DTE Energy Offers Stability At A Price

Summary

• Many investors are desperate for stability, as the events of the past week have caused flashbacks to 2008 and the financial collapse.
• DTE Energy Company enjoys incredibly stable finances regardless of conditions in the broader economy.
• The company is positioned to grow its earnings per share at a 6% to 8% rate over the next five years, which gives it the potential for strong total returns.
• The company has made a lot of progress in improving its balance sheet, but it is still heavily leveraged compared to some of its peers.
• The 3.57% dividend yield appears to be sustainable going forward, but DTE Energy Company stock is a bit expensive today.
• Looking for a helping hand in the market? Members of Energy Profits in Dividends get exclusive ideas and guidance to navigate any climate. Learn More »

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DTE Energy Company (NYSE:DTE) is a regulated electric and natural gas utility that serves the city of Detroit, Michigan, and the surrounding area. The utility sector has long been a favorite among retirees and other conservative investors due to its comparatively high dividend yields and relative financial stability. This financial stability is something that could prove appealing today, considering the fear that has been sweeping over the economy in the wake of the bank failures over the past week.

DTE Energy is certainly no exception to this, as the company's 3.57% current yield is both higher than the broader utility sector and the market as a whole, plus the company's most recent results showcased a great deal of year-over-year stability. Unfortunately, DTE Energy has a fairly high debt load relative to its peers, which could add an element of risk to the position. As I pointed out in my last article on the company, DTE Energy does have a strong focus on developing its renewable capabilities and currently trades at an attractive valuation so there may still be some reasons why the company could be appealing to many investors.

About DTE Energy

As stated in the introduction, DTE Energy is a regulated electric and natural gas utility that serves the city of Detroit, Michigan, and the surrounding areas. This is not nearly as large of a geographic area as many other utilities serve, but it is a highly populated one. As of December 31, 2022, DTE Energy provided electricity to 2.3 million customers and natural gas to 1.3 million customers throughout Southeast Michigan. That is sufficient to make this one of the largest utilities in the United States. Unfortunately for DTE Energy, the population of its service territory has been declining.

World Population Review

This is somewhat of a similar trend as we have been seeing all across the Rust Belt for the past few decades, with the notable exception of Pittsburgh, PA. The population of the Detroit Metropolitan area has held up a bit better than the city itself, but it still posted declines in both 2021 and 2022:

Year	Population of Greater Detroit	YOY Change
2022	4,344,662	-0.47%
2021	4,365,205	-0.47%
2020	4,385,748	1.51%

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(Data from U.S. Census Bureau)

It is currently being projected by the U.S. Census Bureau that the region's population will continue to decline until 2030. This is a negative for DTE Energy because one of the only ways that a utility can grow its operations is through the addition of new customers. As utilities are normally regulated monopolies whose operations are confined to a specific region, they are highly dependent on the population growth of their service territory. As DTE Energy's service territory is declining in population, the company will likely have fewer customers paying their monthly electric and gas bills. All else being equal, that results in lower revenues over time, and it is quite difficult for any company to produce growth when its revenue is declining.

With that said, DTE Energy did manage to deliver revenue growth over the course of 2022. The company's most recent earnings report shows full-year 2022 revenue of $19.228 billion compared to $14.964 billion in the full-year 2021 period. This was partially driven by the fact that natural gas prices were significantly higher in 2022 than in 2021, but that was not the only driver of the improved performance. DTE Energy's electric revenue was also up year-over-year, which was largely due to rate base growth. The rate base is the value of the company's assets upon which regulators allow it to earn a specified rate of return. As this rate of return is a percentage, any increase in the rate base allows the company to adjust its prices upward in order to earn that prescribed rate of return. Thus, DTE Energy was able to charge its customers more than it did a year ago because its rate base was larger.

The company is planning to continue to grow its rate base over the coming years. The way that it intends to accomplish this is by investing money into upgrading, modernizing, and even expanding its rate base. In fact, DTE Energy is planning to invest approximately $21.6 billion over the 2023 to 2027 period to accomplish this:

DTE Energy

The $1.0 billion to $1.5 billion planned investment in DTE Vantage is not included as part of its rate base expansion because that business unit is not a regulated utility. The rate base growth will come from the $18 billion investment into the electric utility and the $3.6 billion that it invests into the natural gas utility. The one big thing that we see above is that the company is planning to invest substantially more into its electric utility operations than its natural gas operations. As already mentioned, DTE Energy serves far more electric customers than natural gas ones, but this is not the sole reason for this. DTE Energy is much more aggressive about promoting the concept of electrification than many other electric utilities. This is something that is actively promoted by politicians and environmental activists, which refers to the conversion of things that are historically powered by fossil fuels to the use of natural gas instead.

