Otter Tail Corp

NASDAQ:OTTR

Earnings Call Analysis

Otter Tail Corporation sees mixed earnings and increases 2024 guidance.

In Q3 2024, Otter Tail Corporation reported diluted earnings per share of $2.03, down 7% year-over-year, yet year-to-date earnings rose 4%. The Electric segment saw a 16% earnings increase, driven by favorable regulatory changes and interim rate impacts. Conversely, the Plastics segment's earnings decreased by 8% due to declining PVC prices, though sales volumes grew 13%. Notably, 2024 earnings guidance is now set between $6.97 to $7.17, up from a previous $6.77 to $7.07, reflecting Plastics' strong performance. The company anticipates a 7% growth in Electric segment earnings and acknowledges challenges in its Manufacturing segment due to demand headwinds.

A Mixed Bag of Earnings in Q3 2024

In the third quarter of 2024, Otter Tail Corporation reported diluted earnings per share of $2.03, down 7% year-over-year. Despite this decline, year-to-date earnings are up 4% compared to the previous year. Notably, the corporation anticipates this could be their strongest year yet for annual earnings, indicating underlying resilience amidst challenging market conditions.

Segment Performance Highlights

The company's Electric segment showed robust performance with a 16% earnings increase, attributed to interim rate adjustments in North Dakota and favorable developments regarding transmission revenue from a recent FERC ruling, adding roughly $4 million to their bottom line. Conversely, the Plastics segment faced an 8% decline in earnings due to decreasing PVC pipe prices, while significant downturns were observed in the Manufacturing segment, where a 71% drop in earnings was recorded, primarily due to reduced sales volumes.

Improving Guidance Signals Confidence

Despite mixed segment performances, Otter Tail has updated its earnings guidance for 2024, raising the range to $6.97 to $7.17 per share—improving from $6.77 to $7.07. This upward revision primarily stems from unexpected strengths in the Plastics segment, highlighting a confidence in the company’s operational strategy and ability to adapt to market fluctuations.

Investment Strategy and Future Growth

Otter Tail is pursuing a five-year capital spending plan targeting 7.7% growth in their rate base, with a focus on renewable energy projects and transmission investments. This not only assures steady revenue growth but also enhances the company’s appeal with customers through lower rates, derived from efficiencies in capital investment. The company is also eyeing substantial investments, potentially reaching $400 million, to improve long-term grid reliability.

Market Dynamics Affecting Business Sectors

Challenges are unmistakably present, especially in the Manufacturing sector, where a 13% drop in sales volume reflects weakened demand across key end markets such as agriculture and construction. This downturn accentuates the cautious approach that manufacturers are adopting. Import competition is also on the rise, further complicating recovery metrics. However, Otter Tail remains optimistic about future growth with a diversified approach, aiming for consistent long-term performance.

Liquidity and Financial Resilience

Despite the pressures within certain segments, Otter Tail boasts a solid liquidity position, with cash levels around $280 million and total available liquidity hitting $544 million. The company maintains a strong balance sheet, with an equity layer of nearly 62% and a return on equity of over 20%. This financial stability positions Otter Tail advantageously against peer companies, many of which will face equity needs to fund their capital growth initiatives.

Looking Ahead: Future Investments and Sustainability

Moving forward, Otter Tail is strategically focused on sustainable practices with significant allocations toward renewable generation and technological upgrades. The firm recently enhanced its Electric segment capabilities and is primed to support new customer loads in energy-heavy sectors. Expectations are set for continuous growth, reinforcing the corporation's longevity and commitment to shareholder value.

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, and welcome to Otter Tail Corporation's Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference call is being recorded. I would now like to turn the call over to the company for their opening comments.

[Beth Eiken, executive]

Good morning, everyone, and welcome to our third quarter 2024 earnings conference call. My name is Beth Eiken, and I'm Otter Tail Corporation's 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 Chuck McFarlane, Otter Tail Corporation's President and CEO; and Todd Wahlund, Otter Tail Corporation's Vice President 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 against placing undue reliance on any of these statements.

