Midsize utilities including CMS Energy (CMS) rallied more steeply in 2016 than their large-cap peers. Consequently, they traded at a hefty premium throughout 2016. But many of them appear to be trading at a relatively fairer valuation in 2017.
As of January 24, 2017, CMS Energy was trading at an EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) valuation of 10.5x, in line with the industry average. Its five-year historical average EV-to-EBITDA ratio is ~10x.
The EV-to-EBITDA ratio indicates whether a stock is undervalued or overvalued, regardless of its capital structure. EV refers to the combination of a company’s debt and market capitalization, minus its cash holdings.
By comparison, WEC Energy Group (WEC) and DTE Energy (DTE) are trading at a valuation multiple of ~10.5x. US utilities (XLU) have been trading at a five-year historical average PE (price-to-earnings) multiple of 15x–17x. But in 2016, they were trading above 20x. In 2017, they seem to be relatively fairly valued, with a PE of 17x, as compared to CMS’s 20x.
US utilities have indeed become cheaper in the last few months, likely due to the stock price correction during the same period. Moreover, the Fed’s aggressive interest rate hike target for 2017 could continue to put downward pressure on these companies going forward.
In the next part, we’ll discuss where CMS Energy stock could go in the near future.