CMS Energy is a holding company with regulated and non-regulated subsidiaries, serving 1.8 million electric customers and 1.7 million gas customers in Michigan. Substantially improved EPS performance underscores unique business strategy; we continue to anticipate predictable, above-average EPS CAGR. Accelerated investment opportunities should fuel attractive total returns, driven by infrastructure upgrade/replacement needed to maintain system reliability as well as additional investment to meet Michigan’s energy policy goals. Constructive regulation is expected to keep earned ROEs close to authorized levels. Growth prospects position CMS well for 5-7% EPS CAGR longer term. ■ CMS reported 3Q15 EPS of $0.53 beating our/consensus estimate of $0.45/$0.49. The 43% Y/Y EPS improvement from $0.37 in 3Q14 is mainly attributable to rate increases in both the electric and gas segments as well as favorable weather and effective O&M cost controls. ■ 2015 EPS guidance narrowed to $1.87-$1.89, in the upper end of management’s long-term EPS CAGR target of 5-7%. 2016 EPS guidance introduced at $1.97-$2.01, which compares with our unchanged forecast of $2.00 and consensus of $2.01. ■ Organic infrastructure investment opportunities drive highly visible EPS growth prospects. CMS estimates $15.5 billion of investment is needed in the next 10 years to improve system reliability, reduce emissions, expand power generating capacity, and upgrade/expand/replace aging energy infrastructure. FY15 expenditures are expected to be $1.6 billion following a record $1.7 billion in 2014. Upside to our forecast may stem from additional investment in renewables, gas-fired generation capacity, and grid modernization. - Capex was $427 million in 3Q15, yielding YTD capex of $1.1 billion, which is approximately 69% of 2015 budget. ■ MI legislation may provide further investment opportunities. Discussions include ROA and renewable portfolio standards. ■ Electric and gas rate cases pending. CMS has requested a $198.6 million rate increase (+5.0%) and $85.7 million increase (+5.1%) for gas utility customers. The requests are predicated on an Electric/Gas rate base of $9.3/$4.2 billion, respectively, a 41.5% equity layer, and a 10.7% allowed ROE (10.3% currently). ■ Valuation. Our $38 price target is ~16x our 2017 EPS (adjusted for $1-$2/share in NOLs). We believe CMS should at least trade in line with peers (15.5x-16.5x) when fully valued, reflecting above-average total return prospects fueled by an extensive pipeline of infrastructure investments supported by a constructive regulatory environment. October 30, 2015 Baird Equity Research Utilities CMS Energy (CMS) EPS Up 43% Y/Y, Highlighting Successful Growth Strategy David E. Parker [email protected]813.274.7620 Jacqueline M. Parlin [email protected]646.557.3206 Mike Bates [email protected]414.765.7054 [ Please refer to Appendix - Important Disclosures and Analyst Certification ] ESTIMATE CHANGE 1-Year Price Chart N-14 D-14 J-15 F-15 M-15 A-15 M-15 J-15 J-15 A-15 S-15 O-15 40 38 36 34 32 30 31 38 Stock Data Rating: Outperform Suitability: Lower Risk Price Target: $38 Price (10/28/15): $36.25 Market Cap (mil): $10,038 Shares Out (mil): 276.9 Average Daily Vol (mil): 2.46 Dividend Yield: 3.2% Estimates FY Dec 2014A 2015E 2016E Q1 0.75 A 0.73 A Q2 0.30 A 0.25 A Q3 0.37 A 0.53 A Q4 0.35 A 0.38 E Fiscal EPS 1.77 A 1.89 E 2.00 E Fiscal P/E 20.5x 19.2x 18.1x Chart/Table Sources: Factset and Baird Data
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CMS Energy is a holding company with regulated and non-regulated
subsidiaries, serving 1.8 million electric customers and 1.7 million gas
customers in Michigan.
Substantially improved EPS performance underscores unique business
strategy; we continue to anticipate predictable, above-average EPS CAGR.
