Q3 2023 Otter Tail Corp Earnings Call

Thomson Reuters StreetEvents

Wed, Nov 1, 2023, 4:33 AM29 min read

In this article:

Participants

Beth Osman

Charles S. MacFarlane; President, CEO & Director; Otter Tail Corporation

Kevin G. Moug; Senior VP & CFO; Otter Tail Corporation

Brian J. Russo; Equity Analyst; Sidoti & Company, LLC

Christopher Ronald Ellinghaus; MD, Principal & Senior Equity Utility Analyst; Siebert Williams Shank & Co., L.L.C., Research Division

Unidentified Analyst

Presentation

Operator

Good morning, and welcome to Otter Tail Corporation's Third Quarter 2023 Earnings Conference Call. Today's call is being recorded. We will hold a question-and-answer session after the prepared remarks. I will now turn the call over to the company for their opening comments.

Beth Osman

Good morning, everyone, and welcome to our Third Quarter 2023 Earnings Conference Call. My name is Beth Osman, and I'm Otter Tail Corporate Manager of Investor Relations. Last night, we announced our third quarter financial results. Our complete earnings release and slides accompanying this call are available on our website at ottertail.com. A recording of this call will be available on our website later today. With me on the call today are Charles MacFarlane, Otter Tail Corporation's President and CEO; Kevin Moug, Otter Tail Corporation's Senior Vice President of Finance and CFO.

Before we begin, I want to remind you that we will be making forward-looking statements during the course of this call. As noted on Slide 2, these statements represent our current views and expectations of future events. They are subject to risks and uncertainties, which may cause actual results to differ from those presented here. So please be advised about placing undue reliance on any of these statements. Our forward-looking statements are described in more details 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. I will now turn the call over to Otter Tail Corporation's President and CEO, Mr. Charles MacFarlane.

Charles S. MacFarlane

Thank you, Beth. Good morning, and welcome to our third quarter 2023 earnings call. Please refer to Slide 4 as I begin my comments on our third quarter results. Through the combined efforts of our employees and diversified business model, we delivered record-setting quarterly earnings. We generated earnings per share of $2.19, driven by increased earnings from our Manufacturing and Plastics segments. Along with the reduction in corporate costs, our Electric segment earnings in the quarter were largely flat to last year but are up 7% on a year-to-date basis.

Based on our strong quarterly and year-to-date results and revised expectations for the remainder of the year, we are increasing our 2023 diluted earnings per share guidance to a range of $6.76 to $6.96 from our previous range of $5.70 to $6. This increase is primarily driven by plastic segment performance, continuing to remain stronger than previously expected. In a moment, Kevin will provide a more detailed discussion of our third quarter financial results and our expectations for the remainder of the year.

Slide 5 shows our expected 5-year compounded annual growth rate in earnings per share with and without the impact of our Plastics segment through the end of 2023 based on the midpoint of our updated earnings guidance. We expect to produce a compounded annual growth rate in earnings per share from 2018 through 2023 of 11% exclusive of our Plastics segment. The additional earnings and cash flows generated by our Plastics segment over this time period provides additional strength through our already strong credit metrics, liquidity and capital structure and allow us for capital investment in our operating companies. Turning to Slide 7, we illustrate Otter Tail Power's efforts in working toward a cleaner energy future. With Hoot Lake Solar becoming operational in August of this year, we expect nearly 40% of Otter Tail Power's owned and contracted energy sources will come from renewable resources. This represents an exciting milestone as we continue to transition to a cleaner energy future while still maintaining reliability and affordability for the communities we serve.

Turning to Slide 11. In March, Otter Tail Power filed its supplemental integrated resource plan with each of our 3 state utility commissions. In Minnesota, we received initial comments from interveners in September and filed reply comments yesterday. We anticipate a hearing with the Minnesota Public Utilities Commission in early 2024, and we expect to receive initial comments from the North Dakota Public Service Commission sometime next week and anticipate an informal hearing later this year.

