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Otter Tail Corp (OTTR -0.15%)
Q3 2019 Earnings Call
Nov 5, 2019, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning and welcome to Otter Tail Corporation's Third Quarter 2019 Earnings Conference Call. [Operators Instructions]
I will now turn the call over to the company for their opening comments.
Loren Hanson -- Investor Relation
Good morning everyone and welcome to our call. My name is Loren Hanson and I manage Otter Tail's Investor Relations area. Last night we announced our third quarter 2019 earnings results. 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 this call. As noted on slide two 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.
Charles S. MacFarlane -- President and Chief Executive Officer
Thank you Loren. Good morning everyone. Last night we released our third quarter results please refer to slide five as I begin my comments. Operating revenues, net income and diluted earnings per share increased compared Third quarter 2018 because we anticipate Sophos and the energy and Agriculture and Markets and low scrap metal prices will negatively impact fourth quarter results, we are narrowing our 2019 guidance range to $2 and 10 cents to $2 and 20 cents per share from the previously announced $2 and 10 to $2 and 25 cents. Our electric segment quarter over quarter, earnings increase due to interim and final rate increases, increased to our sales to commercial customers and increased revenue from investments in transmission projects. Manufacturing segment third quarter earnings were up slightly quarter over quarter driven by improved performance at BTS, Minnesota and Georgia facilities. Plastic segment earnings were lower quarter-over-quarter due to lower sales volume in combination with lower pipe prices. We anticipated 2019 earnings from this segment -- a lower 2019 earnings from this segment in our outlook.
As mentioned last quarter our fourth quarter 2018 results included a planned outage at our Big Stone Plant costs associated with the establishment of foundations at Otter Tail Corporation Otter Tail Power company and increased tax expense at corporate. We do not expect these costs to reoccur in the fourth quarter of 2019. Let's take a closer look at Otter Tail Power. The forecast $1 billion of capex on slide 11 will produce an annual rate base growth of 8.6% between 2018 and 2023 in a constructive regulatory environment. Merricourt Wind Energy Center Astoria Station South Dakota transmission reliability and self-fund transmission projects are all under construction. Our projected investment in those projects totals over $500 million. To put this in context this represents approximately 45% of our 2018 $1.1 billion rate base. I'll touch briefly on a few of these projects. On slide 14 the Merricourt Wind Energy Center remains on time and on budget. We expect 90% of all civil work and foundations to be complete this month. The project has received Minnesota renewable resource rider eligibility North Dakota advanced determination of prudence and South Dakota phase-in rider approvals. We estimate this project will cost approximately $258 million and will generate enough energy to power more than 65000 homes.
This is the largest capital project in Otter Tail Power history. We anticipate to begin commercial operation in late 2020. Construction of Astoria Station began in May 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 which during the peak of its 13-month construction period will create approximately 70 construction jobs. The cost of this project is being recovered through the North Dakota Generation Rider and the South Dakota phase-in rider. Crews are working to finish major foundations duct banks and water tanks this fall. We expect Astoria Station to be online in 2021. In March we completed the first of a 2-phased 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 easements are 90% attained and structures are being set. We expect to energize the line in mid-2021. We have the opportunity to add 3545 million rate base associated with new generator interconnection upgrades as proposed by the my solar generator interconnection process. Self fund is an election by the missile transmission owner in this case auto power to fund the initial network upgrades associated with new generator interconnection. If approved, Otter Tail will fund and earn a return on a return of the capital costs of the network upgrades over 20 years. period from these interconnection customers. Now turning to our manufacturing segment. BTD our contract metal fabricator improved return on sales on a consolidated basis and again improved financial results at the Georgia facility where we added stamping capability to improve logistics and better serve existing and new customers in the southeast. Due to recent reduction in the market demand primarily in the oil and gas fracking industry the company reduced employee counts at its Washington Illinois and Detroit Lakes
Minnesota facilities as part of its Sales Inventory and Operations Planning or SIOP process. Operations continue to balance production output and inventory levels to ensure on-time delivery remains strong. T.O. Plastics earnings remain essentially unchanged between quarters. In anticipation of the upcoming horticulture selling season T.O. Plastics is strategically building product inventory over the Q4-Q1 time frame. We expect to increase production capacity in Q4 to serve various horticulture markets and we continue to improve factory outputs despite tight labor markets at the Otsego and Clearwater facilities. In our Plastics segment Northern Pipe Products and Vinyltech had lower quarter-over-quarter results primarily due to lower sales price on decreased volumes attributed in large part to wet conditions and Northern Pipe Products sales region. Both companies are implementing continuous improvement projects to enhance efficiency and capacity and they continue to improve in the markets they serve by demonstrating responsiveness to customer needs. On a final note we continue to enhance our balanced generation mix. As shown back on slide six we anticipate that by 2022 Otter Tail Power customers will receive 30% of their energy from renewable resources and our carbon emissions will be at least 30% below 2005 levels all while keeping average residential rates nearly 30% below the national average. Merricourt and Astoria which I discussed earlier are catalysts to these 30% trajectories.
