DTE Energy Company (DTE) is a diversified energy company primarily focused on delivering gas and electricity to the greater Detroit area. DTE is 100% owner of The Detroit Edison Company and Michigan Consolidated Gas Company. Both companies are regulated utilities. DTE also has a variety of other businesses ranging from Energy Trading to Pipelines to Power & Industrial Projects. These ancillary businesses accounted for over 25% of DTE's revenue in Q2 2011.
|Segment||Revenue ($ millions)||% of total||Net income ($ millions)||% of Total|
|Gas Storage & Pipelines||23||1%||14||7%|
|Power & Industrial Projects||287||14%||5||2%|
|Corporate & Other & Eliminations||(80)||-4%||72||36%|
Source: SEC filings
DTE had about $8.6 billion in revenue with $639 million in net income in 2010. DTE has a market capitalization of $8.5 billion and an enterprise value of $16.4 billion, suggesting significant leverage. DTE has a strong track record of paying dividends. For 2010, its payout ratio to net income was 56% and its payout to operating cash flow was just 20%. Even adjusting for capital expenditures related to utility and non-utility plants, property and equipment, the dividend payout ratio was still 50%. This shows that there is still an ability to drive growth in the dividend without growth in the underlying financials. It should be noted that the dividend is paid in the quarter after it is declared.
DTE's estimated forward dividend yield is 4.8% based upon a closing price of $49.91 and the author's projected annual dividend of $2.40. The following table shows the estimated forward quarterly dividends as well as the recent historical quarterly dividends.
|Type||Ex-Dividend Date||Quarterly Dividend ($ per share)||Change on prior year|
Source: Author estimates, Yahoo!Finance
What the above table does not clearly show is that from 1993 to 2006, DTE paid a consistent $0.515 quarterly dividend year after year. DTE then increased the dividend to $0.53 which has now seen two additional increases. The following graph shows the historical trailing twelve month yield and spread compared to the 10-year Treasury bond.
Created from data from Yahoo!Finance
This graph shows that the trailing dividend yield is around the historical average. The next graph shows the normalized performance of the stock price, the dividend, and the trailing dividend yield.
Created from data from Yahoo!Finance
The above chart shows the impact of relatively flat dividends. The yield will then vary inversely from the stock price, creating a mirror effect. The one caution it points to is that the stock has climbed a little faster than the dividend. This suggests that investors are rewarding DTE. The second key aspect is that while DTE has two core regulated businesses, it also has several non-regulated businesses to help drive earnings growth. So even if one has concerns about the local Detroit economy (read U.S. auto industry), there are other avenues of growth for DTE. For example, in comparison to Q2 2008, the Gas Storage, Energy Trading, and Power & Industrial projects all saw increased net income. The ability of DTE to grow these business will be substantial help to growing the dividend for the entire company.
Dividend Discount Model suggests fair to slight undervaluation
The first step to using the dividend discount model is to calculate an equity hurdle rate with the Capital Asset Pricing Model. DTE has a beta of 0.6 and with the risk free rate at a very low 2.1% this gives the discount rate to be a 6.3%. As noted above, the forward dividend is approximately $2.40. Applying a long term growth rate of 1% gives an estimated price of $56.09 for DTE. This is approximately a 12% premium to the current price of $49.91. However, as with any dividend discount model, the result is highly sensitive to growth rate and equity hurdle rate assumptions.
|Sensitivity||Equity Hurdle Rate|
Source: Author calculations
On a standalone basis, DTE looks like a reasonable opportunity worth additional analysis; however, it would also be important to consider other utility investments as well. How does DTE compare to them? The second key issue is that one would have to get a much better understanding of the non-utility businesses, since they are a key part of driving DTE's overall growth.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security. You can now follow me on twitter @jtcbp.