One of the areas that are actively targeted for conversion is transportation, and DTE Energy is actively working to increase the capacity of its energy grid to allow for the widespread use of electric cars within its service territory. That will require far more capacity than the company currently has, which I pointed out in a previous article. DTE Energy acknowledges this and has provided this chart of its own projections on electric consumption:

DTE Energy

If the company seeks to expand its grid capacity to the degree that would be necessary to support this, it will need to make enormous investments in capacity. In fact, it will probably need far more than the $18 billion that it currently has budgeted. As I have explained in a number of articles though, it is pretty unlikely that electric vehicles will become as popular as many prognosticators and futurists claim. Even in the absence of the demand growth from electric vehicles though, DTE Energy's investments will still grow its rate base sufficiently that the company should be able to grow its earnings per share at a 6% to 8% compound annual growth rate over the 2023 to 2027 period. When we combine this with the company's 3.57% current yield, investors should be able to expect a 10% to 12% average annual total return, which is quite attractive from a conservative utility investment.

One of the nicest qualities about utilities like DTE Energy is that they enjoy remarkable financial stability regardless of the broader economy. We can see this by looking at the company's net income over the past three years:

	FY 2022	FY 2021	FY 2020
Net Income	$1,083	$903	$1,371

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(All figures in millions of U.S. dollars)

As we can clearly see, there is not a great deal of variation here over time. This comes despite the fact that the macroeconomic backdrop was quite different in all three years. In 2020, the pandemic-related lockdowns caused a great deal of financial hardship for many people and numerous businesses shut down and stopped using electricity. In 2021, the economy was generally swimming with cash as it re-opened just as the Federal stimulus rounds had caused Americans to have full bank accounts that they were eager to spend. In 2022, the high level of inflation started straining many people's budgets, but they kept spending as credit card balances hit record levels.

The reason why DTE Energy was able to deliver relatively stable financial performance is that it provides a product that most people consider to be a necessity for modern life. After all, not very many people today do not have electricity and central heating in their homes! Thus, people will generally prioritize paying their electric bills over discretionary spending during times when money gets tight. As electric consumption does not change very much from year to year, which I explained in an article earlier today, this results in remarkably stable financial performance over time. This is exactly the kind of thing anyone spooked by the events of the past week in the banking sector should be able to appreciate.

Financial Considerations

It is always important to look at the way that a company finances its operations before making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. That is usually accomplished by issuing new debt and using the proceeds to repay the maturing debt, which can cause a company's interest expenses to increase following the rollover in certain market conditions. This is something that could be a very big deal today as the Federal Reserve has been hiking the market interest rate and so far, there are no real signs that it will stop. In addition to interest rate risk, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes a company's cash flows to decline could push it into financial distress if it has too much debt. Although utilities like DTE Energy tend to have remarkably stable cash flows, there have been bankruptcies in the sector so this is not a risk that we should completely ignore.

One metric that we can use to evaluate a company's financial structure is the net debt-to-equity ratio. This ratio tells us the degree to which a company is financing its operations with debt as opposed to wholly-owned funds. It also tells us how well the company's equity can cover its debt obligations in the event of a liquidation or bankruptcy event, which is arguably more important.

As of December 31, 2022, DTE Energy had a net debt of $19.207 billion compared to total shareholders' equity of $10.401 billion. This gives the company a net debt-to-equity ratio of 1.85 today. Here is how that compares to some of the company's peers:

Company	Net Debt-to-Equity Ratio
DTE Energy	1.85
Eversource Energy (ES)	1.45
CMS Energy (CMS)	1.87
WEC Energy Group (WEC)	1.49
Exelon Corporation (EXC)	1.62

Click to enlarge

As we can see here, DTE Energy is somewhat more leveraged than many of its peers. This is a sign that the company may be using too much debt in its financial structure and thus exposing us to more risk than we would like. However, DTE Energy has been making a lot of progress in strengthening its balance sheet over the past year. As regular readers will likely recall, the company had a net debt-to-equity ratio above 2.0 for much of 2022. This is something that we will want to keep an eye on, but the progress that the firm has made recently at strengthening its balance sheet means that it probably is not as risky as it once was in this respect.

