Seeking Alpha

DTE Energy: One Of The Few Value Plays Among Utes

|
About: DTE Energy Company (DTE), Includes: ARTNA, CWT, MGEE, WEC, YORW
by: Robert & Sam Kovacs
Robert & Sam Kovacs
Long only, dividend investing, dividend growth investing
Summary

Six months ago, I said DTE was my favorite stock. WEC was second favorite.

WEC has wildly outperformed DTE since then.

Nothing fundamental has changed with the prospects of DTE as a dividend investment.

As a result, it is one of the few utilities that still offers a good combination of dividend strength and value.

Written by Sam Kovacs

Introduction

In a recent article on WEC Energy (WEC), I mentioned wanting to trim my position to realize some value. Looking back at utilities I analyzed in April, it didn’t take long to conclude that my previous favorite was the best candidate for reinvesting the proceeds: DTE Energy (DTE).

Source: Open Domain

As some of you might remember, six months ago Robert and I analyzed 10 utility stocks and each suggested our two favorites. My two picks were WEC Energy & DTE Energy. While both have beaten the market (when including dividends) since the articles were published, the latter has been uninspiring relative to the rest of the sector. DTE Energy is up only 1.92% while WEC is up 18%.

Back in April, WEC & DTE were the only stocks which offered a combination of dividend yield and dividend growth potential that seemed enticing. Many utes were already looking quite overvalued. Many of those utilities have continued their meteoric rise and are now at prices I couldn’t even consider. For instance MGE Energy (MGEE), which was yielding 2% and has been growing the dividend at 5% per annum now yields only 1.85%.

If you care about money at all, and truly are a dividend investor, owning assets which yield so little and barely grow the dividend shouldn’t be an option. This doesn’t mean that they can’t go up a lot more, as has been the case for many utilities.

Water utilities are by far the most overvalued. In August I wrote a piece titled “What To Do When An Entire Sector Becomes Overvalued”. The article demonstrated why I didn’t believe there were any assets in the water utility industry offering attractive dividend profiles.

While the tide has started to turn for a couple of the stocks I warned against – California Water (CWT) is down 2% since my article, Artesian (ARTNA) is flat since my article – others such as York Water (YORW) have increased by double digits.

Overall, utilities have continued to lead the way. I expressed this clearly in my October article “Opportunities and threats in today’s market”. The median utility stock has better momentum than 72% of US stocks according to our Momentum Score.

But not DTE. In fact, as we will see later, DTE’s three-month price momentum is worse than that of the median US stock. Investors reacted negatively to the latest earnings report when the company missed on earnings. The announcement of equity issuance through the next three years didn’t help.

Nonetheless, an objective look at DTE doesn’t suggest that the stock is in any trouble. If anything, it is one of the few utilities with an attractive combination of dividend yield and dividend growth potential.

DTE Energy has a dividend yield of 3.20% and it trades around $126.59. Based on my M.A.D Assessment DTE has a Dividend Strength score of 74 and a Stock Strength score of 60.

This article will present and discuss the factors which show why I believe that dividend investors should invest in DTE Energy. In fact, if you’re looking for a utility with a good combination of dividend safety, dividend yield and dividend growth potential, DTE might be one of your only choices.

Source: mad-dividends.com

Many of you have become familiar with our approach. We first look at the company’s dividend profile: Is the stock a good pick for a dividend investor at current prices? We then look at the fundamental factors that could influence capital gains: Is the stock likely to do better than the market in upcoming quarters? While many dividend investors overlook this second part, it is important to avoid overpaying for stocks, and suffering subsequent capital losses.

Dividend Strength

What exactly makes a stock a “good pick for dividend investors”? We believe there are two primary aspects to a good dividend stock: dividend safety and dividend potential. What good is there in owning a dividend stock if the dividend gets cut? Your income goals will be way off base, the stock price will likely tank and you’ll have to deal with your poor decision. On the other hand if the dividend doesn’t have the potential to contribute significantly to your total returns, what good does it do to focus on it? Here we’ll be looking for a good combination of dividend yield and dividend growth potential.

