There are a lot of mini-conglomerate stories in the corporate world, many of which hope to be the next Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). Many of these have not been successful (think Biglari Holdings (BH, Financial)), but one that has successfully managed a diverse business model is Otter Tail Corp. (OTTR, Financial). This quality small-cap company owns an eclectic mix of electric utilities and manufacturing businesses.
With a history dating back to 1871, the company currently has a market capitalization of $2.3 billion.
Business segments
According to its website, the company operates through three segments.
The Electric segment produces, transmits, distributes and sells electricity in Minnesota, North Dakota and South Dakota to residential, industrial and commercial customers. Its electricity inputs include coal, wind, hydropower and natural gas.
The Manufacturing segment is involved in contract machining, metal parts stamping, fabrication, painting and the production of plastic thermoformed horticultural containers for a number of industries, including agricultural, construction, industrial and energy. It also manufactures clamshell packing, blister packs, returnable pallets and handling trays for shipping and storing irregular-shaped or difficult-to-handle parts.
The Plastics segment manufactures polyvinyl chloride (PVC) pipes for municipal and rural water, wastewater, storm drainage and water reclamation systems. This segment sells its products to wholesalers and distributors through independent and company sales representatives.
Financial review
On Oct. 31, the company reported record third-quarter earnings, in which consolidated operating revenue increased 21% to $384 million, total net income increased 60% to $84 million and fully diluted earnings increased 60% to $2.01 per share.
The company noted one of they key drivers in this growth was the Plastics segment, which produced $56 million in earnings for the quarter, compared to $28.4 million in the same period last year. Operating margins in this segment continue to benefit from elevated spreads of PVC pipe sale realized prices over resin input costs.
The Electric segment's earnings increased 10.3% compared to the prior-year period, which was primarily driven by increased commercial and industrial sales volumes. The Manufacturing segment produced earnings growth of 48.1% compared to the year-ago quarter, driven by increased sales volumes, improved manufacturing cost savings and lower operating and maintenance costs.
In a statement, CEO Chuck MacFarlane said, “Our long-term focus remains on executing our strategy to grow our business and achieving operational, commercial and talent excellence to strengthen our position in the markets we serve. We remain confident in our ability to achieve a compounded annual growth rate in earnings per share in the range of 5% to 7% using 2024 as the base year. We currently expect to see elevated earnings from our manufacturing platform into 2023 with our earnings mix expected to move to approximately 65% from our Electric segment and 35% from our manufacturing platform beginning in 2024.”
The company maintains a strong balance sheet with cash of $73 million and long-term debt totaling $823 million. Its debt rating is investment grade at BBB. Otter Tail also has $170 million of availability on its line of credit.
Valuation
Currently, approximately 70% of the company’s earnings are derived from the manufacturing side of the business due to high prices and unusually strong margins. During normal times and over the long term, that is reversed with roughly two-thirds of earnings coming from the electric utility segment and one-third from the manufacturing businesses.
The return to normalized operating margins in 2023 will cause an earnings decline next year. Consensus analyst earnings per share estimates for 2023 are approximately $4, which is a decrease from the $6.85 expected this year. This puts the stock selling at 14 times next year's earnings, which is not unreasonable for an electric utility.
The GuruFocus discounted cash flow calculator creates a value of $66 using $4 in earning per share as the starting point and a long-term growth rate of 8%. That growth rate is high for a regulated electric utility, but the manufacturing operations should make up the difference over time.
The company has paid an annual dividend uninterrupted since 1938. The current dividend is $1.65, which equates to a dividend yield of 3.11%.
Guru trades
One guru who recently added to his Otter Tale position was Joel Greenblatt (Trades, Portfolio), while Mario Gabelli (Trades, Portfolio), Jim Simons (Trades, Portfolio)' Renaissance Technologies, Hotchkis & Wiley and Paul Tudor Jones (Trades, Portfolio) reduced their holdings.
Conclusion
Otter Tail is a unique story that provides a stable dividend yield through its electricity utility operations, but provides additional growth through its manufacturing operations. The electric utility alone should be able to provide single-digit growth with planned rate increases that have been approved by regulators.
Although utilities are generally desired by fixed-income investors or conservative investors such as retirees, Otter Tail might offer an investment opportunity for all investors at this point. The company appears to be fairly valued currently, but could still be a good opportunity for long-term investors.