Now I'll turn it over to Kevin for the financial perspective.
Kevin G. Moug -- Chief Financial Officer and Senior Vice President
Well thanks Chuck and good morning. Our consolidated diluted earnings per share were up approximately 7% for the quarter driven mostly by increased earnings in our Electric segment. Please refer to slide 22 and 23 as I discuss our third quarter results. Our Electric segment net earnings increased $3.1 million quarter-over-quarter. The press release describes all the items impacting our quarterly results with key items worth discussing our the $2.8 million increase in retail revenues mainly from higher average electric rates due to interim and final rates in effect from our South Dakota rate case and increase sales to customers in higher rate classifications. Interest rates were implemented on October 18 of 2018. And final rates were implemented on August one of 2019. Increased transmission cost recovery revenues in Minnesota renewable resource writer revenues and increase kilowatt hour sales to commercial customers. These items are offset in part by Laura retail kilowatt hour sales related to milder weather. While most regions of the United States experienced warmer-than-normal weather during the quarter our region experienced a 17% decrease in cooling degree days compared to normal.
This resulted in a negative impact of $0.02 a share. Less favorable weather also negatively impacted earnings by $0.02 a share between the quarters. And it is important to remember that we are a winter-peaking utility in a summer-peaking pool. Lower transmission revenues due to decreased MISO tariff revenues and our O&M expenses increased by $2 million. Net earnings for the Manufacturing segment increased $133000. Key items impacting the change were at BTD net revenues increased $3.7 million primarily from increased product sales to recreational vehicle end markets offset in part by decreased sales to its energy and agricultural end markets. BTD also had a $700000 increase in its tooling revenues. The increased revenues were more than offset by a $3.8 million decrease in revenues from material price changes passed through to customers. And $1 million reduction in scrap metal revenues due to a continued drop in scrap metal prices and lower scrap sales volume. The decrease in revenues along with higher cost of goods sold resulted in a decrease in gross margins which was more than offset by lower operating and depreciation expenses. And despite higher income before taxes income tax expense was lower due to increased research and development tax credits resulting in a $500000 increase in earnings.
The increased R&D credits resulted from a higher level of estimated credits related to qualifying technology improvement investments. And T.O. Plastics earnings decreased $400000 quarter-over-quarter due to lower horticultural sales primarily as a result of timing as sales which historically occur in the third quarter of the year shifted to the second quarter of 2019. Our Plastics segment's earnings decreased $1 million due to an 8.9% decrease in pounds of pipes sold and a 3.5% decrease in pipe sales prices. The lower volume resulted from lower demand for product in both the Midwest and West Coast states that we serve. And our corporate pre-tax expense and net of tax losses increased primarily due to increased employee benefit expense. Let me provide an update on our credit ratings and recent financing activities as highlighted on slides 25 and 26. During the third quarter both Fitch and Moody's reaffirmed their credit ratings for both Otter Tail Corporation and Otter Tail Power Company. S&P Global Ratings raised Otter Tail Power's long-term issuer credit ratings and its senior unsecured debt to BBB+ from BBB and revised the positive outlook to stable. S&P also affirmed Otter Tail Corporation's issuer credit ratings at BBB and revised the outlook from positive to stable.
And we remain committed to maintaining investment-grade credit ratings and we'll manage our operations to reflect that commitment. Otter Tail Power Company entered into a private plant -- private placement transaction on September 12 of 2019 to issue $175 million senior unsecured notes. The use of the proceeds is to fund capital expenditures for rate-based projects. slide 26 shows the tranches associated with the private placement. And on October 10 of 2019 the first tranche was issued for $100 million to pay down on its line of credit and provide funds for capital expenditures. The remaining proceeds will be drawn through delayed draws with $35 million in February and $40 million in August of 2020 respectively. We also have amended and extended both our credit facilities by one year to October 31 of 2024. The line of credit limit on the Otter Tail Corporation credit agreement was increased to $170 million in anticipation of slowing economic conditions and making sure we have the liquidity to manage our business in case of challenging economic times.
Moving on to our business outlook on slide 27. We are narrowing our 2019 diluted earnings per share guidance to $2.10 to $2.20 from $2.10 to $2.25. This equates to a return on equity range of 11.5% to 12% based on an estimated equity to total cap ratio of 54%. We continue to expect increased earnings in our Electric segment for 2019 over 2018 as discussed in our press release. And it is important to remember we incurred $0.05 a share of costs in the fourth quarter of 2018 related to the planned Big Stone Plant outage and the contribution to Otter Tail Power's foundation that are not expected to occur in the fourth quarter of 2019. We now expect earnings from our Manufacturing segment to be in line with 2018 earnings. This revision is a result of softness in energy and agricultural end markets served by BTD due to concerns over a slowing economy and continued softness in scrap metal revenues stemming from lower scrap metal prices. And we continue to expect lower earnings at T.O. Plastics mainly due to first quarter volume softness and the expected impact on business operations from the partial collapse and replacement of the warehouse roof which was damaged in March during a winter storm. And the backlog for this segment is approximately $56 million for 2019 compared with $62 million a year ago.