Dividend Safety

DTE Energy has an earnings payout ratio of 64%. This is a more attractive payout ratio than 28% of dividend stocks.

DTE pays 28% of its operating cash flow as a dividend, putting it ahead of 49% of dividend stocks.

As is customary with utes, DTE spends more in CAPEX than it generates in operating cash flow. This is due to the capital-intensive nature of the business. Therefore, looking at metrics like free cash flow makes little sense. You’re better off thinking in the following way about utilities: Operating cash flow goes towards paying dividends and interest; CAPEX is financed by debt or equity issuances.

30/06/2015

30/06/2016

30/09/2017

30/09/2018

30/09/2019

Dividends

$2.7600

$2.9200

$3.3200

$3.5200

$3.7900

Net Income

$4.70

$4.12

$3.30

$6.72

$5.95

Payout Ratio

59%

71%

101%

53%

64%

Cash From Operations

$10.85

$11.12

$13.19

$14.36

$13.77

Payout Ratio

26%

27%

26%

25%

28%

Free Cash Flow

$-0.75

$-1.56

$-2.10

$-0.49

$-5.10

Payout Ratio

-364%

-186%

-158%

-704%

-75%

Source: mad-dividends.com

Nonetheless, despite the decline in EPS last quarter, DTE’s dividend coverage remains very good. Operating cash flow can cover the dividend three times.

DTE can also cover its interest three times, which is better than 40% of stocks. This level of coverage is in line with the sector median.

DTE has been paying cash dividends for 100 years, which have now been increasing for the past 10 straight years.

I believe DTE’s dividend to be very, very safe.

Dividend Potential

DTE Energy's dividend yield of 3.20% is better than 66% of dividend stocks. While the stock has slightly appreciated in price since I last covered it, the dividend yield has actually increased by 20 basis points.

Source: mad-dividends.com

Why? A recent announcement of a 7% increase in the quarterly dividend, from 95 cents to $1.01 per share ($1.0125 up from $0.9455 if we’re being picky).

This is in line with the company’s five-year dividend CAGR of 7%.

Source: mad-dividends.com

Is dividend growth threatened as we move forward? No, not at all. First, the dilution of the announced equity issuances shouldn’t impact EPS growth. While investors should expect $2 billion to $2.5 billion to be issued between now and 2022 (about 10% of market cap), – $500 million of which will be incurred in 2019 – management has adjusted operating EPS guidance for 2019 and 2020 upwards.

Source: Earnings Presentation

Investors should remain confident that DTE will likely continue to increase its dividend to the tune of 6% to 8% per year for upcoming years.

This level of growth is satisfying for a stock yielding just above 3%. At these yields, I look for mid-single-digit dividend growth potential. DTE fits the bill.

Dividend Summary

The combination of the data presented above gives DTE a dividend strength score of 74 / 100. The dividend safety is unchallenged, and the combination of dividend yield and dividend growth is a rare, refreshing breath of fresh air among many overvalued utilities. DTE is still very much a utility stock that dividend investors can consider for their portfolio.

Stock Strength

But what about potential for capital appreciation? In April I announced that I believe utilities will continue to do well until the end of this bull market. So far they have, but many have become overvalued as a consequence. Investors moving to utilities at the current stage, or increasing their exposure to utilities, should be very careful to not put their capital at risk by investing in overvalued stocks.

Nobody should be willing to pay any price for a stock. Curiously, though, with the ever-increasing popularity of ETFs, more and more investors have become indifferent to the process of price discovery. “Just buy the whole index,” they say. While this definitely isn’t a bad strategy during bull markets, I expect a day of reckoning to come in the next recession. Value should always matter.

However, the data also suggests that we should avoid buying stocks with bad fundamentals and/or bad momentum.

I use our proprietary MAD Scores to assess these factors, and conclude on the likeliness of a stock to do better than the market in upcoming quarters.