Slide 12 provides an overview and status update on our significant capital investment projects. Our team continues to effectively execute our project plans, working to secure projects that are completed on time and on budget. I will now provide a few details on several projects. On Slide 13, an overview of Otter Tail Power's 49-megawatt Hoot Lake solar project is provided. The construction of the facility was completed on time and on budget and became fully operational in August. The facility was constructed on and near the retired Hoot Lake coal plant property in Fergus Falls, allowing us the unique opportunity to utilize existing transmission rights, land and substation assets. Hoot Lake Solar is the lease cost and third largest operating solar site in the state of Minnesota, and its completion marks another step towards a cleaner energy future.

Slide 14 summarizes Otter Tail Power's investments under tranche Hana MISO's long-range transmission plan. Otter Tail Power will co-own 2 tranche 1 projects, the Jamestown Ellendale and the Big Stone South Alexandria to Big Oaks 345 KV transmission projects. Our team is focused on project development and coordinating these complex projects with our co-owners. Both projects have FERC approval for construction work in progress recovery, ensuring the timely recovery of our capital investment. In total, we estimate Otter Tail's capital investment in these projects will be approximately $420 million with 30% of the capital investment to occur before 2028. These investments have very limited impact on our retail customer rates as they are allocated across the MISO Midwest footprint. Our team continues to monitor developments at MISO regarding potential tranche 2 transmission projects.

MISO is currently indicating tranche 2 projects will be approved in 2024. While we expect some investment, opportunity for Otter Tail Power rising from tranche 2 projects, our 5-year capital plan does not include any estimates of future investments for these projects. In addition to the transmission investment opportunities available through MISO's long-range transmission planning, MISO and the Southwest Power Pool or SPP recently partnered to develop the joint targeted interconnection queue or JTIQ portfolio projects focused on improving the reliability of the grid where the 2 regional transmission organizations connect. The Minnesota Department of Commerce on behalf of MISO and SPP, applied to the U.S. Department of Energy for funding to support the JTIQ projects.

The DOE awarded $464 million to 5 of these projects, one of which we are expecting to codevelop with Xcel Energy. While these projects still need to go through the approval process with FERC, we are optimistic about the eventual outcome and the potential investment opportunity. Similar to the MISO tranche 2 projects, we have not yet included this project in our 5-year capital forecast. Turning to Slide 15. We intend to repower 4 of our legacy wind farms in 2024 and 2025 with an investment of approximately $230 million. Each project qualifies for renewed production tax credits with the passage of the inflation Reduction Act and is anticipated to lower customer bills, demonstrating outer Tail Power's continued focus and commitment to customer affordability.

Slide 16 provides an overview of Otter Hill Power's capital spending plan. The plan includes $1.1 billion of capital investment over the next 5-year period and produces a 6.5% annual compound growth rate and rate base over this time frame. It is important to highlight that we have potential additional renewable investment opportunities after 2027, as outlined in our IRP as well as incremental transmission investment opportunities relating to MISO Tranche 2 and JTIQ projects. We anticipate approximately 80% of our capital investments will be recovered through existing rates or riders.

Slide 17 provides an overview of key regulatory matters for 2023. Based on the results of our cost-of-service studies, we determined it prudent to file a general rate case in North Dakota. We will be filing our case on November 2, 2023. The Slide 18 provides a summary of our planned rate case filing with the North Dakota Public Service Commission in which we will be proposing a rate net increase in revenues of approximately $17 million or 8.4% based on a requested ROE of 10.6% on an equity layer of 53.5%. The rate case is driven by increases in our operating costs since our last case filing in the state of North Dakota, which was over 6 years ago. Even with this increase, Otter Tail Power will continue to have some of the lowest rates in the country.

Turning to our manufacturing segment on Slide 22. End market demand is mixed, but our existing customers continue to look to us to add value, resulting in incremental volumes from winning additional work with existing customers. Within the recreational vehicle and lawn and garden end markets, discretionary spending is being impacted by inflation and rising interest rates. However, within the recreational vehicle end market specifically, we have seen a shift to higher-end models as buyers of these models seem to be better insulated from economic pressures. Construction remains a strong end market for us as distributors are still experiencing low levels of inventory with a buildup of fleet replacement needs over the last few years. The agricultural end market is stabilizing as inventory has started to build. And the power generation end market continues to be healthy for us as demand remains high and inventory levels low. Our BTD George expansion expected to cost approximately $20 million is currently underway. We expect to bring the additional capacity online in early 2025.

