117362693 Dividend Policy at FPLdfda

8/20/2019 117362693 Dividend Policy at FPLdfda

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Group 11Kinnari 20121026 | Krutika P 20121028 | Tushar 20121058 | Vijay 20121062

Financial Management - I

DividendPolicyFPL Group Inc



Case Background

Decision Rationale

Financial Analysis

Reflection and conclusion

Agenda

Financial Management – I | Dividend Policy at FPL Group Inc.



Case Backgound



Synopsis


CaseDescription

Current Situation

Competitive

PositionRecommendation



In 1992, federal regulators introduced wholesale wheelingand, by mid-1994, state regulators in 23 states are consideringretail wheeling proposals.

When the California regulators released their retail wheelingproposal, the three largest utilities in the state lost a combined

$1.8 billion in market value.

S&P Electric Utilities Index has declined more than 20% sinceSeptember 1993.

While much of this can be attributed to the increase ininterest rates, some portion of the decline is due to the effectsof deregulation.

Background behind FPL’s decision in dividend




Increase dividend

Remain the same! ($2.48 per share)

Cut dividend

Possible Alternatives






Decision Rationale



Meet Market expectation and legacy of increasing dividends

since last 47 years

Signal good earnings perspective and better future

investments to face the growing competition out of

deregulation

Why would FPL want to increase dividend




To signal worsening industry prospect.

Increased competition leads to increased volatility in

earnings.

Other concerns than signaling. Taxes, transaction cost, or

agency conflicts.

Why would FPL want to decrease dividend

Financial Mana ement – I Dividend Polic at FPL Grou Inc.



FPL’s service territory, eastern and southern Florida, country’sfastest growing markets: FPL expects annual growth of 2.7% (theU.S. average of 1.8%).

FPL’s customer mix is also a competitive advantage sinceindustrial sales represent only 4% of total sales compared to anaverage of 21% for the others.

According to the retail wheeling proposals, having a lowpercentage of industrial customers limits FPL’s risk to the threat ofcompetition.

S&P ranked FPL’s competitive position among the top 10% ofinvestor-owned utilities.

FPL’s competitive advantages

Financial Mana ement – I Dividend Polic at FPL Grou Inc.



FPL’s cash flow is improving due to increasing net income and

declining capital expenditures.

FPL will have $601 million in cash before common dividends in

1998 compared to negative $832 million in cash flow after

dividends in 1992. By slowing dividend growth to 1% per year, FPLcan fund its dividend internally by 1996 and reduce its payout ratio

to below 80% by 1998.

This strong future cash flow makes it unlikely that FPL will cut itsdividend. Indeed, according to the analyst, FPL views earnings

growth as a possible solution to the high payout ratio problem.

FPL’s financial Strength




FPL’s Income Statement Analysis




FPL is a high cost utility in a commodity business.FPL’s generating and transmission costs are significantly

higher than most of its competitors

Because the competitors currently have excessgenerating capacity (capacity margins) and sufficient

transmission capacity for the next several years, they

pose a serious threat to FPL’s future profitability.

FPL’s competitive disadvantages




Financial Analysis



What FPL tries to signal? Better? Or worse?

Improved competitive edge and financial strengthincrease dividend.

Worsening industry profitability cut dividend.

The major problem with cutting the dividend is thelikelihood of severe market reaction.

Both Consolidated Edison and Sierra Pacificexperienced significant share price declines in the wakeof dividend cuts.

Does signaling play a role in FPL’s dividend policy




Non-tax paying institutions (36%) generally don’t carewhichever capital gains or dividends.

For individuals (52%), between 1986 and 1993, they weretaxed at same rates. More recently, tax codes favor capital gains:the tax rate on long-term capital gains peaks at 28% while therate on dividend income can go as high as 39% for high incomeindividuals.

The fact that FPL has a relatively high dividend yield wouldseem to indicate that the tax disadvantage of dividends does notconcern its investors.

Taxes and dividends for FPL




One can see that operating cash flows were approximately

equal to investing cash flows; long term debt issuance wasapproximately equal to debt retirement; and stock issuance wasapproximately equal to the payment of common dividends.

The investment banking fees for the issuances, estimated at 3%of the total amount issued, would equal $60 million.

As a general rule, a firm should not issue equity to paydividends because it results in a deadweight loss for investors.

Transactions Costs




Managers own only 0.1% of stock.

Firm is to ratify a new executive compensation plan, which willemphasize net income and reduce the extent to which bonusesare paid in stock. agency conflict

If Broadhead were to pursue new ways to increase net income,he might well reduce the dividend. FPL could simply invest the$150 million of savings from cutting the dividend at 5% to yield$7.5 million per year. This extra income would increase net incomeby 1%—significant in an industry that is growing at only 2% per

year.

Agency costs






Reflections and Conclusion



Dividend reduction and capital market expectation

FPL’s competitive position and future cash flow seems to

indicate that FPL may increase its dividend or, at a minimum,

hold the dividend where it is.

FPL’s shareholders clientele seems to be satisfied with

current payout dollar and ratio.

Investors view the dividend cut as a bad signal regarding

future profitability because profitable firms rarely cut their

dividends




It is our reflection that FPL reduce its payout ratio to 60%,

because this reduced payout ratio would give better positioning

FPL for future performance and growth in a recently deregulatedindustry.

Additionally, reducing the pay-out ratio reduces taxes for their

shareholders.

Buy back shares subsequent to dividend cut,

o In order to counteract negative market reaction to

dividend cut.

o Make firm less of a target for acquisition.

Reflection




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117362693 Dividend Policy at FPLdfda