Accelerated investment opportunities should fuel attractive total returns, driven by
infrastructure upgrade/replacement needed to maintain system reliability as well as
additional investment to meet Michigan’s energy policy goals. Constructive
regulation is expected to keep earned ROEs close to authorized levels. Growth
prospects position CMS well for 5-7% EPS CAGR longer term.
■ CMS reported 3Q15 EPS of $0.53 beating our/consensus estimate of
$0.45/$0.49. The 43% Y/Y EPS improvement from $0.37 in 3Q14 is mainly
attributable to rate increases in both the electric and gas segments as well as
favorable weather and effective O&M cost controls.
■ 2015 EPS guidance narrowed to $1.87-$1.89, in the upper end of
management’s long-term EPS CAGR target of 5-7%. 2016 EPS guidance
introduced at $1.97-$2.01, which compares with our unchanged forecast of $2.00
[Please refer to Appendix- Important Disclosuresand Analyst Certification]
ESTIMATE CHANGE
1-Year Price Chart
N-1
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D-1
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F-15
M-1
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A-15
M-1
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Stock Data
Rating: Outperform
Suitability: Lower Risk
Price Target: $38
Price (10/28/15): $36.25
Market Cap (mil): $10,038
Shares Out (mil): 276.9
Average Daily Vol (mil): 2.46
Dividend Yield: 3.2%
Estimates
FY Dec 2014A 2015E 2016E
Q1 0.75 A 0.73 A
Q2 0.30 A 0.25 A
Q3 0.37 A 0.53 A
Q4 0.35 A 0.38 E
Fiscal EPS 1.77 A 1.89 E 2.00 E
Fiscal P/E 20.5x 19.2x 18.1x
Chart/Table Sources: Factset and Baird Data
October 30, 2015 | CMS Energy
3Q15 Earnings CMS Energy reported 3Q15 EPS of $0.53 solidly above our/consensus estimates of $0.45/$0.49. The 43% Y/Y ramp in EPS from $0.37 in 3Q14 was primarily driven by increased
electric sales due to weather and increased rates in both the electric and gas segments. Lower O&M spending in both the electric and gas segments also contributed meaningfully to earnings. Partially offsetting these positives were increased depreciation and property taxes and higher benefits costs. 2015 EPS guidance narrowed to $1.87-$1.89 from $1.86-$1.89, consistent with a 6-7%
CAGR, on the upper end of management’s long-term EPS target range. We forecast FY of $1.89 with consensus at $1.88. 2016 EPS guidance introduced at $1.97-$2.01, within the 5-7% EPS growth target off of
2015 estimated EPS midpoint. We forecast $2.00 with consensus at $2.01 as CMS has maintained EPS growth in the 7% range over the last five years.
Figure 1: 3Q15 Earnings
Source: Company reports & RW Baird & Co. estimates
CMS Energy- Results Variance ($ mil)
Variance Drivers
3Q15 3Q14 Baird % EPS $ %
Gross Margin 860 775 745 11% 0.21 115 15%
Electric Margin 659 584 515 13% 0.19 144 28%Higher system deliveries due
to w eather, increased rates
Gas Margin 132 120 124 10% 0.03 8 7%
2015 rate increase; partially
offset by low er deliveries due
to w eather
Expenses:
OG&A 311 329 332 -5% 0.04 (21) -6%Low er electric and gas O&M
spending
Other Taxes 59 57 58 4% (0.00) 1 1%
DD&A 173 153 166 13% (0.05) 7 4%Higher electric depreciation
expense
Total Expenses 1,169 1,194 1,147 -2% (0.06) 22 2%
EBITDA 490 389 373 26% 0.25 117 31%
EBIT 317 236 204 34% 0.20 113 55%
Interest Expense 101 101 103 0% 0.00 (2) -2%
Other Income 7 15 3 -53% (0.02) 4 133%
Pretax Income223 150 190 49% 0.18 33 18%
Higher EnerBank, Enterprise
earnings
Income Taxes 75 47 66 60% 9 13%
Tax Rate 34% 31% 35% (0.02)
Net Income $148 $103 $123 44% $0.16 $25 20%
Diluted Shares 277 276 277 0% ($0.00) (0) 0%
Diluted EPS $0.53 $0.37 $0.45 43% $0.16 $0.09 20%
Electric $0.60 $0.47
Natural Gas ($0.02) ($0.03)
Enterprises $0.01 $0.00
Corp/Other ($0.06) ($0.07)
Quarterly Results Variance BairdChg Y/Y
Details
2Robert W. Baird & Co.