At T.O. Plastics, sales volumes in the horticulture end market decreased in Q3 as lead times have normalized and customers continue to work through inventory purchased early due to scarcity concerns, resulting in lower operating revenues this quarter as compared to the same time last year. Slide 25 provides an overview of our Plastics segment. Sales volumes were relatively flat in Q3 compared to the same time last year, and we believe distributor inventory destocking is generally complete. Slide 26 highlights historic resin costs and PVC pipe pricing. The Plastics segment produced stronger operating margins as our sales price to resin spreads have improved compared to the third quarter of 2022. The sales price of PVC pipe has receded from historic highs and continues to do so. This decline is at a pace slower than the reduction in cost of resin and other materials over the same time frame.

Our updated PVC pipe pricing expectations as well as related margins for the remainder of the year are the primary drivers for increased 2023 earnings guidance that Kevin will expand on. The Vinyltech expansion and plant upgrade is underway, and we anticipate the expansion will increase capacity by approximately 8% or 26 million pounds for the segment. We currently expect to bring this new capacity online in the second half of 2024 at a cost of $50 million. I'll now turn it over to Kevin to provide additional commentary on our third quarter results and our updated outlook for 2023.

Kevin G. Moug

Well, thank you, Chuck. Good morning, everyone. We delivered record-setting quarterly financial results with diluted earnings per share of $2.19. Our financial results for the trailing 12 months ended September 30, 2023, result in a 21.8% return on equity on an equity layer of approximately 62%. Please follow on Slide 30 as I provide an overview of our third quarter segment earnings. Electric segment earnings decreased approximately $300,000 or 1% as compared to the third quarter of 2022. This was driven by increased operating and maintenance expenses primarily due to higher labor costs and strategic spending initiatives, higher depreciation expense and the impact of unfavorable weather. These items were partially offset by increased rider recovery revenues from our Hoot Lake Solar and Astabula 3 investments, increased commercial and industrial sales volumes and lower pension plan costs.

The Manufacturing segment earnings increased $1.2 million or nearly 20% compared to the same time last year. Key elements driving this increase include the following: TV manufacturing has been successful in adjusting sales prices in response to the labor and non-steel material cost inflation, resulting in higher profit margins in the third quarter of 2023 as compared to the same time last year. Also, sales volumes for BTD manufacturing increased in the third quarter, driven by end market demand in the construction, recreational vehicle and power generation end markets as well as incremental volumes from winning additional work with existing customers as they continue to look to us to add value. Partially offsetting this increase, TO plastic sales volumes within the horticulture end market declined in the third quarter of 2023 compared to the same time last year as customers continue their destocking efforts and return to more normal buying patterns.

Plastics segment earnings increased $3.2 million or approximately 6% compared to the third quarter of 2022. The increase in earnings is primarily due to increased profit margins for this segment as our sales price to resin spread improved in the third quarter of this year as compared to the same time a year ago. Both the sales price of PVC pipe and the cost of resin continued to decline, but the sales price has declined at a rate slower than resin costs. Sales volumes were largely flat as compared to the same time last year, and we believe customers are generally through their destocking efforts. Corporate costs declined $3.6 million in this quarter compared to the same time last year. This improvement resulted from lower employee health insurance claim costs and the investment income earned on our short-term cash equivalents in the third quarter of 2023 was higher due to improved yields and higher invested funds.

Moving on to our updated earnings guidance. Slide 33 provides an updated outlook. We are increasing our earnings per share guidance to a range of $6.76 to $6.96, a 17% increase from the midpoint of our previous guidance range of $5.70 to $6. We are tightening the range of expected earnings for our Electric segment and expect our utility to produce earnings growth of 6% over 2022. We are increasing the manufacturing segment earnings guidance due to the strength of third quarter earnings as higher sales volumes; margin improvement and higher research and development credits drove earnings growth at BTD. We are increasing the earnings guidance for our Plastics segment due to continued strength in sales prices and related operating margins of PVC pipe. While sales prices and margins have begun to recede from historic highs, the rate of decline continues to be slower than we anticipated. We expect sales prices to decline modestly over the fourth quarter, resulting in a decline in operating margins.

