DIVIDEND POLICY AT FPL GROUP

Submitted to

Indian Institute of Management, Lucknow

Submitted By
Contents
Brief Intro about the company: ............................................................................................................ 3
Dividend Policy at FPL: ......................................................................................................................... 3
Signaling hypothesis ........................................................................................................................ 4
Clientele effect ................................................................................................................................ 4
Factors of dividend cut ........................................................................................................................ 4
Concerns of FPL management:............................................................................................................. 4
Recommendation ................................................................................................................................ 6
What actually happened?? .................................................................................................................. 7

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Brief Intro about the company:
FPL Energy is one of the nation’s leading independent generators of electricity. Dedicated

to generating clean energy, 80 % of its capacity is fueled by clean and renewable

resources. The United States is the nation with the largest generator of wind energy, and

it operates the two largest solar fields in the world. FPL Group, with annual revenues of

more than $8 billion, is one of the nation's largest providers of electricity-related services.

Its principal subsidiary, Florida Power & Light Company, serves approximately 3.9 million

customer accounts in Florida. FPL Energy, LLC, and FPL Group energy-generating

subsidiary is a leader in producing electricity from clean and renewable fuels.

Dividend Policy at FPL:

FPL has a streak of 47 consecutive years of dividend increases. The payouts of FPL are

very high currently which are over the industry average. Currently FPL pays out as high as

90% of its earnings. The increases in dividends have been getting smaller from 9.6% in

1985 to 1.6% in 1993. The payout ratio was between 60-70% in 1989 and had increased to

90% in recent years. FPL has been able to maintain smooth dividend payouts despite

volatile earnings.

Year 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Net 2.62 3.11 2.90 3.10 3.42 3.12 2.86 1.48 2.65 2.30

Income($/share)

Dividends($/share) 1.77 1.94 2.02 2.10 2.18 2.26 2.34 2.39 2.43 2.47

Percentage 9.6 4.1 4.0 3.8 3.7 3.5 2.1 1.7 1.6

increase

Payout ratio 67.6 62.4 69.7 67.7 63.7 72.4 N/A 161.5 91.7 107.4

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Before we delve into understanding the factors of dividend cut, let’s understand the

following theories about dividends:

Signaling hypothesis: It is based on the idea that the managers have better information

about the future prospects of a firm than the public shareholders. The future dividends are

paid out of future profits. Hence any change in dividends is a reflection of firms forecast of

future profits. Hence when the dividends increase, stock prices also increase and the

opposite is also true.

Clientele effect: It is based on the idea that the different clientele of a firm have different

preference for dividend payout ratios. Thus when a company changes its dividend payout

policy, the old clientele leave and new clientele come in. But if the investors leave quickly

than new ones coming in, the share price may go in a temporary depressed level.

Factors of dividend cut

There were 2 major reasons of considering a dividend cut:

 the recent speed of deregulation in the utilities industry that forced FPL to start

thinking about the impact of not being a regulated company

 dividend payout had grown to a higher than normal level on a historical basis

Concerns of FPL management:

Dividend cut was no easy affair for the FPL management. They had many points to take

care of while thinking of a dividend policy in the 1994. They are listed below:

 The most important issues facing the FPL Group in May 1994 are the interrelated

concerns of potential competition resulting from industry deregulation and

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 reexamining a high dividend payout ratio. The advent of retail wheeling threatens

to reshape the entire electric utilities industry. The Florida Public Service

Commission is not considering a retail wheeling proposal currently, but the general

trend in the industry is towards increased competition, and the implementation of

such a proposal would expose FPL to numerous competitors and potential losses.

The implementation of retail wheeling in California had a severe adverse effect on

the three major utilities in that state. The necessity of competing with rival utilities

must be a primary concern of FPL given the changing landscape of the industry.

FPL needs to ensure that it has the ability to meet the challenge of competition

from both in state and out of state providers.

 The company has a streak of 47 consecutive years of dividend increases.

Increasing dividends again would be a sign of FPL’s continuing strength in the

industry. Increasing dividends seems possible given the company’s recent and

expected rising sales and declining capital expenditures.

 FPL has a very high payout ratio. It needs to retain a larger amount of money in

order to compete in the new environment. Keeping the dividend constant would

strike a balance between the need to reinvest earnings in order to expand and the

need to mollify shareholders who expect a dividend increase. Cutting the dividend

would allow FPL to both reinvest a significant portion of its earnings in order to

meet the challenges of the industry’s future and offer higher rates of dividend

growth in subsequent years

 Cutting the dividends would be a negative signal for shareholders that would be

expecting to receive at least a dividend equal to last year if not more.

 FPL also has a large amount of debt. If the dividend is reduced, it would facilitate

the debt repayment.

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  Another concern is capacity building since the demand for electricity is expected to

rise by huge amount. Hence more capital would be needed to fund this expansion.

Recommendation:

A hold recommendation should be maintained for the shares of FPL group. FPL dividends

are $2.48 per share. There is little reason to believe that the management would decrease

the dividend. The management has signaled that the payout ratio is very high. The payout

ratio can be reduced even while keeping the DPS constant by increasing the earnings.

The only argument in favor of changing the hold recommendation is the 6% drop in prices

of FPL shares. But FPL shares have already decreased by 19.6% in the past 9 months in

response to increasing interest rates. This 6% drop may be a continuation of that only.

The fact that FPL’s stock has fallen recently coupled with its strong expected future

earnings argue in favor of a buy recommendation. However, FPL will face unprecedented

challenges if Florida institutes retail wheeling. The company is already hampered by the

interest expense on its outstanding debt. Responding to potential competition by keeping

dividends constant or cutting dividends will likely produce a market backlash, and rising

interest rates have already precipitated a steep decline in the stock’s price. A buy

recommendation could leave investors with a firm whose stock price is on the decline

and is about to face unprecedented challenges. At the same time, issuing a sell

recommendation would be impetuous. Management’s warning regarding its high payout

ratio suggests only that it is aware of the increasing risks it faces, and does not signal a

concern over earnings. In fact, the financial statements reveal expected future earnings to

be quite strong. Furthermore, there is no current legislation that would expose FPL to

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competitors. FPL’s financial position remains stable and its outlook solid despite the

uncertain industry conditions.

A hold recommendation is consistent with all the available information.

What actually happened??

On March 3rd, 1994 FPL suggested that it would be difficult to increase the dividend. Then

on May 9th, 1994 FPL announced the dividend cut with the stock repurchase program and

the stock price fell $4.375 to $27.50. Then on May 31st, FPL's stock closed at $32.17, or

about 30 cents higher than the pre-announcement price. One year later, FPL's stock price

closed at $37.75, giving stockholders a return of 23.8%. Finally, almost two years later on

April 1, 1996 FPL's stock was trading at $45.25, which provided stockholders with a post

announcement return of 52.9%. Thus, when investors see the Incorporation repurchasing

the stocks, this gives them the concept that the stocks are healthy and will be increasing

in the near future or why repurchasing.

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