Value

  • DTE has a P/E of 21.28x
  • P/S of 1.76x
  • P/CFO of 9.19x
  • Dividend yield of 3.20%
  • Buyback yield of -1.10%
  • Shareholder yield of 2%.

These values would suggest that DTE is more undervalued than 79% of stocks, which makes it look quite cheap relative to its sector. The median utility stock trades at 25x earnings and 11.7x cash flow.

Source: mad-dividends.com

The chart above suggests that DTE is trading below its five-year average PE. A reversal to its average multiple would imply 20% upside.

Relative to its sales, earnings and cash, and to its sector, DTE doesn’t look expensive. In fact it looks quite cheap. It also yields more than the average stock in the sector. The only blemish is the negative buyback yield. However as I mentioned above, the issuance is to complete an acquisition, which should be accretive to EPS. I wouldn’t be too concerned.

Value Score: 79 / 100

Momentum

DTE Energy's price has decreased by -1.85% these last three months, but is still up 2.40% these last six months & 11.41% these last 12 months. The stock now trades at $126.59.

Source: mad-dividends.com

This gives DTE better momentum than 59% of stocks. Its six- and 12-month performance still place it in the second quintile of stocks, but its three-month performance makes it slightly worse than that of the median US stock.

Source: mad-dividends.com

In December of last year, the stock price crossed both its 20-day and 50-day simple moving averages, before recovering. Throughout the year, the 20-day and 50-day SMAs have served as resistance.

During the past week, the stock has once again pushed below both SMAs. In the very short term there could be some more downward pressure. The stock might bounce off the $125 level, or it could go down to $120. I don’t see any rationale for it breaking lower than those levels, barring any unexpected bad news.

Momentum score: 59 / 100

Financial Strength

DTE's debt/equity ratio of 2.6 is better than 32% of stocks. DTE Energy's liabilities have increased by 10% this last year. Operating cashflow can cover 9.2% of DTE's liabilities.

These ratios would suggest that DTE Energy has better financial strength than 45% of stocks. This is an equivalent financial strength score as the median utility stock, and should be considered satisfactory.

Financial Strength Score: 45/100

Earnings Quality

DTE Energy’s Total Accruals to Assets ratio of -13.1% puts it ahead of 66% of stocks. 42.7% of DTE's capital expenditure is depreciated each year, which is better than 15% of stocks. Each dollar of DTE's assets generates $0.3 of revenue, putting it ahead of 38% of stocks. Based on these findings, DTE has higher earnings quality than 37% of stocks. These numbers are all above the sector median. Utilities are penalized in our financial strength and earnings quality scores because of their capital intensive nature. It is therefore more rational for us to compare them with sector medians, while keeping this inherent difference in business model in mind.

Earnings Quality Score: 37 / 100

Stock Strength Summary

When combining the different factors of the stocks profile, we get a stock strength score of 60 / 100 which is quite satisfying. The stock’s financial strength and earnings quality are in line with the industry median, yet the stock’s value is significantly higher. The overall momentum remains better than that of the broad market, but this has turned in the last two weeks. As such the stock could decline to as much as $120 in the short term, which isn’t enough to deter me from advising investors to buy.

Conclusion

With a dividend strength score of 74 and a stock strength of 60, DTE Energy is still a great choice for dividend investors. You’ll be hard pressed to see me advise a buy in any utility stock, but DTE has lagged the sector and as a result its valuation remains reasonable at current prices.

I will be trimming my WEC position by about one-fifth and relocating those funds to DTE. If you are compelled to do the same, have purchased WEC at multiple times and hold your WEC shares in a taxable account, you might want to consider indicating to your broker to use a LIFO sale (assuming the last shares bought were at the higher price).

If you enjoyed this analysis, then I strongly encourage you to click on the orange “follow” button at the top of the article to receive free notifications the next time I publish articles on interesting dividend stocks.

Disclosure: I am/we are long WEC, DTE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.