Additionally, we now expect stronger sales volumes in the fourth quarter as distributors are generally through their destocking efforts with demand rebounding in advance of a seasonal decline anticipated in the latter part of the fourth quarter. And finally, we are improving our guidance for corporate costs. This relates to our third quarter results and an increase in expected earnings on our short-term cash equivalents due to higher level of invested funds and increased yields on those investments. Additionally, we expect lower employee health care costs through the remainder of the year. We now expect our earnings mix for 2023 to be approximately 30% from our Electric segment and 70% from our Manufacturing and Plastics segments net of corporate costs. This anticipated mix deviates from our long-term expected earnings mix of approximately 65% electric and 35% nonelectric as our Plastics segment continues to produce elevated earnings.

We continue to monitor various economic indicators, such as single and multifamily housing starts interest rates and consumer confidence levels to ensure we are well positioned across our portfolio when change occurs. Our diversified business model continues to generate strong financial results for our stakeholders and has put us in an enviable position. The higher level of earnings and cash flows generated over the last 2 years continues to strengthen our balance sheet.

Looking to Slide 32. Our consolidated equity layer as of September 30, 2023, was nearly 62% as compared to 59.4% as of December 31, 2022 and 53.7% as of December 31, 2021. In September, Fitch upgraded the credit rating of both Otter Tail Corporation and Otter Tail Power Company in response to our strengthened financial position and credit metrics. S&P maintained its credit rating for Otter Tail Power Company. We believe it is prudent to retain our excess cash given all the regulated investment opportunities existing at Otter Tail Power Company, not only in the current 5-year period, but beyond. Additionally, our current cash position and balance sheet differentiates us from others in the utility sector as we have no equity needs over the next 5 years despite our sizable CapEx plans.

With our strong financial position and track record of being able to deliver our capital investments on time and on budget, we feel confident in our ability to continue to execute on our rate base growth plans. Our exposure to rising borrowing costs continues to be low risk. We don't have any outstanding borrowings on our parent company facility and the amounts drawn on the utility facility primarily related to capital projects. The increased cost of these borrowings is fully considered in our updated 2023 guidance. As of September 30, 2023, our parent debt to total company debt is 9%. The $80 million, 3.55% parent company note matures in December of 2026. And this is our only outstanding debt at the parent level.

Slide 39 reflects the collective strategies of our platforms and financial performance targets. This business model continues to serve us well, and we remain in the enviable position to fund our rate base growth opportunities at the utility with a strong balance sheet, ample liquidity to support our businesses and strong investment-grade corporate credit ratings.

Charles S. MacFarlane

Before we open the call for questions, I want to take a moment to recognize Kevin, who recently announced his retirement effective at the end of the year. I'd like to thank Kevin for his years of service and contributions to Otter Tail Corporation, its employees and customers. Kevin has been a pillar of integrity for our company and has helped us shepherd through challenging times and enviable financial success. With the deepest gratitude, we congratulate Kevin and wish him all the best in his retirement.

Kevin G. Moug

Thanks for the kind words, Chuck. My 27 years of working for Otter Tail is filled with wonderful memories, challenges and accomplishments. It has been an honor to work for the company, alongside the employees across our electric and manufacturing platforms. It has also been a privilege to have worked with all of you, and I value the relationships we have developed. The support and confidence you have provided me during my tenure is most appreciated. The company is in wonderful hands. And so on January 1, I will hand the football to Todd Wallan as my successor. He is well prepared to move into the role as he has served as VP of Financial Planning and Treasury, at the corporate level, VP of Finance and Planning for our manufacturing platform and most recently as Chief Financial Officer and VP of Finance for Otter Tail Power Company.

Charles S. MacFarlane

Thank you, Kevin. I, too, extend my congratulations and best wishes to you and your retirement. Your leadership has been an outstanding model to follow, and I appreciate all your guidance and coaching over the years. I'm grateful for the opportunity to continue your legacy of excellence and execution on a solid growth strategy. We are now ready to take your questions.

Question and Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Christopher Ellinghaus with Siebert Williams Shank & Co.