CMS Energy Corporation

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

A Michigan-based energy company operating primarily in Michigan. It is the parent holding company of several subsidiaries involved in electricity, natural gas, and renewable energy.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

CMS Energy Corporation, founded in 1886, operates through three main segments:

Consumers Electric Utility: This segment engages in the generation, purchase, distribution, and sale of electricity in Michigan, serving predominantly residential, commercial, and industrial customers.
Consumers Gas Utility: This segment is involved in the purchase, transmission, storage, distribution, and sale of natural gas.
CMS Enterprises: This segment focuses on investments in domestic independent power production, including the development and operation of renewable generation.

Revenue Distribution

For the nine months ended September 30, 2023, Consumers reported $5.1 billion in operating revenues, with $3.7 billion coming from electric utility operations, $1.2 billion from gas utility and a smaller portion from other operations. A similar trend was seen in 2022 as well. The split was a $5.2bn from the electric utility, $1.2bn from the gas utility, and $0.4bn from others.

Industry Landscape and Competitive Landscape

The energy industry is undergoing significant transformation driven by:

Transition to Renewable Energy: There’s a push toward cleaner energy sources and grid modernization. This is affecting all of CMS Energy’s activities. It is also pushing them towards more expensive projects to upgrade the grid and bring new renewable plants.
Regulatory changes: CMS is subject to various federal, state, and local environmental laws and regulations, requiring significant capital expenditure. These regulations and their effects on the business are discussed in detail in the “Outlook” section of the 10Q and 10K filings.
Cybersecurity Threats: Energy companies face increasing risks related to cyberattacks and therefore are needed to implement strong protection measures. CMS has been impacted by a significant cyber attack in the past.
Economic Conditions: The business faces varying commodity prices and supply-demand fluctuations, which in turn affect its operating income and profitability.
Competition: Electric Utilities face a natural competitive disadvantage due to regulations. They face some competition from alternative energy options, but generally, their natural monopoly is unchallenged. Gas utilities, being less regulated face higher competition in a price-sensitive market.
Geopolitics The war in Ukraine, supply chain disruptions and trade wars have introduced new complexities in commodity prices, and general business risks that need constant mitigation.

While CMS Energy benefits from a regulated utility business and its independent power production, they face competition in several areas. However, for example, in a market like Michigan, with high regulatory oversight, the company faces less competition.

What Makes CMS Energy Different

Triple Bottom Line Approach: CMS Energy and Consumers have a “triple bottom line” approach that prioritizes “people, planet, and profit”, reflecting a commitment to employees, customers, and communities while also taking into account the economic side of the business.
Commitment to Sustainability: CMS Energy has a multi-year plan in place to transition its energy sources to more renewable options. As part of that plan, they have initiated programs to conserve energy, increase efficiency, and promote the use of alternative energy sources.
Focus on Local Communities: CMS Energy also focuses on building strong relationships with the local communities. For example, they have made a lot of effort to hire diverse talent, promote workforce development, and invest in the local communities.

Recent Issues and Management View

Rate Increase Case: In December 2022, the MPSC authorized an annual rate increase of $116 million for the projected twelve-month period ending September 30, 2024. In July 2023, the MPSC approved a settlement agreement authorizing a further annual rate increase of $113 million, based on a 9.9-percent authorized return on equity for the projected 12-month period ending December 31, 2023. The rate requests remain subject to some uncertainty and could be adjusted in the near future. In June 2023, MPSC approved a settlement agreement authorizing an annual rate increase of $212 million, based on a 10.25 percent authorized return on equity for the projected 12 month period ending January 31, 2025, for the gas part of CMS.
Higher Interest Rate Environment: CMS is facing a higher interest rate environment that is impacting both their profitability and financial position. High interest expenses are leading to lower profitability. However, that is not unique to them but is affecting a lot of companies. This is being counteracted, to some extent, by the fact that inflation is allowing them to increase their rates as well.
Cybersecurity Incident: In December 2022, NorthStar Clean Energy reported a cyber incident that affected its operations. As a result of this, CMS and Consumers have been spending more money to increase their cybersecurity protection. These costs might hurt near-term profits but reduce the long-term threat from cyber attacks.
Transition to clean energy: The company is in transition from coal and other traditional sources towards renewable sources. Transitioning will result in higher upfront expenditure but will potentially have a better financial position in the long run, if they do it efficiently.
Inflation: CMS expects inflation to decline gradually and they also expect to see some relief in commodity prices after 2024. However, inflation poses a unique challenge of making the financial projections more difficult since it is hard to accurately predict the inflation numbers.