Our forward-looking statements are described in more detail 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. Chuck MacFarlane.

[Chuck MacFarlane, executive]

Thank you, Beth. Good morning, and welcome to our third quarter 2024 earnings call. Please refer to Slide 4, as I begin my comments on our quarterly performance. Our team members continue to perform well as they navigate changing market conditions. We are generally pleased with our consolidated financial results, despite diluted earnings per share decreasing 7% to $2.03 per share compared to the third quarter of 2023. The results exceeded expectations and year-to-date earnings are ahead of last year by 4%.

Additionally, we are guiding to what could potentially be our best year yet in terms of annual earnings. Electric segment earnings increased 16% or $4 million, primarily due to the impact of interim rates in North Dakota, as well as the financial impact of our recent FERC ruling on transmission return on equity. Plastics segment earnings decreased 8% or approximately $5 million as the sales price of PVC pipe continues to decline. The Manufacturing segment is experiencing demand-related headwinds across several of its end markets, resulting in a decrease in earnings of 71% or approximately $5 million due to lower sales volumes.

While Plastics segment earnings were lower than the same time last year, its financial results exceeded what we had anticipated for the third quarter. Due to the strong financial performance within our Plastics segment, we are increasing and narrowing our 2024 earnings guidance to a range of $6.97 to $7.17, from our previous range of $6.77 to $7.07. In a moment, Todd will provide more detailed discussion of our third quarter financial results and our updated earnings expectations for 2024.

Slide 5 shows our expected 5-year compounded annual growth rate and earnings per share with and without the impact of our Plastics segment, through the end of 2024 based on the midpoint of our updated earnings guidance. Even without the impact of the extraordinary results generated by our Plastics segment over the last few years, we expect to produce a compounded annual growth rate above our long-term earnings per share growth target of 5% to 7%.

Turning to our Electric segment. Slide 7 provides an overview of our Electric operations. Earlier this year, our regulated Electric utility announced a sizable 5-year capital spending plan with significant amounts being allocated to renewable generation, transmission investment and technology. In addition to Otter Tail Power's rate base growth, we continue to explore opportunities to bring new large loads online, which is summarized in more detail on Slide 8.

Otter Tail Power is well positioned to address the needs of new large loads. We have approved tariffs already in place and have several sites available that could support these loads with minimal delivery infrastructure investment needed, increasing the speed to market as well as reducing the cost to do so. We will continue to evaluate and pursue these opportunities while balancing the needs of our current customers.

Slide 9 summarizes Otter Tail Power's 5-year capital spending plan, which is expected to produce rate base growth of 7.7%. As discussed in our last earnings call, with the approval of our integrated resource plan in Minnesota earlier this year, we anticipate upside to our 5-year capital spending plan and we'll provide an update during our year-end earnings call in February of 2025.

I will now provide a few details on several projects within the existing 5-year planning period and beyond. Otter Tail Power's advanced metering infrastructure or AMI project is progressing well as summarized on Slide 10. Approximately 90% of the 173,000 meters have been upgraded and we look forward to leveraging the additional data these meters will provide to better serve our customers and enhance their experience. We expect this project will reduce operating expenses through lower meter reading costs and technology-enabled savings.

Turning to Slide 11. Our wind repowering project within investment of approximately $230 million remains on budget and on schedule. We expect to finish the equipment upgrades at the first of our 4 owned wind energy centers later this year, with the other 3 by the end of next year. This project continues to be an excellent example of capital investment that serves both customers and investors. Even with the significant amount of capital investment, we expect the project to lower customer bills through the use of available tax credits and the incremental energy output produced from these upgrades.

Slide 12 summarizes Otter Tail Power's investments under Tranche 1 of MISO's long-range plan, which are expected to total approximately $420 million. We continue to be in the development phase of these projects and are working to secure the various required regulatory approvals. Separately, in June of 2024, MISO revised their proposal for Tranche 2 of their long-range plan and released their near final Tranche 2 portfolio projects. We currently anticipate Otter Tail Power will co-own 3 projects included in the portfolio and anticipate the Board -- MISO Board of Directors to approve the portfolio later this year.

