Why did DTE's 2006 earnings decline so sharply?

Net income fell to $433 million ($2.43 per diluted share) from $537 million ($3.05) in 2005. The main causes were the temporary idling of the nine synfuel plants in mid-2006, which reduced synfuel gains and triggered $157 million of reserves and impairments, and about $80 million of net losses in Power and Industrial Projects, mostly impairments. Partly offsetting these were higher Detroit Edison earnings and the absence of 2005 Energy Trading mark-to-market losses.

What is the main risk to DTE's synfuel cash flows?

Synfuel production tax credits expire December 31, 2007, and they are reduced or eliminated if the IRS Reference Price of oil exceeds set thresholds. The 2006 Reference Price was estimated at about $60 per barrel, inside the phase-out range (threshold $55, full phase-out at $69). DTE has hedged part of its 2007 exposure, but a partial or full phase-out could still hit expected cash flows of about $900 million over 2007-2009 and could increase refund obligations to synfuel partners.

How is the electric utility performing, and what is the regulatory outlook?

Detroit Edison's net income rose $48 million in 2006 to a segment total of roughly $2.1 per diluted share, helped by the expiration of the residential rate cap and fewer customers leaving for alternative suppliers. Regulatory uncertainty remains: a $79 million total rate reduction takes effect in stages starting in 2007, and a full general rate case must be filed by July 1, 2007. Customer Choice continues to create financial risk.

What is DTE doing to strengthen its balance sheet and credit rating?

Management plans to redeploy synfuel cash and proceeds from non-utility monetizations to reduce debt and buy back stock, with a goal of improving credit ratings and making any asset sales accretive to EPS. Parent senior unsecured debt is rated BBB- by S&P, Baa2 by Moody's and BBB by Fitch, all investment grade. The company also has about $383 million of potential collateral exposure if the rating drops below investment grade.

Are there significant legal or environmental liabilities investors should watch?

Key items include a breach-of-contract arbitration against BNSF Railway over western coal transport, with a hearing scheduled for mid-2007; roughly $2.3 billion of estimated future environmental expenditures, largely for air emission controls; a remediation reserve of $41 million for former manufactured gas plant sites; and about $2.4 billion of guarantees tied to synfuel partner obligations, of which $181 million is reserved. Management expects these matters not to have a material adverse effect on operations, but outcomes remain uncertain.

DTE Energy 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

DTE Energy's 2006 10-K shows a company in transition.

Consolidated net income fell to $433 million^a, or $2.43 per diluted share, from $537 million ($3.05) in 2005, and income from continuing operations was $437 million ($2.45 diluted). The decline was driven mainly by the temporary idling of its nine synthetic fuel plants from May to October 2006, along with roughly $157 million of synfuel reserves and impairments and about $80 million of Power and Industrial Projects losses, largely impairments. The electric utility (Detroit Edison) was the bright spot, with net income up about $48 million on higher rates after the residential rate cap expired and lower Customer Choice losses.

Operating revenues were flat at $9.0 billion^b. Management is pursuing a strategic review of its non-utility businesses, which it says could generate more than $800 million of cash proceeds in 2007. Synfuel-related cash flows of roughly $900 million are expected from 2007 through 2009, plus about $500 million of tax benefits.

Management intends to use these proceeds to reduce debt and repurchase stock, and to strengthen the balance sheet and credit ratings, which are currently at the low end of investment grade (BBB-/Baa2/BBB at the parent). Synfuel production tax credits expire at the end of 2007, and an oil-price-linked phase-out is a live risk, with 2006 Reference Price estimated at about $60^c per barrel, inside the phase-out range. Key risks for investors include the phase-out of synfuel credits, the hybrid Michigan electric Customer Choice market, the cost of roughly $2.3 billion in future environmental capital spending, a pending BNSF arbitration in mid-2007, and a general rate case due by July 1, 2007.

