How Does CMS Energy Corporation Make Most of Its Money?

With a 3.1% yield and 12 years of annual dividend increases, CMS Energy Corporation (NYSE:CMS) is an enticing stock for conservative investors looking for a utility investment. However, add in the roughly 7% annualized dividend growth rate over the past decade (more than double the historical rate of inflation growth), and things start to get a little more exciting. Here’s what you need to know about this largely traditional utility with a solid history of rewarding income investors.

The core of the business

Roughly 95% of CMS Energy’s revenue is derived from its regulated electric and natural gas utility operations. The rest comes from a tiny merchant power operation and “other.” Interestingly, the company operates in only one state: Michigan. Although Detroit has been making headlines in recent years for not-so-good reasons (notably for declaring bankruptcy in 2013), the population of Michigan has actually been expanding, with 2017 marking the sixth consecutive year of population growth and the first year since 2001 that more people moved into the state than moved out. More people means more customers, which is a positive for CMS Energy’s utility businesses.

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CMS serves roughly 6.7 million customers (about two-thirds of Michigan’s population). Generating and selling electricity accounts for roughly 55% of the top line, with natural gas distribution pitching in about 40%. The company gets around 38% of its electricity from natural gas, 17% from nuclear power, 9% from renewable power, 10% from storage and power purchases, and the rest (26%) from coal. As it has for most utilities, reducing the importance of coal has been a key focus in recent years, with that power source declining from roughly 50% of supply in 2005 to about 25% in 2017. The goal is to completely remove coal from the mix by 2040.

An odd thing to brag about

This brings up an unusual tendency the company has — it’s happy to tell investors that it has a large and aging system. For example, its coal fleet is more than 50 years old. Its distribution system is older than those of its peers. And most of its 1,670 miles of gas pipelines were built before World War II.

This is actually great news because of the basic model used in the regulated utility space. Essentially, utilities are granted monopolies but must get rate increases approved by regulators. The way to get rate hikes approved is to spend money on the business, either to expand it or, as in the case of CMS, upgrade it. Regulators generally make sure that the rates a utility earns are high enough not only to pay for the work that’s being done but to provide an additional return on the investment dollars to make it worth the effort for utilities and their public shareholders. With a coal fleet that’s 50 years old, it’s easy to sell a rate hike to build new power plants, because CMS is both improving its system and reducing carbon emissions. The same goes for replacing natural gas pipelines that were built in the 1930s.

The current five-year plan calls for spending roughly $10 billion on upgrades and improvements. About $5 billion of that is earmarked for the natural gas distribution business, $3.5 billion for electricity distribution, and $1.5 billion for power production (two-thirds of the power spending is slated to go toward clean energy). That said, CMS believes its system needs more than $50 billion of investment over the long term. It can’t do that all at once, meaning there’s more spending to come after the current five year plan runs its course.

CMS believes this spending will push its rate base higher by roughly 6% to 8% a year, which in turn should support dividend growth of around the same amount over time. That’s a fairly attractive growth rate for a utility, backed by the company’s clear need to spend on its aging infrastructure.

Boring… and that’s a good thing

CMS doesn’t do anything particularly exciting, but that doesn’t mean that investors aren’t being well rewarded as the company’s aging business gets much needed upgrades, which should, in turn, lead to reliable earnings and dividend growth for years to come. You can find higher-yielding utilities, and utilities with higher earnings and dividend growth rates, but the mix of yield, growth, and business simplicity at CMS is worth a very close look for conservative investors.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.