These long-range transmission investments, which helped to support overall grid reliability are expected to have a limited impact on our retail customer rates as they are allocated across the entire MISO North footprint, of which our customer base only comprises a small percentage. In addition to the transformation investments available through MISO's long-range transmission plan, MISO and the Southwest Power Pool or SPP, partnered to develop the joint target and interconnection queue or JTIQ portfolio projects, focused on improving the interconnection queue backlog along the MISO SPPC.

MISO and SPP have filed their cost allocation tariff with FERC and requested them to act on or before mid-November. If FERC approves the filing, we expect the MISO Board to approve the portfolio at its December meeting. We remain optimistic about the potential investment opportunity, which we estimate to range from approximately $350 million to $400 million.

While Tranche 2 and JTIQ represent incremental transmission investment opportunities for us, most of the spend is likely to fall outside of our current 5-year planning period. Turning to Slide 13, ensuring affordable electric service for our customers remains a top priority of ours, and we are proud of Otter Tail Power has some of the lowest electric rates in the country, compared to other investor-owned utilities. We continue to seek ways to keep customer bills low while making significant capital investments to support safe, reliable and increasingly clean Electric service.

Slide 14 summarizes Otter Tail Power's key regulatory matters for the remainder of 2024. North Dakota staff and intervenor testimony relating to our rate case was received in October. And as expected, there are differences between our request and their position. Despite these differences, we continue to expect being able to work towards a constructive outcome, an evidentiary hearing is scheduled before the North Dakota Commission in December, and we anticipate the final outcome of the rate case will occur in early 2025.

For more information regarding the case, please refer to Slide 15. We do not expect to file a rate case this year in either Minnesota or South Dakota. Separately, we had an informal hearing before the North Dakota Commission in October to discuss our integrated resource plan. We are waiting on a decision from the commission to obtain further clarity on what renewable resource additions, if any, would be jurisdictionally allocated to North Dakota.

Turning to our Manufacturing segment on Slide 18. BTD and T.O. Plastics continue to face end market demand-related headwinds. We continue to take actions to tightly manage costs to mitigate the impact of lower sales volumes on earnings. Despite this near-term softness, we remain confident in the longer-term fundamentals of the segment.

Our BTD expansion project in Georgia is progressing well, and we anticipate occupying the new space later this year. We look forward to bringing this additional capacity online in early 2025, to better serve our customers in the Southeast, which is a growing market for us. We anticipate the additional capacity at our Georgia location can support up to $35 million in additional annual revenue.

Turning to our end market outlook on Slide 20. Many of the end markets BTD serves have softened, primarily within recreational vehicle, agriculture, construction, and lawn and garden. T.O.Plastics primary end market horticulture has softened as well. Distributor and grower inventory levels have largely normalized after working through elevated inventory levels during the latter part of 2023 and most of 2024. But we are facing increased competition from import markets. Additionally, end-user demand is expected to be flat to down as the market adjusts to consumers post-pandemic behaviors and buying patterns.

Slide 21 provides an overview of our Plastics segment. Despite Plastics segment earnings decreasing from the same time last year, due to lower sales prices of PVC pipe. The segment continues to perform better than expected, capitalizing on customer sales volume growth and improved distributor and end market demand. Our ability to fill orders on an immediate basis is serving us well in the current environment. First phase of our Vinyltech expansion project in Arizona continues to progress well and is nearly complete. We look forward to adding large-diameter PVC pipe production capability at this location, later this year so that we can better serve our customers in the South and Southwest, while simultaneously freeing up large diameter capacity at Northern Pipe Products in North Dakota.

PVC pipe prices continue to decline but at a slower rate than we expected. Our prices reflect the dynamic nature of the business and the industry, including the supply and demand of PVC pipe in the cost of supply and material inputs, including PVC resin. Improved demand has moderated the rate of pricing declines. However, we continue to expect the sale price of PVC pipe to decline over time. We continue to closely monitor new home construction, vacant lot development and interest rates.

