Saturday, August 8, 2009

DTE Energy: Plodder, But A Relatively Safe One

"Detroit R.I.P." How many times have we heard or read that? There certainly was cause, as two of the Big Three have collapsed into bankruptcy. Parts of Detroit seem to be wasteland. The June unemployment rate for Michigan was 15.2%.

And yet, DTE Energy's earnings were up in the first half of 2009 as compared with the same period in 2008. DTE's an electric utility holding company for Detroit Edison. The company also owns two gas utility providers for the southwestern Michigan area.

In continuing-operations earnings per share terms, DTE isn't really a grower. Its 10-year continuing-operations EPS growth, as measured by logarithmic regression, is just below zero: -0.1091%. Its 10-year return on shareholder's equity, as calculated by dividing the sum of net income over 10 years by the sum of shareholder's equities over the same period, is 10.42%. It's unsurprising that a regulated utility would have a not-so-great ROE; those same regulations cushion the blows to ROE that would come with new environmental legislation. DTE would need it, as it uses a lot of coal.

A large part of DTE's tripling of 2Q EPS from '08 to '09 came from energy trading, which benefitted from much lower natural gas prices. If natural gas prices have bottomed, then expecting the same performance would be iffy. Energy trading contributed $27 million of DTE's $81 million net income in 2Q '09; it took away $14 million from net income in 2Q '08. Its gas-utility operations took away $4 million more from net income in 2Q '09 than in 2Q '08. Perhaps surprisingly, electric-utility operations contributed $24 million more to net income in 2Q '09 than in 2Q '08. If everything else is held constant except electric-utility contribution, then DTE's net income would have doubled in the same timeframe.

I'm not suggesting that DTE will be a long-term earnings grower, but what I am suggesting is that the company will not be a long-term earnings decliner. That's important for a utility company.

Here's why: because the regulations uses amount of capital for rate-of-return calcuations, they encourage a utility to have a nonexistent or negative free cash flow. For DTE over the last four years, capex spending has been close to cash flow from operations or even above it when the year is done. The difference is made up of debt, typically secured debt on new projects. So, using free cash flow for safety-of-dividend analysis is problematic for a utility. The simpler approach of earnings coverage suffices, even if some prefer to use EBITDA coverage.

DTE's current payout ratio, with a 6.16% yield and 12-month trailing earnings of $3.43, is about 62%. At today's dividend level, using its 10-year average EPS of $3.27, its long-term payout ratio would be about 65%. Only in 2001 did its EPS come in below its dividend payout, and the difference was only 2 cents per share; the dividend was not cut. DTE hasn't had an annual loss in the last ten years. I note parenthetically that its EBITDA per share, as gotten from this Website, has never been less than three times the dividend payout. It's usually between four and five times.

As a yield stock, there's something to be said for the company. Its dividend is well covered by earnings per share. With a yield of 6.16%, it's one of the higher yielding electric utilities in the Low P/E Bin. A 65% payout rate (using 10-year average EPS and backfitting of the current dividend) may be high for some, but its businesses are largely stable. Although this point appeals to near-term factors, the fact that EPS has gone up in the last quarter is an added plus.

I can't hold out any hope for a dividend increase, even if the bump-up in net income continues this year. If Detroit's death has been exaggerated, then EPS may not benefit all that much. The ramp-up in net income from electric-utility operations has been in the teeth of an 11.1% decline in electricity sales and an 11.5% decline in delivered power. Thus, the increase in net income came from cost control; it's not a source of long-term income growth. Once cost control is no longer necessary, it's likely that costs will ramp up with revenues again. The only potential "kicker" comes from its natural gas operations. If the winter's to be cold, then DTE will sell more gas and should see the gas contribution to net income better the corresponding contribution of the year-ago period. As noted above, though, DTE has not been a long-term grower. Any EPS boost due to the gas factor would do little more than increase the safety margin for the dividend.

As far as the risk of further environmental-related costs are concerned, the regulations evidently permit DTE to pass the cost on to its customers. If the cap-and-trade bill is passed, there might be a sell-off but DTE's dividend should not be affected by it.

In conclusion: this company is not a grower, but its $2.12 per year dividend is evidently safe. Essentially, it's a yield stock; except for the possibility of P/E expansion due to general recovery, there's not much hope for a serious capital gain from the stock. On the other hand, at this stage in the economic cycle, the risk of capital loss is less than, say, in 2005-07. The company's held up well in a region of the country that has a semi-wrecked economy, which adds a contrarian flavor to the stock.

Disclosure: DTE is one of the stocks in my actively-managed Marketocracy mock fund.

Note: I'm not licensed to act as an investment advisor in my home jurisdiction of Ontario in Canada, nor am I qualified to become licensed as such.

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