Construction materials

MDU Resources sells building materials business Knife River Corp

Overview of the offer

On August 4, 2022, MDU Resources Group (NYSE: MDU, $30.82, market cap: $6.3 billion) announced that its board of directors had unanimously approved a plan to spin off its business from 100%-owned building materials, Knife River Corp. Post-split, MDU Resources (truncated entity) will focus on regulated utilities, gas pipelines and related infrastructure services businesses. While Knife River (NewCo.) will operate as a stand-alone, aggregate-based, vertically integrated building materials and contracting supplier.

The spin-off is expected to be effected by distributing shares of Knife River to MDU Resources shareholders on a pro rata basis. The transaction is expected to be tax-exempt for MDU Resources and its shareholders for US federal income tax purposes. The separation is expected to be completed in 2023, subject to customary conditions, including final approval by MDU Resources’ Board of Directors, receipt of tax advice and effectiveness of a registration statement on form 10 with the United States Securities and Exchange Commission.

MDU Resources is dedicated to establishing sound capital allocation strategies for each company that align with each entity’s respective long-term objectives. After the separation, MDU Resources intends to maintain a dividend policy consistent with its historical practice. Based on management’s comments, Knife River’s dividend policy will be decided going forward in a manner consistent with its stated capital allocation strategies. Further details regarding the capital structure, governance and other elements of the transaction will be announced at a later date.

Following the planned separation, MDU Resources and Knife River will continue to be headquartered in Bismarck, North Dakota, and MDU Resources will continue to act as a parent entity for other wholly owned subsidiaries.

JP Morgan Securities LLC and PJT Partners are acting as financial advisors for the transaction; Wachtell, Lipton, Rosen & Katz is acting as legal counsel.

Investors reacted positively to the news, with the stock price rising 6.3% on the day of the announcement. Subsequently, New York-based activist investment firm Corvex Management, known for its investments in utility companies, acquired a roughly 5.0% stake in MDU Resources. He also emphasized that this decision was a positive step and expressed his intention to consult with MDU management on additional strategic alternatives to increase the revenue potential of its existing energy business.

Rationale for Agreement

MDU Resources (Parent) is an umbrella company with a diverse group of wholly owned subsidiaries operating under its name, namely: Montana-Dakota, Cascade, Intermountain, WBI Energy, Centennial Capital and Knife River. All subsidiaries have an inherent value in their activities and have different strategic objectives. The Board continually assesses its business operations and opportunities for value creation. Previously, in 2016, as part of its strategic review process, it sold the company Fidelity Exploration and Production to exit the oil and natural gas production market. Now, according to the Board of Directors, Knife River (NewCo) is ready to operate as a stand-alone public company, deriving multiple synergies for shareholders and thereby resulting in maximization of value.

After acquiring an aggregate company in 1992, over a period, MDU Resource built Knife River into a leading aggregate-based building materials company. Since then, Knife River has grown through organic and inorganic pathways. Historically, the building materials industry has always been volatile and susceptible to inflation and supply chain disruptions. Therefore, to make its business model less risky, Knife River is strategizing to expand its market presence into higher margin material businesses like rock, sand, gravel, asphalt oil, ready-mixed concrete and related products. Currently, Knife River has a presence in the western, central and southern United States and also plans to further expand its market footprint in the United States. Additionally, it currently has over 1.2 billion tons of aggregate stockpiles, 110 ready-mix concrete plants, 50 asphalt plants, and a combined storage of 410,000 tons of liquid asphalt and cement. However, the reserves are naturally exhaustible, which is why they are constantly looking for acquisition opportunities to replace them. Over the past four years, they have acquired 12 companies and increased their revenue by 23%. Given the growth driven by its acquisition, the business is capital intensive and with the separation, its management team is looking to establish strong and aligned capital allocation strategies to fuel growth and maximize the value of shareholders. In addition, as an infrastructure company, Knife River stands to benefit from infrastructure development funding offered under the Infrastructure Investment and Employment Act (IIJA) at the federal and local levels.

While MDU Resources’ existing regulated electric and natural gas utilities (truncated entity), natural pipelines and construction services are now expected to contribute approximately 70% of its pro forma EBITDA. With the segregation of the riskiest assets, the stem entity will focus on low risk and relatively stable businesses so that it can explore opportunities for business expansion. Additionally, with two new publicly listed companies, investors will be in a better position to appropriately evaluate each company based on their operational and financial characteristics.

Overall results

2Q22 results

MDU reported revenue of $1.7 billion, up 20.9% year-on-year, beating consensus of 22.9%. By segment, construction services revenue was $685.4 million, grew 30.4% year-on-year due to higher workload, revenue natural gas distribution business was $210.6 million, reflecting year-over-year growth of 36.8%, primarily supported by increased retail sales resulting from colder weather. Building Materials and Contracts segment increased 12.3% year-over-year to $711.8 million, driven by increased workload as well as higher average material prices. The Pipeline and Electric segments recorded revenues of $37.6 million and $85.3 million, a year-over-year increase of 5.6% and 1.8% respectively. Other income increased slightly to $4.4 million from $3.4 million a year ago.

Adjusted EBITDA decreased 8.8% year-on-year to $201.1 million (-9.6% vs. consensus), while corresponding margin fell 380 basis points to 11.7% . Operating profit decreased 12.4% to $120.6 million (-19.1% vs. consensus) with comparable margin down 266 basis points to 7.0%. Net income from continuing operations decreased 29.5% to $70.6 million (-33.0% vs. consensus), and the corresponding margin decreased 293 basis points to 4.1%. Diluted EPS fell 30.0% to $0.35 (-30.0% vs. consensus).

Outlook

For FY22E, management lowered its earnings per share estimate by $0.25 to $1.75-$1.90 and guided the EBITDA range from $875.0 million to $925.0 million , a reduction of $25.0 million due to a slower start to the year and headwinds from inflation and supply chain challenges. As for the segment, the revenue forecast for building materials is unchanged, while the construction services business is expected to have a strong backlog for the rest of the year, which has led to an increase in forecast revenue of $200.0 million with slightly lower margins year-over-year. Growth in electricity and natural gas customers remained unchanged between 1.0% and 2.0%. Capital expenditures revised to $747.0 million for FY22E in anticipation of being funded by cash flow from operations of between $550 and $600 million. Capital expenditures are expected to reach $3.1 billion over the next five years.

Company Description

MDU Resources Group, Inc. (Parent)

Incorporated in 1924, MDU Resources is a diversified United States-based company engaged in regulated utilities, energy distribution, and building materials and services. It primarily operates through five business segments: power, natural gas distribution, pipeline, building materials and contractors, and construction services. The Company’s business activities are controlled by its wholly owned subsidiaries MDU Energy Capital and Centennial. MDU energy additionally operates through Montana-Dakota which controls natural gas and electricity operations, Cascade and Intermountain which is in natural gas; while Centennial has WBI energy which controls pipeline business, Knife River is in building materials and contracts, MDU construction services has construction services business, and Centennial Capital controls other businesses. The company has operations across the United States, and at the end of FY21 had 12,826 employees.

Knife River Corp. (spin off)

Founded in 1917 in North Dakota, Knife River is primarily engaged in the processing and sale of building materials such as crushed stone, sand and gravel; production of bituminous mixes and supply of ready-mixed concrete. He has a diverse client base, including federal, state, and municipal government agencies, commercial and residential developers, and private parties. With approximately 1.2 billion tons of aggregate reserves and more than 6,000 employees, Knife River is the sixth largest aggregator in the United States.


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