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Dividend Policy: The FPL Group, Inc. ("FPL") I. Executive Summary A. Current Situation
Dividend Policy: The FPL Group, Inc. ("FPL") I. Executive Summary A. Current Situation
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.
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.
1
Harvard Business School, Dividend Policy at FPL Group, page 4.
2
Harvard Business School, Dividend Policy at FPL Group, page 4.
3
Harvard Business School, Dividend Policy at FPL Group, page 3.
1
Corporate Finance Columbia University
Low capacity margin (8.6%) suggests FPL has less room for growth
compared to their peer companies.4
Exhibit A
Competitive Position
FPL Group Carolina Power Duke Power Florida Progress SCANA Corp Southern Co. TECO Energy
Transmission Cost/
KWH* $0.0019 $0.0009 $0.0010 $0.0010 $0.0007 $0.0008 $0.0006
Percent Of Power
Purchased* 30% 11% 1% 15% 26% 7% 3%
* Case Exhibit 7: Investor Owned Utilities in the Southeastern United States in 1993.
Regulatory Changes
Credit Risk
4
Case Exhibit 7, Investor-Owned utilities in the Southeast United States in 1993.
5
Case Exhibit 7.
6
Harvard Business School, Dividend Policy at FPL Group, page 6
2
Corporate Finance Columbia University
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, better
positioning FPL for future performance and growth in a recently deregulated
industry.7 Additionally, reducing the payout ratio reduces taxes for their shareholders.
o Buy
o Sell
o Hold
Traditionally, utilities, with their large dividend payments, attract an ‘income’ investor
base, one less focused on growth and more focused on receiving steady cash.8
7
Dividend Payout ratio range was 60.8 – 106.2%, Case Exhibit 9.
8
Individual investors hold approximately 51.9% of FPL’s shares.
3
Corporate Finance Columbia University
Despite a history of volatile earnings, FPL has maintained an inappropriately high payout
ratio, thereby creating additional risk for the shareholders. Dividend cuts are not
uncommon for utilities except in situations of financial trouble, and even then, are not
well accepted by the market.9
According to the Miller-Modigliani theory, 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.
III. Conclusion
The recently deregulated electric utility industry introduced new market competitiveness.
FPL’s current dividend policy is inappropriately high for such a market environment.
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, better positioning FPL for
Broadhead’s vision of future performance and growth.
Kate Stark should revise her investment recommendation from “hold” to “buy,”
upgrading her rating because the value reflected after the decrease in payout ratio is lower
than the intrinsic value of the stock ($42.16, see Exhibit B). The lower value reflected by
the decreased payout ratio is the result of the effect of signaling in the market.
9
Harvard Business School, Dividend Policy at FPL Group, page 6
4
Corporate Finance Columbia University
Exhibit B
Key Ratios
Current Target
Payout Ratio 90% 60% a
Dividend $2.48 $1.65 b
Dividend Yield 6% 4% e
Effective Price per share $41.33 $42.16 f
a: Current: Exhibit 7, Target: Case assumption; such a ratio would place FPL at the
lower end of the range of that of their peer companies
b: Current: Exhibit 7, Target: Dividends = (Change in Payout Ration) * Current Dividends
c: Change In Dividends = Current Dividends - Target Dividends
d: Exhibit 7
e: Current: Exhibit 7, Target: Dividend Yield = Annual Dividend / Price Per Share
f: Current: Price Per Share = Annual Dividend / Dividend Yield