2023-08-02 09:15:14 ET
Summary
- Otter Tail Corporation's Q2 2023 earnings report beats expectations, with $1.95 in diluted earnings per share and $337.72M in revenue.
- The company's Electric segment shows promising growth, while the Manufacturing and Plastics divisions face challenges.
- Despite undervaluation and an attractive dividend yield, cautious inventory management and soft market conditions suggest a "hold" rating for investors.
Thesis
Otter Tail Corporation's (OTTR) Q2 2023 earnings report showcased an EPS of $1.95 that beat by $0.50 and revenue of $337.72M (-15.58% Y/Y) that beat by $12.48M. This achievement marked the third-highest quarterly performance in the company's history. However, this analysis argues that while the company revised its earnings per share guidance for 2023 upwards, cautious inventory management and soft market conditions present potential headwinds. And despite the stock's undervaluation and attractive dividend yield, the projected uncertainties suggest a "hold" rating for investors, who should closely monitor future developments.
Company Overview
Otter Tail Corporation, a diversified company based in the U.S., maintains a threefold business presence spanning electric utilities, manufacturing, and plastics. Its Electric segment powers a significant number of customers across Minnesota, North Dakota, and South Dakota, with a generation mix that includes coal, wind and hydro, and natural gas. Simultaneously, it plays a considerable role in the Midcontinent Independent System Operator markets.
In Manufacturing, Otter Tail's footprint includes contract machining, metal parts stamping, and the production of an array of plastic thermoformed containers, offering wide-ranging solutions to several industries.
Meanwhile, its Plastics segment provides PVC pipes for a myriad of applications, serving industries from horticulture to electronics, bolstering the company's market resilience.
Noteworthy is the company's longevity, having been founded in 1907 as Otter Tail Power Company and rebranded to its current name in 2001, all while maintaining strong roots in Fergus Falls, Minnesota.
Otter Tail Corporation's Q2 Earnings Highlights
Otter Tail Corporation has released its Q2 2023 earnings report, reflecting a sound financial position with $1.95 in diluted earnings per share.
This accomplishment does not stand in isolation; it signifies the third highest quarterly performance in the company's history. Furthermore, the company managed to attain an impressive return on equity of 22.2% over the trailing 12 months ending in June 2023. This notable return was achieved with an equity layer positioned at approximately 60%.
Digging into the performance of Otter Tail's various business divisions, the Electric segment has demonstrated a promising growth trajectory. The revenues for this division increased by around 4% in comparison to the previous year. This progression was underpinned by several contributing factors. Among them was the growth in revenues from MISO transmission services and an upward trend in recovery revenues from the construction of the Hoot Lake Solar project. The segment also witnessed an expansion in commercial and industrial sales. Furthermore, a hike in the discount rate supplemented the overall revenue growth.
On the other hand, the Manufacturing division presented a mixed bag of results. The segment experienced a dip in earnings by 21% compared to the second quarter of 2022. However, despite this downturn, the division exhibited a silver lining. Sales volumes and prices registered an upswing, catalyzed by strong demand from the construction, agriculture, and power generation sectors. Furthermore, Otter Tail expressed a strong commitment to nurturing its workforce. The firm highlighted initiatives centered on employee training, career advancement opportunities, and retention strategies, projecting that these efforts will elevate efficiency and productivity over time.
Meanwhile, the Plastics division depicted a complex scenario. While it grappled with a reduction in sales volumes attributed to soft market conditions, it benefited from a significant cut in material costs. Material expenditures declined by a substantial margin, nearly 40%, in Q2 2023. Moreover, a stronger-than-anticipated spread between sales prices and resin costs invigorated earnings for this segment.
In light of the recent performance and future projections, Otter Tail revised its earnings per share guidance for 2023 onwards. The new range is set between $5.70 and $6.00, denoting a 24% escalation from the midpoint of the previous guidance. The corporation also updated its forecast for corporate costs, following a review of the second quarter outcomes and potential earnings from short-term cash investments.
Performance
Looking at Otter Tail's share price growth within the medium-term, we see a jump from USD 26.63 in 2016 to USD 88.78 in 2023 - that's an annualized rate of return of 17.21% excluding dividends, trouncing the S&P 500 Index's 11.22%.
Also, the company's compound growth at 19.01% handily exceeds S&P's 12.49%, and we're also seeing some attractive dividend growth here too - an average growth rate of 4.30% over seven years.
Valuation
Otter Tail's blended P/E ratio (see chart below), standing at 15.93x in comparison to the historical norm of 20.63x, suggests that OTTR is undervalued. Undervaluation is even more striking given the company's healthy adjusted operating earnings growth rate of 9.11%.
A closer look at the dividend yield, which is at 1.97%, in combination with an EPS yield of 6.28%, indicates that the company's earnings are more than sufficient to cover its dividends. This suggests a sustainable and reliable dividend policy, which is generally a positive signal for income-focused investors.
Risks & Headwinds
Despite the overall promising financial performance, Otter Tail did face some obstacles, particularly in its Manufacturing and Plastics segments, during the second quarter .
The Manufacturing segment was met with a set of unique challenges that led to a downturn in earnings. Falling steel prices were one significant factor. Even though they lowered revenues, these decreased prices did not have a direct effect on the segment's earnings. Moreover, the company grappled with decreased scrap revenues, a development largely attributable to lower metal prices in the market. Besides these market-induced obstacles, Otter Tail also contended with internal hurdles. Labor costs rose, and productivity experienced a downturn during the quarter. These factors combined exerted pressure on cost absorption, ultimately contributing to a reduction in the segment's profitability.
Meanwhile, the Plastics segment also faced its share of trials during the period. The company reported a 13% decrease in net earnings compared to the same quarter of the previous year. This decline was largely tied to a 26% slump in sales volumes. The causes of this drop, according to management, were multi-faceted, with general market softness and cautious inventory management strategies among distributors and contractors playing significant roles. Higher interest rates and a slowed housing market activity further compounded the impact, influencing the behaviors of distributors and contractors, and thus, the performance of the Plastics segment.
Looking ahead to the second half of 2023, Otter Tail is bracing for a potential decline in profitability in comparison to the results achieved in the first half of the year. This forecast is based on a myriad of factors, but chiefly among them are the anticipated ongoing softness in the end market and the continuation of cautious inventory management strategies among distributors and contractors. Given these projected conditions, the company expects sales volumes to maintain their downward trajectory, presenting an additional challenge to Otter Tail as it seeks to navigate through the rest of the fiscal year.
Final Takeaway
Based on the information provided, I would rate the stock of Otter Tail Corporation as a "hold." While the company has demonstrated sound financial performance in Q2 2023, with impressive earnings per share and a promising return on equity, there are some concerning factors to consider. The Manufacturing and Plastics divisions faced challenges, leading to a dip in earnings and sales volumes. Additionally, the projected decline in profitability for the second half of 2023 due to soft market conditions warrants caution. The company's undervaluation and attractive dividend yield may be positive factors, but the risks and uncertainties in the current market environment suggest that investors should hold their positions and closely monitor future developments.
For further details see:
Otter Tail's Q2: A Whisker Away From Perfection