Dividend Analysis

One of the major reasons that investors purchase shares of utility companies like DTE Energy is the high yields that these companies tend to possess. Indeed, DTE Energy currently yields 3.57% compared to the paltry 1.64% yield of the S&P 500 Index (SP500). Unfortunately, the company has not been as reliable as most other utilities with respect to its dividend:

Seeking Alpha

As we can see, the company has varied its dividend a bit over the past five years. That is something that may be concerning since utility companies usually increase their dividends on an annual basis. While this dividend cut was caused by the spin-off of its midstream operation and not due to any real problems at the company, its dividend history is still not as attractive as other utilities. Nonetheless, we can see that the company makes efforts to increase its dividend annually, especially in the years following the spin-off of DT Midstream, Inc. (DTM). The most important thing for anyone purchasing today is, of course, the ability of the company to maintain the current dividend because new money will not be affected by the company's past. So, let us investigate the company's current dividend sustainability.

The usual way that we judge a company's ability to pay its dividend is by looking at its free cash flow. Free cash flow is the money that was generated by a company's ordinary operations that is left over after it pays all its bills and makes all necessary capital expenditures. This is therefore the money that can be used for tasks such as reducing debt, buying back stock, or paying a dividend. During the fourth quarter of 2022, DTE Energy reported a negative levered free cash flow of $418.5 million. That is, unfortunately, not enough to pay any dividends but the company paid out $171.0 million in dividends during the quarter. This is certainly concerning at first glance.

However, it is not unusual for a utility to finance its capital expenditures through the issuance of stock and especially debt. It then pays its dividend out of operating cash flow. This is because the high costs involved in constructing and maintaining utility-grade infrastructure over a wide geographic area would prohibit the company from paying any dividend if it relied on free cash flow. During the fourth quarter of 2022, DTE Energy had an operating cash flow of $565 million. That was more than enough to cover the $171.0 million that the company paid out in dividends and left it with a good deal of money remaining to cover its other expenses. Overall, the company can probably afford to maintain this dividend without much difficulty.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate a suboptimal return on that asset. In the case of a utility like DTE Energy, we can value it by using the price-to-earnings growth ratio. This ratio is a modified version of the familiar price-to-earnings ratio that takes a company's forward earnings per share growth into account. A price-to-earnings growth ratio of less than 1.0 is a sign that the stock may be undervalued relative to its forward earnings per share growth and vice versa. However, today's market is richly valued and as such there are relatively few companies that appear undervalued using this metric. That is particularly true with low-growth companies like utilities. As such, the best way for us to use this ratio is to compare DTE Energy to its peers in order to determine which company offers the most attractive current valuation.

According to Zacks Investment Research, DTE Energy will grow its earnings per share at a 6.00% rate over the next three to five years. That is in line with what the company should be able to deliver based on its rate base growth, so it seems like a pretty solid number. This gives the stock a price-to-earnings growth ratio of 2.86 at the current stock price. Here is how that compares to the company's peer group:

Company	PEG Ratio
DTE Energy	2.86
Eversource Energy	2.63
CMS Energy	2.38
WEC Energy Group	3.40
Exelon Corporation	2.65

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As we can clearly see here, DTE Energy looks somewhat expensive compared to most of its peers. This is not really unusual for this company, as I have pointed out in previous articles on it. While DTE Energy is focusing more on renewables than some companies, that cannot justify the higher valuation as the above ratio takes the company's earnings per share growth into account. As such, it would make the most sense to wait a bit until the share price drops to a level that is closer to the company's peers.

Conclusion

In conclusion, DTE Energy Company looks like a reasonable investment for investors that are seeking a safe haven in a climate of fear. The company is quite stable financially regardless of any fluctuations in the broader economy. Unfortunately, the company appears a bit expensive relative to its peers. This is probably due to the company being more focused on renewables than some other renewables, but if that does not translate into sufficient earnings growth to justify the valuation, then it is meaningless. It would likely be best for investors to watch for a better entry price, although DTE Energy Company is certainly not a bad pick today.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.