As that conclude, I want to acknowledge the class action lawsuits against many of the pipe manufacturers in the industry. We believe there are factual and legal defenses to the allegations in the complaints and we intend to defend ourselves. These are current and active cases, we will not be commenting further today on these allegations and claims against Otter Tail and the industry.

I will now turn it over to Todd to provide additional commentary on our third quarter financial results and our expectations for the remainder of the year.

[Todd Wahlund, executive]

Thank you, Chuck, and good morning, everyone. Diluted earnings per share for the third quarter totaled $2.03, a 7% decrease from the same time last year. Despite the lower quarterly earnings, our year-to-date earnings exceeded last year by 4%. Our Plastics segment continues to perform better than expected, capitalizing on customer sales volume growth, distributor and end market demand and PVC sales prices that have remained stronger than what we had anticipated.

Due to the continued strong financial performance within our Plastics segment, we increased the midpoint of our 2024 earnings per share guidance by $0.15 or 2%. Please follow along on Slide 25, as I provide an overview of our third quarter financial results by segment.

Electric segment earnings increased 16% from the third quarter of 2023 due to the impact of the North Dakota rate case, in term rate increase, increased transmission and rider revenue. and the impact of favorable weather. This was partially offset by higher interest and depreciation expense. Transmission revenue for the quarter was higher compared to last year due to a recent decision issued by FERC, which supported our lowering the estimated refund on the allowed return on equity dating back to 2013. This resulted in a nonrecurring earnings per share increase of $0.04 in the third quarter.

Manufacturing segment earnings decreased 71% compared to the third quarter of 2023 due to lower sales volumes and profit margins, product pricing and sales mix changes and decreased scrap revenue. This was partially offset by lower SG&A expense. Sales volumes in the Manufacturing segment decreased 13% in the third quarter of 2024, compared to the same time last year. The end markets that saw the greatest declines in the quarter included recreational vehicle, agriculture, construction and lawn and garden.

Sales volumes have softened due to lower end market demand as well as manufacturers and dealers tightly managing their inventory levels amid uncertain market conditions. Lower profit margins were largely driven by the mix of products sold during the quarter as well as reduced leverage of our fixed manufacturing costs due to decreased production and sales volumes. Despite the near-term softness, the fundamentals of the segment remains strong, and we expect the Manufacturing segment to produce earnings growth in line with our EPS growth target over the long term.

Plastics segment earnings decreased 8% from the third quarter of 2023, primarily due to lower profit margins, which was partially offset by higher sales volumes. Gross profit margins decreased in the third quarter due to lower sales prices. Pipe sales prices have steadily declined throughout the year and decreased 11% compared to the same time last year. Sales volumes increased 13% from the third quarter of 2023, due to incremental customer sales volume growth and improved distributor and end market demand.

With the increased earnings and cash generated by our diversified business model, our balance sheet and credit metrics continue to be very strong. Slide 27 shows our total available liquidity on our lines of credit as of September 30, 2024. This, combined with our $280 million of cash results in total available liquidity of $544 million. Our consolidated equity layer of nearly 62% continues to be at a very healthy level and our return on equity over the last 12 months exceeded 20%, outpacing our utility peers.

Turning to Slide 28. Due to the continued strength within our Plastics segment, we are increasing and tightening our 2024 diluted earnings per share guidance to a range of $6.97 to $7.17, from our previous guidance range of $6.77 to $7.07. This increases the midpoint of our guidance to $7.07, which is a $0.15 increase over previous guidance midpoint.

We are maintaining our Electric segment and corporate cost center guidance for 2024. Our Electric segment earnings are expected to increase 7% over 2023 levels. We are decreasing our 2024 earnings guidance for our Manufacturing segment, primarily due to lower anticipated sales volumes in the fourth quarter. As mentioned previously, many of our markets are experiencing end user demand-related headwinds, and we expect manufacturers to continue to tightly manage their production and inventory levels in response throughout the remainder of the year.

Additionally, we anticipate product pricing-related pressures due to weakened demand. We will continue to take action to tightly manage our costs in this down cycle, while ensuring our team and operations remain agile to respond quickly when demand improves. We are increasing our Plastics segment 2024 earnings guidance for a couple of reasons.

First, our third quarter financial results were better than what we had expected. Second, while we anticipate the sales prices of PVC pipe, to continue to decrease, we now expect this decrease to be at a slower rate of decline than what our previous earnings guidance assumed. Additionally, we expect sales volumes in the fourth quarter to be higher than what we had previously assumed.

With the changes made to our earnings guidance for the year, we anticipate our earnings mix for 2024 to be 30% Electric and 70% nonelectric, net of corporate costs. While this anticipated mix deviates from our long-term earnings mix target of approximately 65% Electric and 35% Nonelectric, the incremental earnings and cash generation helps drive shareholder value as we remain in an enviable position to execute on their long-term growth plan with the support of a strong balance sheet and no equity needs in the current 5-year planning period.

We continue to expect to reach our targeted long-term earnings mix of 65% Electric and 35% Nonelectric, as Plastics segment earnings declined to a range of $45 million to $50 million on an annual basis. While our Electric segment earnings grows, at a rate in line with our projected rate base growth, compound annual growth rate. Our 5-year capital spending plan, which is a key driver of earnings growth for our Electric segment is included in more detail on Slide 29.

No changes have been made to this plan since it was first announced earlier this year. However, as Chuck mentioned, we expect sharing an updated 5-year capital spending plan during our year-end earnings call and anticipate incremental capital investment opportunity, primarily within our Electric segment over the next 5-year spending period.

Slide 30 provides a summary of our financing plan for 2025 through 2028. We continue to plan for retiring and not replacing our only outstanding parent level debt when it matures in 2026 and continue to forecast no equity needs within the existing 5-year planning period and potentially beyond despite our significant rate base growth plan. This helps to differentiate us from many of our utility peers that will need to issue additional equity to fund their rate base growth plan, resulting in earnings per share dilution.

We are positioned well to deliver upon our increased 2024 earnings guidance and meet our long-term investment targets as summarized on Slide 33. Our diversified business model continues to produce above-average returns and long-term value for our shareholders. We have many growth opportunities across our segments and are positioned well to grow with our customers. We are in an excellent position to support this growth with our strong balance sheet, ample liquidity and investment-grade credit ratings.

We are now ready to take your questions.

[Operator]

[Operator Instructions] And our first question comes from Ida Wozniak of Siebert Williams and Shank.

[Christopher Ellinghaus, analyst]

This is Chris. Chuck, you've talked about some potential new large loads for a while. Have you got any ability to elaborate for give us any sense of what kind of time line that might be?

[Chuck MacFarlane, executive]

Chris, thanks for the question. We, as many in the industry are working with a number of entities that are interested in this, both the end-use customer and people that would make the facilities in a data center mode, but also Crypto mining and then particularly to our geographic area, we have a lot of interest in clean fuels, whether it's sustainable aviation fuel or a little carbon ethanol type facilities in each of those. I would indicate we're in discussions with a number of people.

We have not moved to signing any electric service agreements, but we have several projects that are in discussions or letter of intent situations on that. So from a time frame, I would expect we will have to have something here within the next 2 quarters.

[Christopher Ellinghaus, analyst]

Okay. That helps. As far as the Plastics segment goes, you now have rising volumes, which has its own pressures on price. And that's beginning to sort of offset declining price. Have you got any new insights into what you think the glide path towards normal is? And has your thoughts on what new normal will ultimately be changed at all?

[Chuck MacFarlane, executive]

Chris, I don't think that our idea where the new normal would be has changed. We have been fairly consistent in that $45 million to $50 million. We anticipate that in the 2026 time frame. And we anticipate the prices will continue to receive between where they are now and that level over that time period.

[Christopher Ellinghaus, analyst]

Okay. Great. You alluded to some import pressures on Manufacturing end-markets. Can you elaborate on that? And how much of it do you think is some consumer pressures from interest rates and maybe postponing some purchases hoping for a better 2025?