October 30, 2015 | CMS Energy
Figure 2: Variance Drivers
Source: Company reports & RW Baird & Co. estimates
Figure 3: Electric and Gas Stats
Source: Company reports & RW Baird & Co. estimates
Figure 4: Capital Expenditures Trend
Source: Company reports & RW Baird & Co. estimates
CMS Energy CMS Energy
Electric Stats Gas Stats
3Q15 3Q14 Y/Y Chg 3Q15 3Q14 Y/Y Chg
Electricity Sales (millions of kWh) Gas Sales (thousand Bcf)
Regulatory Outlook Electric rate case. CMS requested a revised $198.6 million rate increase, based on a 10.7%
ROE, 41.5% equity component, and $9.248 billion rate base. The company proposes a $201.9 million initial increase, with an additional $35.2 million increase with the close of Jackson natural gas plant (expected to close post 12/1/15), and finally a $38.5 million decrease with the close of several coal plants in 4/2016. Also in this filing, the company proposes an additional $163.7 million rate increase on 6/1/16 and $78.2 million on 6/1/17 through an Investment Recovery Mechanism. The ALJ judge recommended a ~$106 million increase on 9/16/15. A final order is expected by the end of 2015. Gas rate case. CMS filed a gas rate case on 7/17/15 requesting an $85.7 million revenue
increase, premised on a 10.7% ROE and 41.42% equity component; rate base of $4.0 billion. CMS also requests an Investment Recovery Mechanism to increase rate by $146.7 million due to estimated investments during 2017-2019. New Commissioner Appointed. Governor Snyder appointed Norm Saari to the MPSC on
July 22. Saari began his term on the Commission following Senate approval, on August 2 to replace Greg White. Saari represents the Republican Party and has held other legislative jobs as well as worked for Consumers for over 30 years.
Recent Events/Outlook Significant regulated investment opportunities expected to drive above-average EPS CAGR. CMS Energy’s regulated utility, Consumers Energy (Consumers), plans to invest $7.6
billion from 2015-2019 to improve system reliability, reduce power plant emissions, expand power generating capacity and upgrade, expand or replace aging energy infrastructure. Investment is earmarked for: cleaner/efficient power generation, expanding electric and natural gas infrastructure capacity, enhance system reliability and optionality and system expansion. CMS’ project pipeline includes “bite sized” projects, which we believe lowers execution risks.
FIGURE 5: 5-YEAR CAPEX PLAN
Source: Company reports
CMS delves deeper into the realm of renewable energy as Michigan’s Energy Goals create need for significant energy infrastructure investment. Underinvestment, changing
customer needs, and tightening emission and environmental standards have boosted needed infrastructure investment. Michigan’s governor recently reiterated the state’s energy policy: reduce the reliance on coal, grow use of renewable energy and natural gas, and improve energy affordability and reliability while protecting the environment.
4Robert W. Baird & Co.
October 30, 2015 | CMS Energy
Community Solar Project. CMS will develop 4 MW of solar energy in a community
solar program called Solar Gardens. CMS has been increasing their renewable fuel mix and last year, CMS reached its goal of 10% of its electricity use from renewable sources.
Apple Blossom Wind Farm. Producing 100 MW, this project is under construction
and should be commercially operational in 2016. CMS will utilize a PPA agreement with the option to purchase. CMS currently utilizes two wind farms and has contracts to purchase wind, landfill gas, anaerobic digestion, hydro, and solar energy.
