balance sheet with a BBB+ credit rating from S&P, and has a net debt to EBITDA ratio of 3.7x, which is reasonable considering the capital-intensive nature of the business with steady and reliable earnings. MDU also pays a healthy 4.1% dividend yield, which is well-protected by a 45% payout ratio. It has 31 consecutive years of dividend growth and a 5-year CAGR of 4.7%.

Risks to MDU include potential for higher costs due to inflation, which would pressure margins. Higher than anticipated project costs could also be a burden, and population movements out of its service territories could reduce earnings.

Lastly, MDU remains a solid value play at the current price of $21.97 with a forward PE of 13.7, sitting below its normal PE of 17.3. MDU could reasonably deliver bottom line EPS growth in the mid-single digit annually, which combined with the dividend yield could give investors total returns that are closely aligned with the long-term return of the S&P 500, all while providing investors a far higher income stream. As such, I believe a forward PE of 15+ isn’t out of the question.

Investor Takeaway

MDU Resources is a diversified utility and pipeline company that has provided investors with consistently growing capital returns for decades. Its businesses are demonstrating respectable growth and expansion projects could provide an additional kicker.

The stock remains attractively priced, offering investors a 4.1% yield, combined with the potential for mid-single digit EPS growth over the coming years to produce total returns closely aligned with the long-term return of the S&P 500. As such, value and income investors seeking reliable dividends should consider MDU the current price.

For further details see: