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Otter Tail Corp
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Good morning and welcome to the Otter Tail Corporation's 2019 Earnings Conference Call. Today's call is being recorded and we will hold a question-and-answer session after the prepared remarks.
I will now turn the call over to the Company for opening comments.
Good morning, everyone and welcome to our call. My name is Loren Hanson and I manage Otter Tail's Investor Relations area. Last Friday, we announced our 2019 earnings results and our 2020 earnings per share guidance range. Our complete earnings release and slides accompanying this call are available on our website at ottertail.com. A replay of the call will be available on our website later today.
With me on the call today are Chuck MacFarlane, Otter Tail Corporation's President and CEO; and Kevin Moug, Otter Tail Corporation's Senior Vice President and Chief Financial Officer.
Before we begin, I want to remind you that we will be making forward-looking statements during the call. As noted on Slide 2, these statements represent our current judgment or opinion of what the future holds. They are subject to risks and uncertainties that may cause actual results to differ materially. So please be advised about 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.
For opening remarks, I will now turn the call over to Otter Tail Corporation's President and CEO, Mr. Chuck MacFarlane.
Thank you, Loren and good morning, everyone. Welcome to our 2019 year-end earnings call. Please refer to Slide 5 as I begin my comments. Earnings per share were $2.17 which is above the midpoint of our updated 2019 earnings guidance of $2.10 to $2.20. Operating revenues, net income and diluted earnings per share all increased year-over-year.
Our Electric segment earnings increased primarily due to transmission costs and renewable resource rider recovery as well as final rate increases in South Dakota rate case. While Manufacturing segment earnings were relatively flat, we saw improved performance of BTD driven by growth in parts revenue. As anticipated Plastics segment earnings were lower due to lower pipe prices and lower operating margin. Some of Otter Tail Power's 2019 accomplishments include, the Merricourt Wind Energy Center, Astoria Station, South Dakota Transmission Reliability and self-fund transmission projects all began construction. Our projected investments in those projects totals approximately $500 million. To put this into context, this represents approximately 43% of our current $1.2 billion rate base. I'll touch briefly on a few of these projects.
On Slide 16, the Merricourt Wind Energy Center remains on time and on budget. More than two-thirds of all civil work and tower foundations are complete. The project has received Minnesota Renewable Resource Rider approval, North Dakota advanced determination of prudence and South Dakota phase-in rider recovery. We estimate this project will cost approximately $258 million and will generate enough energy to power more than 65,000 homes. This is the largest capital project in Otter Tail Power history and we anticipate beginning commercial operation in the fourth quarter of 2020.
On Slide 17, Astoria Station construction also remains on time and on budget. We awarded the general work contract last quarter. Astoria will be a highly efficient 245 megawatt natural gas combustion turbine. It will complement our wind generation by providing a reliable backstop when the wind isn't blowing and it will have flexible operating options and low CO2 emissions.
We expect to invest approximately $158 million in this project and anticipate it will be online near the year end 2020. We completed the first of a two-phase transmission project to improve reliability for customers who live in the southern part of our service area. The first phase was a new 15-mile 115 KV transmission line that connects the expanded Hedland substation to the new Lake Northern substation in South Dakota. In August we began construction of a second phase of this project, a new 43-mile 115 KV transmission line in Lake Norden to Astoria South Dakota. Phase 2 engineering is 90% complete. We have attained 99% of project easements and we set approximately 18 of the 43 total miles of structures. We expect to energize the line in mid-2021.
As shown on slide 19, we have the opportunity to add approximately $45 million of rate base associated with new generator interconnection upgrades as proposed by the MISO generator interconnection process.
Self-fund in an election by the transmission owner, in this case, Otter Tail Power, to fund the initial network upgrades associated with new generator interconnections. To date FERC has approved eight facility service agreements, or FSAs, between interconnection customers and Otter Tail Power. We have another seven FSAs filed with FERC and MISO is preparing an additional 12. Otter Tail will fund and earn return on and return of the capital costs of these network upgrades over a 20-year period from the interconnection customers. Minnesota Public Utilities Commission approved an extension until September 1st of 2021 for filing of our next resource plan.
Two key federal environmental regulations that may impact our Company are the Regional Haze Rule and the proposed Affordable Clean Energy Rule. Generation source is subject to [indiscernible] of the Regional Haze Rule including Coyote Station will likely be required to undertake emission control measures, reasonably consistent with those required of sources [indiscernible]. Delaying our resource planning will allow us to better understand the direction of environmental regulations and develop a more informed plan. I would like to give special recognition to Otter Tail Power Company employees who marked 2019 with the Company's best OSHA record -- rate on record and continue to put safety first.
BTD, our contract metal fabricator, had an excellent year, increasing sales 4% and net income by 14%. IN our Washington, Illinois plant, which has some protection of parts used in the oil and gas fracking industry, continues to be impacted by the impacts of the soft oil and gas environment. The Company reduced employee counts at Illinois and Detroit Lakes, Minnesota sites last year as part of its sales, inventory and operation planning or SIOP process. They continue to balance production outputs and inventory levels to ensure continued on-time delivery. The Georgia facility significantly improved profitability as sales grew nearly 20% in 2019. The Company achieved this while reporting its lowest OSHA rate on record and its highest on-time delivery this year.
In our Plastics segment, as part of our strategic succession plan, Northern Pipe Products announced Terry Mitzel as Company President. Mitzel has been employed with Northern Pipe Products for more than 12 years. His most recent roles were Vice President of Sales and Marketing preceded by Director of Sourcing. In his role as President, Mitzel oversees the executive leadership team and continues to manage the resin buying process for the Plastics segment.
We are confident that his experience and skills coupled with a strong team and momentum existing in Northern Pipe Products will lead to continued achievement of outstanding customer service, operational excellence and talent development. Both companies are implementing continuous improvement projects to enhance efficiency and capacity.
On final note, we continue to enhance our balanced generation mix. As shown back on Slide 6, we anticipate that by 2022 Otter Tail Power customers will receive 30% of their energy from renewable resources, our carbon emissions will be at least 30% below 2005 levels all while keeping average residential rates nearly 30% below the national average. With growing investor concern about companies generating more than 25% of revenues from thermal coal, it's assuring to know that Otter Tail Corporation's percentage of revenue from coal assets is well below that threshold. As shown on Slide 10, the percentage of consolidated revenues from our coal assets was 13.7% in 2019 and it is projected to decline to 11% by 2020.
I'll now turn it over to Kevin for the financial perspective.
Well thanks, Chuck and good morning everyone. I'll cover the following items, our 2019 full year financial results, details on the fourth quarter results are covered in our earnings release, our liquidity position, strength of balance sheet, corporate credit ratings, the increase in our 2020 indicated annual dividend rate, our five-year capital expenditure plan and our 2020 business outlook. 2019 was another strong year for us financially. We earned $2.17 a share, which represents a 5.3% increase over 2018. This increase was primarily driven by our Electric segment supported in large part by our continued investments in our growing rate base.
Our Manufacturing segment earnings were flat year-over-year. BTD's earnings grew approximately 14% but were offset by disappointing year-over-year decline of T.O. Plastics earnings of 54%. And as expected our Plastics segment earnings were down from our record year in 2018. Our 2019 return on equity was 11.6% on an equity ratio of 52.9%. Our two-platform strategy continues to deliver higher returns on equity on a higher equity layer when compared to holding company peers.
Let me now provide an overview of 2019 earnings by segment, as shown on slides 24 and 25. Electric segment net earnings increased $4.6 million. Key drivers include increased transmission cost recovery in Minnesota, renewable resource rider revenues, increased retail revenues in South Dakota due to the final outcome of our 2018 South Dakota rate case settlement, increased revenues from the establishment of a generation cost recovery rider in North Dakota in conjunction with the construction of the Astoria Station, increased Minnesota SIP revenues and slightly favorable year-over-year weather impact.
Other key items impacting Electric segment earnings were a decrease in transmission service revenues into lower MISO tariff revenues and the impact of the November FERC ruling related to the methodology used to determine the return on equity component of the transmission rate under the MISO tariff. This ruling negatively impacted Electric segment earnings by $1.4 million, a reduction in O&M expenses as explained in the earnings release and higher depreciation in property tax expense associated with rate base additions in 2019 and increased income tax expense.
Net earnings for the Manufacturing segment were basically flat year-over-year. Key items impacting these changes were, at BTD net revenues increased $9.5 million due to a $12.3 million increase in parts sales to its major end markets except for decreased sales to its energy end markets. $11.6 million of the increase relates to higher sales volumes with the balance representing higher material costs passed on to the customer.
The increased parts revenues were offset in part by a $2.8 million decrease in scrap revenues from lower scrap metal prices. Higher cost of goods sold and material costs were partially offset by the recovery of tooling costs from customers. And increased gross margins were partially offset by higher operating expense resulting in a $1.4 million increase in BTD's year-over-year earnings.
T.O. Plastics' revenues declined $700,000 due to lower industrial and horticultural sales and change in their sales mix due to a customer bringing more production in-house. These were partially offset by increased sales in life science and scrap materials.
Higher cost of goods sold due to the increased labor costs, increased operating expenses and lower operating margins due to the unfavorable sales mix resulted in a $1.4 million decrease in year-over-year earnings. Our Plastics segment earnings decreased $3.2 million year-over-year due to a 4.2% decrease in pounds of pipes sold and a 3.3% decrease in pipe sales prices. The lower volume resulted from poor weather conditions across our sales territory last year combined with lower demand for products in both the Midwest and West Coast states that we serve.
Cost of goods sold decreased $8.9 million due to the decrease in sales volumes and a 1.9% decrease in the cost per pound of pipe sold. The decrease in pipe prices net of the decreases in costs resulted in a 7.7% decrease in gross margins.
Corporate costs net of tax decreased $3.1 million year-over-year primarily due to there were no contributions made to Otter Tail Corporation's foundation in 2019. We experienced increases in the value of corporate-owned life insurance benefits, corporate cost allocated to our operating companies, increased earnings from our captive insurance company and lower post-retirement benefit costs. These items were offset in part by higher employee benefit costs and higher interest expense. We also had an increase in corporate income tax savings of $2.3 million due to changes in uncertain tax positions, state net operating loss valuation allowances and other tax adjustments.
Moving to Slide 26, let me review our financial condition and liquidity. Our 2019 financing activity consists of $175 million private placement of debt for Otter Tail Power Company. Slide 27 shows tranches associated with the private placement. The first tranche was issued for $100 million in October of 2019. The remaining proceeds will be issued in 2020 through delayed draws of $35 million in February and $40 million in August.
We also issued $19.8 million in new equity, net of commissions during the fourth quarter last year. We expect to issue additional equity in 2020 from our at-the-market, dividend reinvestment and employee stock purchase programs. Both the debt and the equity are being issued in connection with our rate base growth projects at utility. Our two credit agreements are in place until October 31 of 2024, between expected cash flow generated from 2020 operating activities. And in these credit facilities, we have the appropriate levels of liquidity to support our businesses.
As shown on Slide 28, the Board of Directors increased our indicated annualized dividend rate from $1.40 a share to $1.48 per share. This 5.7% increase reflects our solid 2019 performance, our 2020 outlook, the Company's strong balance sheet, liquidity, cash generation profile and our commitment to enhancing shareholder returns. We expect future dividend increases to be in line with earnings growth rate while maintaining a targeted payout ratio of 60% to 70%. And this will be the 81st year or 325 consecutive quarters we have paid a dividend on our common stock.
Slide 29 highlights our capital expenditure plans for the 2020 through 2024 time frame. We expect capital expenditures for 2020 to be $385 million of which 96% is earmarked for our Electric segment. Planned expenditures for this year include $178 million for the Merricourt Wind project and $83 million for the Astoria Station natural gas-fired plant. The five-year capital expenditure plan calls for approximately $897 million in utility projects, of which approximately 40% will be recovered through riders. The plan also includes $87 billion for Manufacturing and Plastics segments.
Moving on to our business outlook on Slide 30, our 2020 diluted earnings per share guidance is $2.22 to $2.37 a share. The midpoint of the guidance reflects a 6% growth rate off 2019 diluted earnings per share. Our guidance also reflects $0.05 of dilution associated with additional equity plan for this year. And the guidance range equates to a return on equity range of 11% to 11.7% based on an estimated equity to total cap ratio of 53%.
We expect our Electric segment to provide 75% of our consolidated earnings in 2020 with an increase over 2019 segment net income based on increased revenues from capital expending on our Merricourt and Astoria Station rate based projects, increased revenues related to anticipated capital spending for the self-funded generator interconnection agreements and oil plant planned outages for 2020.These items were offset in part by normal weather. Weather favorably impacted earnings per share by $0.08 compared to normal in 2019. Increased expense is in large part due to higher pension expense. Our discount rate for 2020 is 3.47% compared to 4.5% last year. Each 25 basis point decline in the discount rate results in an increase in pension expense by about $1 million. Also the long-term rate of return for 2020 is 6.8% compared to 7.25% last year. Each 25 basis point decline in this rate results in approximately a $700,000 increase in pension expense.
Higher property tax and depreciation expense due to large transmission projects put in service, an increased interest expense on the $100 million of senior unsecured notes that were issued in October of 2019 and interest on the $35 million and $40 million of senior unsecured notes expected to be issued in February and August of 2020. We expect earnings from our Manufacturing segment to be in line with 2019 earnings due to lower sales volumes in the recreational vehicle end markets served by BTD and continued softness in scrap metal revenues stemming from lower sales volumes while scrap prices are expected to stay flat between years.
We expect higher T.O. Plastics mainly due to increased sales to horticultural, life science and industrial end markets. The backlog for this segment is approximately $179 million for 2020 compared with $211 million a year ago. Material price deflation is driving down backlog by $19 million and the remaining $13 million decrease in backlog is volume driven.
We expect Plastics' 2020 net income to be lower than 2019 due to lower operating margins resulting from lower sales prices and stable resin prices on slightly higher volumes compared to last year. And our corporate costs, net of tax are expected to be higher in 2020 primarily due to higher short-term borrowing costs at the corporate level, higher income tax expense which are offset in part by lower employee benefit and health care costs.
Our strategic initiatives to grow our business and achieve operational and commercial excellence positions us to achieve a 5% to 7% compounded annual growth rate in earnings per share using 2019's'$2.17 a share. Key drivers in achieving our 2020 guidance for the utility include continued execution of our Merricourt and Astoria Station capital projects. Our compounded annual growth rate in rate base is projected to be 8.2% over the 2019 through 2024 time frame.
For BTD, key drivers will be continued utilization of existing capacity and operational improvements across all locations to further improve our return on sales margins and returns on invested capital. And our Plastics segment is well positioned to provide another strong year in earnings and continues to provide strong cash flows to support our dividends and returns on invested capital.
We are now ready to take your questions.
[Operator Instructions] After the Q&A, Chuck will return for a few closing remarks. Our first question comes from Tate Sullivan with Maxim Group.
Hi, thank you. Good morning. Slide 19 on the self-fund transmission projects, are the -- can you just walk through what is included in your current CapEx guidance just the ones that have received FERC approval, is that the case?
Good morning, Tate. This is Chuck. The ones that are included are all the ones that we anticipate to interconnect in '20 and '21. They include both ones that have approved FERC interconnection and anticipated ones. One other thing is there each project may have more than one FERC FSA that goes with it. So we are anticipating that these are largely the projects that will be put in service before the end of the ramp down of the PTC for wind.
Okay, thank you. And then Kevin on CapEx on the -- also on the CapEx guidance, slight changes from your previous guidance. I mean can you just comp, was it timing related to, I think you previously guided spending $233 million this year, you spent $207 million and then you increased by a lesser amount for the out years. But can you just give us some context to what changed, please?
Yes. I mean, Tate, thanks. I mean it's -- a fair amount of it's just timing in terms of the one that expenditures are coming through. So, one we originally expected is what's driving that kind of change. And then maybe just to further clarify your first question, we have what's actually included in the self-fund is the $45 million in our capital plan that we show on Slide 14 and on Slide 19.
Okay. Thank you for that. I'll get back in line.
Our next question comes from Chris Ellinghaus from The Williams [ph].
Hey guys. How are you today?
Good, Chris.
Good, Chris.
Can you just elaborate a little bit about your outlook for BTD and specifically sort of what you're thinking about the ATV [ph] market and how that might influence Georgia's performance also?
Yes, Chris, this is Kevin. As we head into '20 and what we're seeing from our customers in that recreational vehicle market, we're starting to see some softening in terms of the -- some of the demands that are coming from them. And so our 2020 guidance for manufacturing of which BTD is included is reflecting what we expect to see that decline in volumes to be coming from the RV end market or specifically the customers within that end market.
Okay. So can we infer from the -- with the midpoint of the Manufacturing guidance seems to be kind of in the flat range, should we be generally expecting a little weaker TD offset by your expectations?
In terms of [indiscernible] but in terms of the guidance range of that $31 million to $35 million and that midpoint, BTD's part of that is slightly lower now than where 2019 earnings came in and that -- like I said, that's really driven in large part by the softening in the RV end market.
Okay. Yes, what I was saying was it looks like or -- I mean I'm inferring from the midpoint of the range being kind of flat [Technical Difficulty] maybe BTD is down a little bit but that's picked up by slack from improvement you talked about expecting at T.O.?
That's correct.
And what is -- what is your thought about T.O.'s outlook to better than 2019 at this point?
Sure. T.O. has kind of a handful of struggles in 2019. They were started out the year as a challenge with productivity, efficiency on the manufacturing side. They had some challenges related to, of course, the roof collapse in March that occurred and shut the warehouse down and had impact on shipping for a while and then we had a number of new hires in the plant. There were lots of transition and training and education that occurred with that. So our productivity and efficiency around the manufacturing process was certainly below our expectations in '19 when we saw that continue into December of '19. And as we head into '20, we expect that those efficiencies and -- productivity and inefficiencies, I should say are pretty much behind us. And so we would expect to see better productivity coming out of the plants [ph]. And then given some of the slowness that occurred in sales in the fourth quarter in December, we expect to see a pickup from that as we head into 2020.
Okay. And as far as PVC's outlook sort of address what your -- kind of weakness that you saw in some of the demand in 2019 and also can you elaborate on what the weather impact look like in 2019 a little bit?
Yes, I think -- we do expect -- we saw weather impact in the second part of the -- probably the tail end of the first quarter, into the second quarter. And as we talk about increased volumes in 2020, we expect that we're going to see some of that come back to us in 2020 because of the delays that were caused by the heavy rains that occurred in our regions that we serve. So that -- this volume increase that we're talking about for '20 is in part driven by giving that weather back -- or I am sorry, the weather delays back based on, if you will, a more normal weather pattern for construction that we would expect to see in our regions.
Okay. And the general demand weakness that you sort of note, was that influenced by the weather as well?
In part, it certainly was, yes.
And your -- what kind of market [Technical Difficulty] weakness in last year and is that outlook better for this year?
Well we saw, weakness in parts of our Midwest and West Coast service territories, if you will, in '19. We ended up -- we saw a fair amount of product in the Texas as a part of softening in the Midwest and West Coast. And based on this, we expect to see in 2020 some strengthening back in that West Coast and Midwest markets, as we head into the year and we certainly have assumptions around that in our guidance.
Okay [Technical Difficulty] 2019, are they ending up being lower margin due to the distance for transportation?
Yes.
Thanks, guys. Appreciate the color.
Thanks, Chris.
Our next question comes from Brian Russo with Sidoti.
Hi, good morning. The $158 million total cost for Astoria, how much is allocated to Minnesota?
Brian, this is Chuck. All of our generation and transmission is based on allocation partly driven by our coincident [ph] peak. So, roughly 53% of the total project will be allocated to Minnesota.
Okay. And that as well as any other accumulating rate base you will file for recovery in late 2020 with a 2021 test year?
We will -- I think it's important that in Minnesota, because we do have rider recovery in the Dakotas for the Astoria Station, in Minnesota we have approval in our integrated resource plan of the gas plant and we will need to file that. We're collecting AFUDC at this point, we will need to file that in our next general rate case, which is rightly anticipated at end of 2020 for a 2021 test year, yes.
Okay, great. And remind us of when the last rate case was finalized in Minnesota?
That's 2017.
2017, but I do not have the month regarding the final order.
Yes, it was filed -- we filed in the November of '17 and I think the final order was in the third quarter or early fourth quarter of '18.
Got it. Okay. And then I think you said there is $0.05 dilution to the -- at the market and/or dividend reinvestment plans in 2020. Would you mind just quantifying that on an absolute basis of how much equity might be needed?
Yes. Brian, we're expecting the issue another $55 million to $60 million of equity in 2020.
Okay, great. And then just on pension expense, the incremental information was helpful. What is the drag in 2020 over 2019 due to the lower interest rate and is that one-time or is that just kind of the new levelized cost going forward?
Yes, so the impact on the discount rate change is approximately $4 million year-over-year from [indiscernible] to the new rate that we have for 2020 and then the drag on the long-term rate of return changes is about another $1 million. So collectively about $5 million year-over-year impact because of change in the two rates. That is then affects -- that's the impact for 2020. We reset those rates annually so in the December -- late December of 2020, we will reset those rates based on current interest rate conditions in place at the time using methodologies we use upon matching our model to set our discount rate. And then of course we'll look at what kind of actual returns we had in our pension plan and what our asset allocation is amongst the plan assets to help set the long-term rate of return for 2021.
Okay. And is that -- incremental pension expense, is that included in the updated -- or included in the corporate costs for 2020 or is that -- does that fall somewhere else?
That is predominantly, Brian, in the utilities numbers.
Okay.
The utility is where the pension plan sits. Corporate has a slight impact from that because there are a few corporate employees that are in the pension plan, but it's predominantly at utility.
Okay, great. And I think you mentioned in 2019 there was a $0.06 positive weather impact versus normal. Could you narrow that down to which quarter that occurred in?
It was $0.08, Brian, was the impact in the -- that was about a pretty healthy impact in the first quarter of '19, is where a fair amount of that came from.
Okay, great. And then just lastly, the mix of business, I think you disclosed in 2020, roughly 75% of earnings will be derived from the Electric segment. Is that kind of the ideal mix, 75%-25% or do you expect given what appears to be well above average electric or regulated utility growth rate is offset by rather flat, if not lower unregulated segment earnings? So if all else equal the regulated earnings profile on a percentage basis should increase through the planning period?
Hi Brian, this is Chuck. Yes our target is 25% manufacturing, 75% utility. We have been over the last couple of years had a little bit higher percentage than 25% from manufacturing and our target is to get to -- in 2020 because of the utility investment to get back to this 25%-75% and we project that will -- we want to maintain that and give or take, that's going to vary a little bit year-to-year. But that is our target long-term.
Okay, great. Thank you very much.
[Operator Instructions] And I'm not showing any further questions at this time, I'd like to turn the call back to Chuck MacFarlane for closing comments.
Thank you for your questions and your support to Otter Tail Corporation. We continued execution on our utility growth projects and emphasis on operational and commercial performance in our manufacturing companies. We remain confident in our ability to deliver shareholder value. In 2020 we will focus on continuing to improve BTD profitability. We will further refine our long-term strategy for Northern Pipe, Vinyltech and T.O. Plastics and we will continue to execute on Otter Tail Power's major generation transmission projects. We believe this will allow us to deliver on our 2020 guidance of $2.22 to $2.37 a share.
Thank you for joining our call. We appreciate your interest in Otter Tail Corporation and we look forward to a successful year.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.