Management appears to be proactive in mitigating risks and capitalizing on opportunities with their commitment to sustainability, improving operating efficiencies, and being responsive to regulatory changes.

Moat Assessment

CMS’s moat assessment is tricky because of its regulatory structure and its participation in a mix of energy businesses.

A “moat” is a company’s ability to maintain its competitive advantages over the long term, allowing it to generate sustained profits and returns on capital.

Strengths

Regulatory Barriers: As a regulated utility in Michigan, CMS enjoys some level of protection from competition. Government regulations and licensing can make it difficult for new entrants to compete effectively in these markets.
Niche Market Dominance: While not a dominant player in the entire energy sector, in local niche markets, where CMS has control over local transmission or local infrastructure, it faces very little competition. This allows it to generate a higher return than a competitor without such benefits. For example in Natural Gas and other commodities that are hard to transport long distances.
Switching Costs: For many customers, it will be difficult to change their electricity or gas providers. The hassle of setting up new billing and other such operations leads to people sticking with their current providers which can act like switching costs.

Weaknesses

Lack of Pricing Power Although regulations can guarantee profits for a utility, it can limit the ability to make profits, therefore decreasing long-term value of a company. Pricing power is a moat that protects the profit margins of a company, and CMS has only some of it.
Technology Disruption: CMS faces a high risk from technological disruptions, including the rising popularity of distributed renewable energy and distributed energy technologies. Changes in technology can make current energy infrastructure obsolete, therefore hurting current businesses and creating a need for new investment.
Limited Brand Strength: While local goodwill can certainly help, utilities don’t generally have strong brands. Therefore they are more interchangeable and can be undercut in prices if a company can set up an alternative business.
Commoditized product: Electricity is a commodity that is essentially indistinguishable from its competitor’s, which results in higher competition.

Moat Rating: 2/5

Given the analysis, I would rate CMS with a moat of 2 out of 5. While there are barriers to entry from regulatory hurdles and the difficulty of creating a large distribution network, these advantages are often limited by regulations and lack pricing power as well as the risk of disruption from technological changes. The presence of a wide moat is unlikely given the strong competition faced in the industry.

Legitimate Risks to the Moat

Regulatory Changes: Shifts in regulations, especially regarding renewable energy targets or rate setting, could alter CMS’s profitability. Regulators might become less lenient than today and start forcing new changes, which will result in a higher burden on CMS.
Technological Disruption: The emergence of new, more efficient and cost effective technologies (e.g., alternative methods of generation) could diminish the need for CMS’s current infrastructure and could potentially render current assets unneeded. It can also affect the existing business lines of the company, with the increasing popularity of renewable sources for home power.
Commodity Price Volatility: Fluctuating prices of natural gas, and other energy commodities can affect profitability and revenue predictability of CMS, especially since these prices are being actively changed by global conditions.
Economic Cycles: Downturns can curtail energy consumption, affecting revenues and potentially lowering return on capital. During a recession, households and businesses tend to consume much less and therefore utilities that are largely tied to those consumers may face a reduction in revenues.
Cybersecurity Threats: As the energy infrastructure is increasingly digitized, the risk of cyberattacks poses a significant threat to operations and finances and therefore would require higher investments in cybersecurity protection.

Business Resilience

Reliable Infrastructure: The company has a large network of electrical lines, gas pipelines, and generation plants, all of which are essential for economic activity in Michigan. This should enable the company to bounce back from the negative impacts.
Geographic Diversification: Though primarily focused in Michigan, some of their renewable assets are geographically diverse. Also, they are starting new operations in new territories, which will provide them more protection.
Long-Term Contracts: The company operates under government regulations, where prices are locked and the demand is inelastic. They are also exploring PPAs, with most of these contracts lasting over a decade. This provides some certainty to future revenue.
Commitment to sustainability: The company’s commitment to the triple bottom line and their goal for net-zero emissions helps improve their reputation and attractiveness to consumers.

