Seduced by Plastics: Otter Tail

Otter Tail (Nasdaq: OTTR  ) , the Motley Fool Hidden Gems selection and putative miniature Berkshire Hathaway (NYSE: BRKa  ) (NYSE: BRKb  ) , may be trying to seduce me as an investor. There's a lot to like in its mixed bag of just-reported first-quarter results, and the near-term obstacles look manageable, too.

Net diluted earnings per share came in at $0.50. That number beat analyst estimates by a hefty 16%, thanks to 31% higher net income over the comparable quarter last year, after backing out a $1.9 million one-time refund of overcharged electric-grid fees.

The net profit margin remained stable at 4.7%, but the underlying mix of profit streams from Otter Tail's various operations changed considerably. Food ingredient processing turned last year's profits into a $1 million loss because of rising ingredient prices. The health services segment faced higher labor costs and a bit of downtime for some of its facilities. And the mainstay electric utility services delivered essentially flat earnings (after backing out that refund) on rising coal prices and some trouble with getting Burlington Northern Santa Fe (NYSE: BNI  ) to deliver enough coal.

So where did the gains come from, you ask? I have just one word for you. Plastics.

From 2003 to 2005, the plastics segment has been responsible for an increasing percentage of operating income. This quarter, that number is up to 31%. Net income from plastics also advanced by 73% year over year, despite a mere 18% revenue increase. That's Olympic-grade expansion, and it marks the first time in recent memory that any line of business beat the electric utilities' profit margins -- in this case, by a score of 12% to 9.4%.

In all fairness, the manufacturing sector has done well too, having more than doubled its income on the strength of 23% higher revenues. Yet the operation still runs at a razor-thin 3.3% net profit margin. It takes a lot of revenue to make good money that way, and the plastic pipe business is simply outgrowing its wind tower and metal parts processing counterparts.

I mentioned trouble ahead, and it will come from the rail delivery of coal, which is expected to reduce the effectiveness of Otter Tail's coal-fired electric plants. Management has reduced the full-year outlook by 10 cents to account for that setback. Also notable is that the torrid growth in the better-performing lines of business relies in part on continued economic growth in the Midwest.

But as long as the plains states need water pipes and wind towers for infrastructure projects, Otter Tail stands to benefit. The railway issues will pass, and the company is always out looking for new opportunities to grow by acquisition.

A freshly renewed and enlarged credit line will help it do just that, and a steady cash flow from utilities and manufacturing takes the pressure off other business lines, leaving them free to plan for the long term. That's not a half-baked business plan. In fact, I'd call it completely baked.

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Fool analyst Bill Mann, aka TMF Otter, liked the name of this company so much that he selected it forMotley Fool Hidden Gemsin September 2005. To see what else he has recommended, try out Hidden Gems free for 30 days.

Anders Bylund doesn't own shares in any company mentioned in this article, but he actually used to work on the railroad and knows a frog from a deadhead. The Motley Fool has a disclosure policy.


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