Modifications to Michigan’s energy policy could provide upside for investment opportunities. Michigan lawmakers are diligently working on a new bill to address retail open
access adjustments and renewable portfolio standards. ROA may be capped at 10% with a one-way door for customers to return to the utility. Discussions include debate on whether customers should come back into the system over three to five years and how that process would work. ROA load in CMS service territory is about 800 MW, and if that load returned, CMS has indicated the need for longer-term new generation solutions. ROA changes are not in management forecasts and would provide upside to the current projections. Renewables standards are also a topic being discussed as the Clean Power Plan puts demands on states to meet certain emission reduction goals. In the past, CMS has added wind generation to its rate base at attractive cost to customers. Committee hearings were completed in October; the bill will go on to a Committee and full vote before potentially being signed by the governor into law likely by year-end. CMS displays capacity diversity as it has already worked to move its generation to a cleaner and more cost competitive mix. Management plans to further decrease coal mix to
25% by next year and boasted their reduction efforts of coal source to ~33% from over 40%. These reductions are a result of CMS decision to retire seven coal-fueled units. With the planned retirement of these units and the potential tightening of the MISO capacity market, Consumers could experience a shortfall in generation capacity of up to 1,500 MW in 2016. In 2013, 46% of the energy Consumers delivered was generated at its four operating coal-fueled generating sites.
FIGURE 6: CAPACITY PORTFOLIO MIX EVOLUTION
Source: Company presentation
Substantial generation investment opportunities reflecting short power capacity position likely provides EPS growth upside. In order to meet Michigan’s renewable portfolio
standards, reduce emissions and meet a larger percentage of its customers' energy needs via owned resources, CMS plans $1.7 billion in new generation over the next ten years. A recent MISO study shows Zone 7 to have a capacity shortfall of ~$1.3 GW.
Expiring PPAs, retiring coal-fueled generation capacity, coal-heavy fuel mix provides upside potential to CapEx forecasts. Consumers relies heavily on power
generation from third parties, with 49% of the electricity delivered to regulated customers through long-term PPAs, seasonal purchases, and the MISO energy market in 2013. Consumers must supplement its generation capability with purchases from the MISO energy market to meet its customers’ needs during peak demand
5Robert W. Baird & Co.
October 30, 2015 | CMS Energy
periods. With 3,000 to 4,000 MWs of supply/demand changes in the next ten years, upside to infrastructure investment forecast likely exists and $1 billion in annual PPA costs enhances Consumers buy/build/own generation optionality.
FIGURE 6: 10-YEAR OWNED CAPACITY GROWTH POTENTIAL FROM EXPIRING PPAS
Source: Company reports
6Robert W. Baird & Co.
Investment Thesis
Significant regulated investment opportunities expected to drive above-average EPS CAGR.
Our Outperform rating reflects our expectation that accelerated infrastructure investment needs will
drive attractive total returns. We forecast CMS Energy’s EPS CAGR to be 5-7% for the foreseeable
future, supported by infrastructure upgrade/replacement needed to maintain system reliability as well
as additional investment to meet Michigan’s energy policy goals. Potential modifications to Michigan's
energy policy, likely in 2015, could fuel additional investment needs.
■ Energy investment improves reliability, system efficiency. Under-investment, changing state
energy policies and changing customer needs as well as tightening emission and environmental
standards have boosted needed infrastructure investment. CMS estimates that over $15.5 billion of
investment (current rate base $12.9 billion) is needed in the next 10 years. Despite substantial rate
base growth, the impact to a customer’s bill is expected to be less than inflation (~2%/year).
■ With over $6 billion in infrastructure investment in its rear view mirror, CMS has
demonstrated expertise at managing accelerated investment program. A 6% increase/year in
rate base fueled a five-year EPS CAGR of 7%, making CMS a top total return investment in the
past five years. Residential and commercial customer bills remain below regional averages.
Expected changes in rate design should improve industrial rate comps.
■ Substantial generation investment opportunities reflecting short power capacity position
likely provides EPS growth upside. In order to meet Michigan’s renewable portfolio standards,
reduce emissions and meet a larger percentage of its customers' energy needs via owned
resources, CMS plans $2.3 billion in new generation over the next 10 years, which may increase if
ROA is modified/eliminated.
■ Constructive regulation. Innovative regulatory practices and policies, like forward test years,
self-implementing interim rates and enhanced regulatory recovery mechanisms have kept earned
ROEs above peers despite accelerated investment.