Financial Analysis

Recent Financial Performance

For the nine months ended September 30, 2023, CMS Energy Corporation reported:

Operating revenues of $5.1 billion, a slight increase from $5.0 billion in 2022.
Net income of $575 million, compared to $486 million from last year, indicating better overall earnings.
Year to date EPS of $1.96, compared to $1.70 of last year
CMS’s results were driven largely by the electric and gas utility segments, which contribute most to the company’s revenues.

Income Statement

Revenues are mostly derived from electric and gas utility services. Although, some revenue is also produced through their renewable facilities under CMS Energy segments.
Operating expenses generally vary due to material, labor, and fuel costs. These costs have been rising recently, thus pushing their prices higher and margins slightly lower.
Interest expense is a big line item, because utilities are quite capital intensive and take a lot of debt. Currently, the high interest rate is also impacting their interest expenses. They, however, use interest rate derivatives to mitigate the impact of changing rates.
Taxes are a very complicated thing for utility and energy companies. They have a wide range of credits and expenses, which makes tax rates hard to generalize. For example, the investment tax credits from their renewable investments, tax shields from interest expenses, and deferred tax liabilities all add to the complexity.

Balance Sheet

Their total cash balance, as of the end of September 2023, is around $600 Million. That’s a slight decrease from December 31, 2022 when they reported $841 million.
Current Assets including cash, receivables and others is $2.7 billion, and Total Assets are $33.9 billion, which is a very large amount. It is to be noted that they are largely a capital-intensive business.
Long term debt is $13.3 billion, with total debt at $14.2 billion. Which is more than half of the assets. This debt, however, is also an asset, since it is used for making the company more profitable.
The company had a debt-to-equity ratio of 1.8, which indicates that the company’s debt is a bit higher than its equity.

Cash Flows

Cash from operations has mostly been strong, showing stable revenues and profitability of the business. However, the net cash flow from operating activities for the nine months ended September 30, 2023 is $1.1 billion (down from $2.1bn from the prior year) which indicates a change in working capital levels, due to changes in prices and business environment.
Investing activities generally involve capital expenditures in plants, power-generation facilities and other such equipment, most of which are needed for maintaining and growing their capacity. In general the company makes significant investments each year.
Financing activities mainly include debt repayments, dividends, and new borrowings, showing the nature of the company’s financing and capital structure. In 2023, the company mainly borrowed and paid off a portion of debt.

Overall, CMS’s finances are a mixed bag. On one hand, they generate stable revenues and profit, but on the other, they use a lot of debt to finance their business, and have complex financial statements.

Understandability Rating: 2 / 5

The business model is moderately complex.

Industry Complexity: the industry itself is difficult to understand, with all its regulations and technical details.
Accounting Complexity: CMS Energy’s finances include complex accounting rules, which requires the investor to have significant knowledge of accounting, to understand. The utility business in particular has a complicated financial structure, with multiple balance sheet items being regulated and having separate rules from normal companies.
Numerous Business Segments: Though the company mainly works in two segments, they have several side operations in the form of NorthStar Clean Energy and other such projects that complicate the business understanding.

Because of the above reasons, CMS receives an understandability rating of 2/5.

Balance Sheet Health: 3/5

CMS’s Balance Sheet is relatively strong, but it’s not without its potential issues:

Solid Assets The total assets of $33.9 billion are mostly represented by reliable infrastructure. Though some intangible assets and goodwill exist.
Good Liquidity A cash reserve of ~$600 million gives CMS a buffer for any contingencies. But this cash balance has declined over the recent few quarters.
High Debt Burden They carry significant amounts of long-term and current debt, which is something to keep in mind since it might reduce profits if something goes wrong.
Contingencies: The company has also recognized potential losses and contingencies in its annual reports, which increases the risk and requires close monitoring.

Overall, CMS’s balance sheet health is moderate, which is why we have assigned a rating of 3/5.

Conclusion

CMS Energy Corporation, while a vital utility company in Michigan, faces a number of challenges and also has some important strengths. The company operates in a complicated environment with lots of regulatory oversight and challenges. Their long-term value and moat depend on their ability to maintain high profitability while still adapting to changing market forces. Their reliance on high debt also increases the financial risks, if something goes wrong.