INVESTMENT THESIS
CMS Energy Corp. (NYSE: CMS) based on the company’s solid growth in both EPS and dividends, which has been supported by capital investments and cost-savings programs. Management continues to project annual EPS growth of 6%-8% – better than the average of 5%-7% for most utilities – with actual EPS growth remaining close to 7% over the last fifteen years.
CMS also benefits from a favorable location in Michigan, which has a rising population, a high proportion of skilled labor, a business-friendly regulatory environment, and relatively low exposure to severe weather events. The shutdown of auto plants due to the pandemic has ended, and we look for the industrial load to increase into year-end. We believe that the company’s consistent, above-average growth more than offsets concerns about the stock’s high valuation and occasional earnings misses.
Following the release of above-consensus 3Q20 results, we are boosting our 2020 non-GAAP EPS estimate and reaffirming our 2021 non-GAAP EPS estimate. CMS saw a 9% decline in revenue in 1Q20, which we attribute to closed automotive plants. However, second-quarter revenue was flat with the prior year, as strength in residential demand was helped by the resumption of auto production. And 3Q20 revenue rose 2% year over year, as still strong residential demand was supplemented by recovering industrial and commercial demand. During 2020, the company has helped offset soft revenue trends with cost cutting.
RECENT DEVELOPMENTS
The beta on CMS is 0.73.
On October 29, CMS reported third-quarter adjusted earnings of $218 million or $0.77 per share, up from $0.73 in 3Q19. EPS growth was driven by favorable regulatory decisions, better cost controls, and an improved sales mix. Revenue of $1.58 billion rose 2% from the prior year but missed the consensus forecast of $1.62 billion. The GAAP operating margin increased to 23.4% in 3Q20 from 22.7% a year earlier on lower operating expenses.
In the three largest categories of electric deliveries, kilowatt hour sales (kWh) for residential customers rose 6% year-over-year in 3Q20, as coronavirus shutdowns continued to keep many customers at home. Commercial kWh sales declined 4%, however, and industrial kWh sales declined 3%, as employees only gradually returned to work sites. As industrial and commercial customers resume full operations, we look for a more normal pace of growth in the industrial, commercial, and residential categories.
Given consistent conservative guidance from management, our revised estimate is slightly above the high end of this range. The reiteration of guidance was impressive amid the ongoing impact of COVID-19.
The utility industry is heavily regulated and the company’s results reflect recent rate case decisions. In September 2019, the Michigan Public Service Commission granted Consumers Energy, CMS’s main business, a rate increase of $144 million on its gas rates, based on an ROE of 9.9%. On August 8, 2020, that settlement was approved. The increase in rates is intended to pay for safety and reliability improvements, as well as an electric vehicle charging program.
In February 2020, the company filed its annual electric case, requesting $244 million in additional revenue and a 10.5% ROE. It subsequently lowered that request to $230 million to take account of the impact of the pandemic on ratepayers.
EARNINGS & GROWTH ANALYSIS
CMS has two main business segments: Electric Utility (65% of 2019 revenue) and Gas Utility (28%). Enterprises, CMS’s nonutility operations, and EnerBank, a home-improvement lender, made up the remaining 7% of 2019 revenue.
In the third quarter, Electric Utility revenue rose 1% to $1.26 billion. Gas Utility revenue increased 9% to $193 million. The gas business is highly seasonal, with strength in the coldest quarters. In Enterprises, sales declined 3% to $57 million. EnerBank revenue rose 17% to $68 million, as homebound consumers engaged contractors for more remodeling projects.
Our estimates take into account the company’s cost-cutting ability and potential impacts from the coronavirus. We expect an increase in industrial load growth as auto assembly plants and related factories return to full operations, and slower residential demand as more employees return to work outside the home. We also look for a higher rate base due to increased investment.
Looking farther out, management’s five-year growth plan includes $12.25 billion in capital projects to upgrade infrastructure and increase generation reliability, as well as a 10-year plan to invest $25.0 billion. The company is also increasing its renewable energy portfolio. It generates 10% of its electricity from renewable sources and plans to increase that to 30% by 2030. While CMS is benefiting from Michigan’s generally strong economy, we are concerned about the regulatory climate in the state given increased unemployment and other negative effects from the pandemic.
FINANCIAL STRENGTH & DIVIDEND
S&P and Moody’s have BBB and Baa1 ratings on CMS’s debt, respectively, and both agencies have stable outlooks.
CMS has raised its dividend by an average of 5.6%.
MANAGEMENT & RISKS
On November 18, CMS Energy announced that CEO Patti Poppe would leave the company on December 1, 2020, to become CEO of PG&E Corp. in California. We expect the transition to be smooth as Mr. Rochow has worked at CMS for more than 17 years.
Management’s goal is to make CMS Energy a smaller, stronger company focused on its Michigan-based core utility, Consumers Energy. Specific risks that may prevent the stock from reaching our target price involve liquidity and credit issues as well as the long-term competitiveness of Michigan’s economy.
COMPANY DESCRIPTION
CMS Energy is a Michigan-based holding company with electric and natural gas utilities. Its nonutility businesses are focused on domestic independent power production.
VALUATION
We believe that CMS warrants a premium valuation based on its above-peer-average EPS growth; attractive mix of residential, industrial and commercial customers; and favorable regulatory environment.
On November 20, BUY-rated CMS closed at $61.25, up $0.67.
Source: Argus
