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FIN 670: Case 4 FPL Dividend Policy In this case you will evaluate optimal payout policy for FPL Group. Most of your analysis in this case will be qualitative in nature. The analysis of the case requires you to think through why FPL has decided to make this change to the dividend policy and whether this change is going to be of interest to shareholders. 1.Briefly discuss how FPL ’s dividend yield and payout ratios compares to other firms. Also discuss recent trends in FPL’s dividend growt h and payout ratio. Traditionally, the environment experienced by public electricity utilities allowed them to pay their investors extraordinarily high dividends. Exhibit 9 lists the dividend payout ratios by industry for the first quarter of 1994. The average payout ratio for electricity utility companies at 79.85% is clearly significantly higher than any other industry. As of 1993 FPL Group, Inc .’s dividend payout ratio was 91%. A level significantly higher than the average of its peers. Because of the changing competitive landscape, FPL needs to focus its operations and begin to grow its business in order to remain its position. Given the uncertainty surrounding the industry’s future, the high payout ratio would limit the firm’s financial flexibility. By reducing the dividend by 32% from $2.48 to $1.68 per share, FPL will have the extra cash flow by approximately $145 million per year. It is definitely a strong force that helps FPL to expand and reinforce its core business to meet the projected demand in the foreseeable demand. In addition, the launch of the stock repurchase program, can be as a strategy to boost up the stock price. In the short term, it might hurt the shareholder’s current benefit, however, in the long -run, the shareholder will be compensate by FPL’s current financial strategy. 2. Does FPL ’s recent payout policy appear to be driven by any of the theories we know of? It reminds me the information content (Signaling theory), which investor view dividend changes as the signal of management’s insider view of the firm’s future value. The Tax preference theory can also be reflected in the FPL dividend strategy. It benefits the investors in different ways. company believes future investment opportunities (possibly due to deregulation) could provide returns in excess of required returns on the equity, and that it is cheaper to finance these opportunities internally (in light of recent interest rate increases). Also, cutting dividends today could allow FPL to show large dividend increase in future years assuming continued CF growth. 3. Explore how easily FPL could meet future dividend payments out of its cash flows. With deregulation giving rise to competition payout ratio was 91%, FPL plans to establish a new target dividend payout ratio of 60% -65% of prior year ’ s earnings. FPL’s management’ s purpose in to lower the payout ratio in order to retain funds for profitable investment, maintaining them instead of cutting them could signal confidence in future growth. Since utility company has very lower beta than the market, the recurring revenue is very much foreseeable and stable. By having the adjustment of the financial strategy, not only FPL can focus on maintaining and improving the underlying facility and build the new facility to increase its efficiency and capacity in future operation, but also FPL can repurchase its own stock to take advantage of its own growth profit. Even though the rising competition in utility industry, FPL still is a strong business influencer corporation in electricity business, FPL will very easily to meet future dividend payment out of its cash flows. 4. How vulnerable is FPL to recent changes in the utility industry? By retaining only 9% of its earnings, the firm would find it very difficult to grow quickly without the expensive acquisition of capital. The current dividend payout ratio is too high considering the challenges the company will face in a deregulated and competitive environment. For FPL Group, Inc. lowering the payout ratio to a lower value would be more appropriate. The lower payout ratio would provide the firm with much needed capital in the form of retained earnings. 5. How might a change in dividends affect shareholder value? 6. Given your analysis, would you recommend a buy, sell or hold for FPL ’s stock? Explai n FPL lowered its dividend from $2.48 to $1.68. The stock price initially took a big hit (down from $35 in April-94 to ~$30 in May 94). However it had recovered strongly by the end of the year and in May-95 was trading at $39. It went on to trade at $45 in May-96. First, the majority of the FPL ’ s stock holders are individuals, we will address their needs at the highest level. It would be advantageous for individual investor to have FPL ’ s dividend payout ratio at a lower level. Traditionally a cut in a companies ’ dividends would indicate a problem with the financial position, causing a decline in stock price. However, in the case of FPL we feel that the company is coming from a position of strength which makes this perception irrelevant. We do realize that initially the company could see a short term decline in stock price from a dividend cut however, we would expect the long term outlook of the company to be in a better competitive position giving way to growth and eventually a rise in the stock price. Under the scenario where FPL cuts its dividends we would recommend a Buy rating. Since the Price of FPL has fallen by more than 6% we feel the stock is a good value at this time.