■ Attractive dividend yield and above-average dividend growth potential. At 3.2%, CMS has a
dividend yield generally inline with peers in the regulated electric/gas utility group, which has an
average yield of 3.5%. We expect CMS to grow its dividend ~6%/year and maintain a payout ratio
to EPS of roughly 60%.
■ Valuation. Our $38 price target is ~16x our 2017E EPS (adjusted for $1-$2/share in NOLs). We
believe CMS should at least trade in line with peers (15.5x-16.5x) when fully valued reflecting
above-average total prospects fueled by an extensive pipeline of infrastructure investments
supported by a constructive regulatory environment. Despite accelerated investment needs, CMS
has earned solid regulated ROEs reflecting a constructive Michigan regulatory environment and
CMS’ successful cost containment efforts. These key metrics support a valuation multiple at least in
line with peers, if not a premium valuation.
Risks & Caveats
Our suitability rating on CMS Energy is Lower Risk, reflecting the stable earnings provide by its
regulated natural gas distribution and electric operations, long-term dividend history, and solid balance
sheet. Risks include the following:
■ Weather and declining consumption trends. As per capita usage decreases due to
conservation, utility revenue tied to volume consumption can be negatively affected. As the
company does not yet have decoupling, revenue is linked to weather patterns. Mild winter
temperatures decrease demand while extreme winter weather increases operating expenses as
crews work around the clock to restore power after outages.
October 30, 2015 | CMS Energy
7Robert W. Baird & Co.
■ Changes in regulatory climate. We believe the company has a constructive relationship with the
Wisconsin commission. It is difficult to predict how changes in the Commission’s makeup could
change the company’s regulatory treatment.
■ Economic cycle risk. While residential usage tends to be largely immune to economic slowdown,
use by commercial and industrial (C&I) customers may be impacted. C&I customers make up 62%
of CMS Energy’s total electric sales.
■ Commodity price increases. The company has limited control of the wholesale prices of natural
gas, oil or coal. A spike in the price of these fuels could adversely affect the company’s financial
results. CMS Energy has a recovery mechanism to allow it to pass fuel costs onto customers, but it
must stay within a 2% symmetrical band of its estimate or defer the costs or benefits, and high rates
may increase regulatory pressure.
■ Purchased power increases. CMS Energy engages in open-market purchases for a portion of its
electricity needs. Like natural gas prices, the price of wholesale electricity can and does fluctuate.
Such fluctuations could adversely affect CMS Energy’s operations.
■ Additional external financing possible. All capital requirements that exceed available cash will
have to be provided by external financing. The availability of funds depends on many factors,
including conditions in the securities markets and general economic conditions generally, as well as
the debt ratings and future income and cash flow of CMS and its subsidiaries.
■ Financial risk. Increases in interest rates could result in increased cost of capital as CMS Energy
Rate Base 10,519 11,060 11,445 12,336 12,925 EV / EBITDA 8.2x 8.3x 8.3x 9.7x 9.1x
ROE (Rate Base) 10.8% 9.7% 11.3% 11.2% 9.5% EV / EBITDA with Op Leases 8.2x 8.3x 8.3x 9.7x 9.1x
Current Ratio 1.10 1.35 1.30 1.29 1.19
Days Sales Outstanding (DSO) 52.1 54.8 54.9 42.9
EBIT/Interest Expense 2.42 2.73 2.87 2.83 2.91
Debt/Total Cap 71% 70% 69% 70% 69%
Debt/Total Cap (Incl Op Leases) 71% 70% 69% 70% 69%
Book Value/Share 11.50 11.89 12.71 13.36 14.09
Source: Company Reports and Baird estimates
Please refer to Appendix - Important Disclosures and Analyst Certification.
CMS Energy(CMS-NYSE)
10Robert W. Baird & Co.
Appendix - Important Disclosures and Analyst Certification
Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q315
20
25
30
35
40
2013 2014 2015 2016
05/22/14I:O:$35
01/29/15O:$38
Rating and Price Target History for: CMS Energy (CMS) as of 10-29-2015
Created by BlueMatrix
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