CMS Energy

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 4/5

CMS Energy is a diversified energy company, primarily operating in Michigan. It’s engaged in the electric and natural gas utility business as well as in independent power production.

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 operates through three main business segments:

  1. Consumers Electric Utility: This segment involves the generation, purchase, distribution, and sale of electricity to approximately 1.9 million customers in Michigan’s Lower Peninsula.

  2. Consumers Gas Utility: This segment focuses on the purchase, transmission, storage, and distribution of natural gas, serving roughly 1.8 million customers across Michigan.

  3. CMS Enterprises: This segment develops, owns and operates independent power generating plants. This includes wind, solar, natural gas and hydro. It operates the facilities and sells the energy.

CMS Energy’s operations are mainly concentrated in Michigan, making them vulnerable to region-specific economic factors and regulatory changes.

  • Transition to Renewable Energy: The energy sector is undergoing a significant transition, with increasing focus on renewable energy sources to mitigate climate change. This includes government mandates and customer preferences for cleaner energy.
  • Grid Modernization: To enable the integration of renewable energy sources and address grid reliability issues, significant investments are required for grid modernization. This includes adding smart grid technology and updating distribution infrastructure.
  • Shift Towards Decarbonization: There is an increasing focus on reducing greenhouse gas emissions from electricity and natural gas production, with the goal of achieving net-zero emissions over time.
  • Rising Commodity Prices: Prices of natural gas, coal and other commodities fluctuate from time to time, affecting the input costs of generation and operations of energy companies. Supply chain disruptions also play a key part.

The industry is highly regulated, especially for utilities like CMS Energy. Any rate-setting decisions by the regulatory agencies directly affect profitability and cash flows. Also, the company will likely need to make significant investments to keep up with current and upcoming regulations.

Competitive Landscape

  • Regulated Utilities: CMS Energy, in its utility operations, operates in a regulated environment, where there is typically a limited degree of competition. The market is defined by their service territory, though they do compete in rates.
  • Independent Power Production: CMS Enterprise operates in a competitive market for power generation. They compete with independent developers, other large companies that use renewable energy or natural gas, and even large tech companies that are developing data centers.
  • Local Competition: The markets for their gas and electric utility business in Michigan are defined geographically which can lead to competition from local utility companies in their territories.

CMS Energy is a fully-integrated energy supplier. This provides them with scale and diversification, as well as a better ability to manage the transition to renewable energy. This also makes them more dependent on the regulations of their different business lines, compared to competitors that only operate in one line of business.

Financials

Revenue Distribution

In 2022, CMS Energy’s consolidated revenue was $7.2 billion, which was allocated among their 3 primary business segments:

  • Electric Utility: generated approximately $5.6 billion in revenue
  • Gas Utility: generated around $2.7 billion in revenue
  • Enterprises: generated just around $0.5 billion in revenue

The company’s overall revenue has grown over 2019 to 2023 but has remained fairly flat since. The Electric utility division makes up a large majority of their revenue and profitability.

Note, these 3 segments have many intercompany dealings which net to a lower overall consolidated revenue. A larger company will be able to have higher revenues while keeping the operating costs similar. Therefore, these are highly correlated.

Margins

  • Operating Margins: Consumers electric utilities operating margin has historically been around 20%. Consumers gas utilities have typically ranged around 10%, which has grown in the last 2 years. The Northstar Clean Energy division has not been profitable in the past but is starting to become profitable. In general, operating margins will also be highly affected by regulatory decisions.
  • Net Income: CMS Energy’s net income was $877 million in 2022 and $1.546 billion in 2021, which gives a diluted EPS of $3.05 and $5.66 respectively. In 2023, it had a net loss of $65 million.
  • Return on Invested Capital (ROIC): Historically, CMS has struggled with maintaining a strong ROIC. In 2022, its ROIC (including goodwill) was 4.8%, well below its average cost of capital. The best ROIC (without including goodwill) was in the Utilities segment and was only 5.5%. A large focus for the management is to ensure that ROIC stays above the WACC.
  • Debt: CMS Energy uses a significant amount of debt, having over $13 billion in long-term debt and finance leases at the end of 2022. The cost of debt has been rising in the past year, and so far has also increased the weighted average cost of capital (WACC).

CMS Energy’s main challenges include the highly regulated business environment, where profits can get reduced if the cost recovery does not match inflation or if regulations increase their operating costs. Rising interest rates also increase the company’s cost of borrowing, reducing their operating margin.

Balance Sheet Health

CMS has a strong balance sheet with over $1.5 billion in cash, and a consistent ability to raise more capital if it needs it. Their cash from operations is also consistent and growing. However, they also have a large amount of debt, almost 2.5 times more debt than equity.

Because of their high levels of debt, their balance sheet is more volatile and can be severely affected by interest rate hikes and by reduced profitability.

Economic Moat

  • Regulatory Moats: As a regulated utility, CMS Energy benefits from a regulated moat—the presence of regulations that protect the company within its service territory. It also means that regulators need to approve any rate hikes, therefore limiting earnings potential.
  • Economies of Scale: The utility business is quite capital intensive and requires massive investments in infrastructure. Larger companies like CMS Energy can benefit from scale advantages and can handle the cost of distribution and maintenance.
  • “NIMBY” characteristics: This is also partially valid in their landfill division where the company owns landfill sites or contracts to use landfill sites, which face significant regulatory and local resistance when a new competitor enters the market.

Moat Rating: 2/5

Although they have strong regulatory barriers to their market and scale in their core business, they have relatively weak barriers to entry for the independent power production business. The main business is heavily regulated and therefore they have a high risk of their rate increases not going through. They also have a large dependence on debt, so fluctuations in interest rate will impact the profitability of the core business as well.

Risks to the Moat and Business Resilience

  • Regulatory Changes: The business is exposed to new environmental regulations, which could force the company to invest a substantial amount in new, expensive, and potentially risky technologies. Also, rate changes or a lack of rate increases from the regulatory body will directly impact profitability.
  • Economic Downturn: A severe downturn can reduce electricity and natural gas demand, thereby impacting the financial performance of the company. A reduced demand could lead to the company becoming unprofitable and not fulfilling its contracts.
  • Weather: Extreme weather events or extreme fluctuations in temperatures may disrupt energy supplies and increase costs. This is another factor that could hurt the demand and price for energy commodities.
  • Technological Disruption: A new technology could render CMS Energy’s current assets obsolete (such as solar power, wind or nuclear which are capital intensive) or change the way in which the company must service its customers. For example, battery technology could make utility companies unnecessary by allowing people to have completely self-contained power generation.
  • Rising Input Costs: CMS Energy is exposed to high commodity prices like natural gas, which may increase input costs and reduce profitability.

Overall, CMS’s resilience is mixed. The utility business offers consistent profitability with strong regulatory oversight, but this also limits opportunities for outperformance. While the independent power production provides growth opportunities, it also adds risk. The company also has a lot of debt which also increases risk.

Understandability

The business is easy to understand since it operates as a utility which is well understood by many. Although they have multiple lines of business (utilities and independent power production), they function under similar principles and regulations, making it easier to understand.

Understandability Rating: 1/5

Balance Sheet Health

CMS Energy has a substantial amount of debt on its books, making it vulnerable to interest rate hikes. However, their cash position is also strong, and the company has the ability to raise new equity if needed.

Balance Sheet Health Rating: 4/5