We continue to expect Plastics' 2019 net income to be lower than 2018 due to lower operating margins resulting from lower sales volumes and lower sales prices compared to last year. And corporate costs net of tax are expected to be lower in 2019. This is due in large part to $0.08 a share of expenses incurred in the fourth quarter of 2018 related to a contribution to establish the Otter Tail Corporation Foundation and accruals related to certain tax matters. These costs are not expected to occur in the fourth quarter of 2019. Our third quarter results are in line with our financial plan and we remain positioned to achieve our 2019 earnings guidance. The utility continues to work on our large capital projects of Astoria and Merricourt which put us on track to have Otter Tail Power customers receive 30% of their energy from renewable resources by 2022 and our carbon emissions to be at least 30% below 2005 levels. Both these projects will provide immediate returns for amounts invested while under construction.
These investments along with others position us to grow our rate base in support of regulatory environments at an 8.6% compounded annual growth rate over the next 5 years. And over time the electric utility will provide approximately 75% of our overall earnings. The Manufacturing and Plastics segments continue to provide organic growth through new products and services market expansion and increased efficiencies. And the Manufacturing and Plastics segments are expected to provide around 20% -- 25% of our earnings over time. We expect to be able to deliver total shareholder return of 8% to 10%. Our earnings per share are expected to increase at a 5% to 7% growth rate off of 2018 results and our dividend yield is approximately 3%. And looking forward we would expect to grow the dividend in line with our earnings-per-share growth rate while maintaining a dividend payout ratio of 60% to 70%. And our company maintains a strong balance sheet and corporate credit ratings.
We are now ready to take your questions.
Questions and Answers:
Operator
[Operators Instructions] And our first question comes from Tate Sullivan with Maxim. Your line is now open.
Tate Sullivan -- Maxim Group, LLC -- Analyst
All right. Thank you Sorry if I missed a couple more comments on the Manufacturing exposure earlier. But are you comfortable with the current capacity of your Manufacturing business excluding the T.O. Plastics part? And how quickly can you see demand come back from some of your customers if there was a pause at the end of the year in that business usually please?
Kevin G. Moug -- Chief Financial Officer and Senior Vice President
Yes. This is Kevin. Our capacity for the -- both the companies in the Manufacturing business BTD and T.O. Plastics are -- we have plenty of capacity in the business to take on additional organic growth opportunities. The slowing that we started to see in the third quarter came in energy and ag markets which is -- looks to be impacted because of this concerns in those end market industries relating to a slowing economy and some of the challenges occurring in the ag market as well. In terms of -- we'll give guidance in -- for 2020 in February. But certainly as we sit here today and the slowing in ag and energy and the revision of guidance for Manufacturing to now be in line with last year's earnings per share I don't think we're going to expect to see any kind of turnaround in those end markets here as we finish up the year. And certainly if there were changes we would look to discuss that in 2020. But I think as we sit here today we wouldn't expect to see any immediate changes into 2020.
Tate Sullivan -- Maxim Group, LLC -- Analyst
Okay. And then for the Plastics guidance -- yes so excuse me for Plastics. Any -- and we -- you consistently mentioned the different resin prices and the pricing any change in the distribution for your PVC pipes in general? I think there were some change in distributors in the last couple of months but any fundamental changes in that market please?
Kevin G. Moug -- Chief Financial Officer and Senior Vice President
Yes. Tate there has been no changes in terms of who our key distributors are over the last number of years. And we continue to sell into our distributor base and then they in turn are selling to the end users of the pipe but we've not seen any changes there. Okay, thank you very much.
Tate Sullivan -- Maxim Group, LLC -- Analyst
Thank you for that detail. Have a good day.
Kevin G. Moug -- Chief Financial Officer and Senior Vice President
You too.
Operator
[Operators Instructions] I'm not showing any further questions at this time. I would now like to turn the call back to Chuck MacFarlane for any further remarks.
Charles S. MacFarlane -- President and Chief Executive Officer
Our financial performance continues to demonstrate the value of employees' actions to grow our business achieve operational and commercial excellence and develop talent. We are pleased with the continued progress of our Astoria and Merricourt projects and we are narrowing our 2019 earnings per share guidance range to $2.10 to $2.20. Thank you for your continued interest in Otter Tail Corporation. We appreciate you joining the call and look forward to speaking with you next quarter.
Operator
[Operator Closing Remarks].
Duration: 25 minutes
Call participants:
Loren Hanson -- Investor Relation
Charles S. MacFarlane -- President and Chief Executive Officer
Kevin G. Moug -- Chief Financial Officer and Senior Vice President
Tate Sullivan -- Maxim Group, LLC -- Analyst
