Dividend Policy at FPL

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


Case Description

Current Situation

Competitive PositionRecommendation

In 1992, federal regulators introduced wholesale wheeling and, by mid-1994, state regulators in 23 states are considering retail wheeling proposals.

When the California regulators released their retail wheeling proposal, 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% since September 1993.

While much of this can be attributed to the increase in interest rates, some portion of the decline is due to the effects of deregulation.

Background behind FPL’s decision in dividend


Increase dividend

Remain the same! ($2.48 per share)

Cut dividend

Possible Alternatives


Efficient Market Hypothesis apply

Analysts’ investment rating are limited to 3 options

Buy

Sell

Hold

Signaling exists in market place

Key Assumptions


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


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

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

According to the retail wheeling proposals, having a low percentage of industrial customers limits FPL’s risk to the threat of competition.

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

FPL’s competitive advantages


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, FPL can 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 its dividend. 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 excess generating 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 strength increase dividend.

Worsening industry profitability cut dividend.

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

Both Consolidated Edison and Sierra Pacific experienced significant share price declines in the wake of dividend cuts.

Does signaling play a role in FPL’s dividend policy


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

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

The fact that FPL has a relatively high dividend yield would seem to indicate that the tax disadvantage of dividends does not concern 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 was approximately equal to debt retirement; and stock issuance was approximately 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 pay dividends 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 will emphasize net income and reduce the extent to which bonuses are 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 income by 1%—significant in an industry that is growing at only 2% per year.

Agency costs


May 9: FPL announces new financial strategy 32% reduction in quarterly dividend Dividend payout targeted at 60-65% Repurchase 10 million shares over 3 years Reduce debt levels Move annual dividend announcement to February

Broadhead’s explanation for the cut that the firm needs more financial flexibility to deal with future competition. For electric utilities industry which generate large amounts of free cash flow, financial slack may not be such a good thing. Stock price falls by $4.375 to $27.50 [down 13.7%], Stock price is down 22.3% since April 29

What Will Broadhead do?


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 deregulated industry.

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


Documents

Dividend Policy at FPL