The company's Antrim and Barnett shale gas assets are also being explored for partial sale. The 2007 dividend was raised to $0.53^d per quarter.

02—Key points

Key Highlights

Net income fell 19% to $433 million ($2.43 diluted EPS) from $537 million ($3.05) in 2005, mainly due to synfuel idling, reserves and impairments, and non-utility impairments.
Electric Utility (Detroit Edison) net income rose $48 million in 2006 on higher rates after the residential rate cap expired January 1, 2006, and lower Customer Choice losses (6% of retail sales lost in 2006 vs. 12% in 2005).
Synfuel operations were idled May 12 to October 4, 2006. Pre-tax synfuel reserves and impairments totaled $157 million, and expected synfuel cash impacts of about $900 million for 2007-2009 plus $500 million in tax benefits are at risk from the oil-price phase-out of credits that end December 31, 2007.
Management is conducting a strategic review of non-utility assets that could generate over $800 million of cash in 2007, with proceeds earmarked for debt reduction and share repurchases.
Unconventional Gas Production added 219 Bcfe of proved reserves in 2006, bringing total proved reserves to 616 Bcfe, and the company is exploring a partial sale of its more mature Antrim and Barnett shale assets.
Capital plan is large: Electric Utility expects about $4.3 billion and Gas Utility about $1.0 billion through 2011, with up to $2.3 billion of future environmental spending through 2018.
Quarterly dividend increased to $0.53 per share from $0.515, effective January 15, 2007. The $700 million buyback authorization through 2008 had $651.5 million remaining at year-end 2006.

03—Questions

Frequently Asked Questions

Why did DTE's 2006 earnings decline so sharply?
Net income fell to $433 million ($2.43 per diluted share) from $537 million ($3.05) in 2005. The main causes were the temporary idling of the nine synfuel plants in mid-2006, which reduced synfuel gains and triggered $157 million of reserves and impairments, and about $80 million of net losses in Power and Industrial Projects, mostly impairments. Partly offsetting these were higher Detroit Edison earnings and the absence of 2005 Energy Trading mark-to-market losses.
What is the main risk to DTE's synfuel cash flows?
Synfuel production tax credits expire December 31, 2007, and they are reduced or eliminated if the IRS Reference Price of oil exceeds set thresholds. The 2006 Reference Price was estimated at about $60 per barrel, inside the phase-out range (threshold $55, full phase-out at $69). DTE has hedged part of its 2007 exposure, but a partial or full phase-out could still hit expected cash flows of about $900 million over 2007-2009 and could increase refund obligations to synfuel partners.
How is the electric utility performing, and what is the regulatory outlook?
Detroit Edison's net income rose $48 million in 2006 to a segment total of roughly $2.1 per diluted share, helped by the expiration of the residential rate cap and fewer customers leaving for alternative suppliers. Regulatory uncertainty remains: a $79 million total rate reduction takes effect in stages starting in 2007, and a full general rate case must be filed by July 1, 2007. Customer Choice continues to create financial risk.
What is DTE doing to strengthen its balance sheet and credit rating?
Management plans to redeploy synfuel cash and proceeds from non-utility monetizations to reduce debt and buy back stock, with a goal of improving credit ratings and making any asset sales accretive to EPS. Parent senior unsecured debt is rated BBB- by S&P, Baa2 by Moody's and BBB by Fitch, all investment grade. The company also has about $383 million of potential collateral exposure if the rating drops below investment grade.
Are there significant legal or environmental liabilities investors should watch?
Key items include a breach-of-contract arbitration against BNSF Railway over western coal transport, with a hearing scheduled for mid-2007; roughly $2.3 billion of estimated future environmental expenditures, largely for air emission controls; a remediation reserve of $41 million for former manufactured gas plant sites; and about $2.4 billion of guarantees tied to synfuel partner obligations, of which $181 million is reserved. Management expects these matters not to have a material adverse effect on operations, but outcomes remain uncertain.

04—Continue

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