[Chuck MacFarlane, executive]

Chris, our reference on this is primarily to T.O. Plastics. And I think there's a review of just what you mentioned, spending patterns of the end-use customers in the [indiscernible] market, but also the import market we think has changed just because of the price of overseas freight has declined significantly. And while it was there, pre-pandemic during the high freight periods, a lot of that pressure from imports dropped off that. We feel that that's now come back.

[Christopher Ellinghaus, analyst]

Okay. So lastly, with the new capacity in Arizona, can you just sort of talk about the dynamics between the large diameter pipe market in Arizona, the absence of having to ship the pipe? So what does that do to Arizona margins? And also, if North Dakota is and selling into the Arizona market? Do they have a void there that they can fill with their large capacity pipes? So are you expecting improved margins overall in volumes?

[Chuck MacFarlane, executive]

So I think on volumes, we would expect increased volumes. And by way of background, when we get an order for a development or whatnot, it may include some amount of large diameter pipe, which in the Southwest, we have been unable to provide from the Vinyltech facility because it didn't have equipment -- able to make that. And so you would only get a partial order or not get an order because you couldn't fulfill the whole thing or we had to ship it at a very high cost from North Dakota. We think that will be alleviated and should improve our sales volumes in the South and Southeast.

[Christopher Ellinghaus, analyst]

And what ends up happening to the volumes that North Dakota was providing? Will they be able to sell that locally?

[Chuck MacFarlane, executive]

We believe so. It was not a lot of volume. It is a long way to ship pipe. So...

[Operator]

Our next call comes from the line of Tate Sullivan of Maxim Group.

[Tate Sullivan, analyst]

First, going back to PVC. I mean, can you talk about why distributors that buy the PVC such as [ Corn Main ] and Fergusons are willing to pay prices above the historical spread to resin or your customers, the distributors waiting for extra supply? Do they still want extra inventory? Can you go into some background on that dynamic, please?

[Chuck MacFarlane, executive]

Thanks for the question. We believe that there's a lot of supply and dynamics in PVC pipe and pipe pricing. There are a number of issues that go into how that's set. I can't really ascertain will speak for the distributors. And beyond that, we just -- we're not really going into any of the stuff that's going into the litigation, since it's an ongoing litigation, I'm not in a position to comment particularly on that.

[Tate Sullivan, analyst]

And then when you comment on -- I mean the margins going down, the pricing going down in the PVC eventually, are you really basing that on what you're seeing for the resin prices? And can you -- what is resin prices done since September since you have more visibility than many?

[Chuck MacFarlane, executive]

There's a lot of things that go into the pricing, not just [ RASM ], and I really not able to go into that anymore at this time due to the litigation. .

[Tate Sullivan, analyst]

Okay. I understand that. And then -- and then, Todd, the manufacturing, you mentioned on the weakness in BTD, you covered it in a lot of comments and the questions. What is the relative manufacturing revenue mix between BTD and T.O.Plastics? Is it still well a majority of BTD or T.O.Plastics? I mean, have you given the percent breakdown before?

[Todd Wahlund, executive]

You're absolutely right, Tate. BTD is the much larger entity of the 2. So most of our financial results would be driven by BTD. And this year, T.O.P has been very challenged all year long with sales volumes. So it's a little higher this year than normal.

[Tate Sullivan, analyst]

And then just -- sorry, just on the PBC as well. You mentioned the $45 million to $50 million. Is it normal? What is that referring to? -- the -- I mean, because you have [ 350 pounds ] of capacity growing that by about 7%? What were you referring to with that number?

[Chuck MacFarlane, executive]

Tate, I was referring to our forecast net income from that segment in 2026 or beyond.

[Operator]

As there are no remaining questions in the queue, I would now like to turn the call back over to Chuck for his closing remarks.

[Chuck MacFarlane, executive]

Thank you for joining our call and your interest in Otter Tail Corporation. If you have any questions, please reach out to our Investor Relations team. We look forward to speaking with you next quarter.

[Operator]

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.