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Prepared by: Bachhawat, Vivek Hadgis, Demetrios Tsoka, Katerina Uccellini, Jessica
Professor Charisa Asbury
Dividend Policy: The FPL Group, Inc. (“FPL”) I. Executive Summary A. Current Situation: In the spring of 1994, Merrill Lynch’s utilities analyst downgraded their investment rating for the FPL Group, the parent company of Florida Power & Light, Florida’s largest electric utility. The Merrill Lynch analyst downgraded FPL because he/she believed FPL was on the verge of cutting its dividend for the first time in 47 years. Reacting to this news release, Kate Stark, an electric utilities analyst at First Equity Securities Corporation, faced the decision whether or not to revise her own current ‘Hold’ recommendation on FPL’s stock. Following chairman Marshall McDonald’s retirement in 1989, FPL experienced a streamlining of its businesses and operations under his successor, James Broadhead. At FPL, Broadhead implemented a commitment to quality and customer service, increased its focus on the utilities industry, expanded capacity, and improved its cost position. In the 1990’s, Broadhead sold off several of FPL’s non-utilities businesses.1 In May, 1994, one of the most important issues confronting the FPL Group was the decision whether or not to decrease their dividend payout ratio as a result of an evolving competitive market place. B. Competitive Position: Chairman James Broadhead’s vision for the electric utilities business was one of free and open competition, and he intended to better position FPL for such a marketplace.2 Initially, under chairman Marshall McDonald, FPL underwent a period of diversification and expansion in the 1970’ and 80’s, acquiring major companies in various industries, such as real estate, insurance, and information services.3 Later, under Broadhead, FPL reversed that trend of diversification and instead focused on streamlining their business and operation in order to improve efficiency and lower costs.
Harvard Business School, Dividend Policy at FPL Group, page 4. Harvard Business School, Dividend Policy at FPL Group, page 4. 3 Harvard Business School, Dividend Policy at FPL Group, page 3.
0010.0006 3% * Case Exhibit 7: Investor Owned Utilities in the Southeastern United States in 1993. (FPL = $.4 FPL’s Transmission and Power costs far exceed those of their competitors.6 4 5 Case Exhibit 7.) High transmission costs place FPL at a competitive disadvantage in a deregulated industry (Exhibit A below).0008 7% TECO Energy $0. $0.0019 30% Carolina Power $0. Dividend Policy at FPL Group. o Power generation costs are high because FPL purchases 30% of power used in the generation process from outside sources. Regulatory Changes o 1992.0007 26% Southern Co. Retail Wheeling allowed customers to buy power from utilities other than the local monopoly supplier through third-party transmission.6%) suggests FPL has less room for growth compared to their peer companies. page 6 2 . Investor-Owned utilities in the Southeast United States in 1993. 6 Harvard Business School.0010 1% Florida Progress $0.Corporate Finance Columbia University Low capacity margin (8. Wholesale Wheeling enabled one utility to sell power to another utility company using third-party transmission. thereby making FPL sensitive to fluctuations in power purchase prices (Exhibit A below).5 o FPL’s 1993 Transmission Costs are at the higher range compared to that of their peer companies. Credit Risk o Concerns by rating agencies of FPL’s interest expense given the 140 basis point increase in long-term interest rates since 1993.0009 11% Duke Power $0.0019 compared to an industry average of $.0010 15% SCANA Corp $0. o 1994. Exhibit A Competitive Position FPL Group Transmission Cost/ KWH* Percent Of Power Purchased* $0. Case Exhibit 7.
Case Exhibit 9. Buy back shares subsequent to dividend cut. utilities. better positioning FPL for future performance and growth in a recently deregulated industry.2%. Individual investors hold approximately 51. attract an ‘income’ investor base. Recommendation: Dividend Policy It is our recommendation that FPL reduce its payout ratio to 60% because such a ratio would place them at the lower end of the range of that of their peer companies. Typically. such as FPL. III.9% of FPL’s shares. with their large dividend payments. one less focused on growth and more focused on receiving steady cash. II. 3 . Analysis: Dividend Policy Dividends are a share of a company’s profits distributed to its shareholders. o Make firm less of a target for acquisition. pay dividends to attract shareholders. Analysts’ investment rating recommendations are limited to three options: o Buy o Sell o Hold Analysts use public information to formulate their recommendations. Signaling exists in the marketplace. such firms retain more of their earnings instead of distributing them in the form of dividends. Key Assumptions Our analysis is based on the following key assumptions: The Efficient market hypothesis applies.8 Conversely. ‘growth’ investors generally seek to invest in companies with long-term capital appreciation prospects. Traditionally.Corporate Finance Columbia University C. o In order to counteract negative market reaction to dividend cut. 7 8 Dividend Payout ratio range was 60. reducing the payout ratio reduces taxes for their shareholders. Companies.8 – 106. and make every effort to use reliable. comprehensive information.7 Additionally.
16. resulting in lowered stock price. dividend policy should not matter since the returns that investors would earn would be the same as the return that the firm would receive if the cash were reinvested. improving the macro-economic conditions.9 According to the Miller-Modigliani theory. Dividends inject cash into the market. thereby creating additional risk for the shareholders. page 6 4 . Lesser share of the profits to shareholders by means of dividends. Conclusion The recently deregulated electric utility industry introduced new market competitiveness. Dividend cuts are not uncommon for utilities except in situations of financial trouble. FPL’s current dividend policy is inappropriately high for such a market environment. Kate Stark should revise her investment recommendation from “hold” to “buy. such as market volatility and deregulation. FPL has maintained an inappropriately high payout ratio. see Exhibit B). Dividend Policy at FPL Group.” upgrading her rating because the value reflected after the decrease in payout ratio is lower than the intrinsic value of the stock ($42. Negative market reaction. The lower value reflected by the decreased payout ratio is the result of the effect of signaling in the market. FPL must reduce its payout ratio to 60% because such a ratio would place FPL at the lower end of the range of that of their peer companies. III. Results in excess cash. better positioning FPL for Broadhead’s vision of future performance and growth. Dividends are taxed more than capital gains (almost double). which can then be used for future growth through acquisitions.Corporate Finance Columbia University Advantages of Reducing Current Dividend Policy: Reduced payout ratio helps reduce exposure to increased industry risks. (Current capacity is close to being maximized. This suggests that FPL’s current dividend policy is too high (<90% in 1993).) Disadvantages of Reducing Current Dividend Policy: Reducing its dividend would be seen as signaling in the marketplace. Despite a history of volatile earnings. 9 Harvard Business School. therefore by reducing or not issuing dividends a firm can save investors money in terms of the amount of taxes they will pay. are not well accepted by the market. and even then.
33 Current 90% $2.16 a b c d e f a: Current: Exhibit 7.50% 4% $42.48 Target 60% $1. Target: Dividend Yield = Annual Dividend / Price Per Share f: Current: Price Per Share = Annual Dividend / Dividend Yield 5 .65 -$0. Target: Case assumption. Target: Dividends = (Change in Payout Ration) * Current Dividends c: Change In Dividends = Current Dividends .Target Dividends d: Exhibit 7 e: Current: Exhibit 7.83 12.Corporate Finance Columbia University Exhibit B Key Ratios Payout Ratio Dividend Change in Dividend (!d) Return on Equity Dividend Yield Effective Price per share 6% $41. such a ratio would place FPL at the lower end of the range of that of their peer companies b: Current: Exhibit 7.
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