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 FPLs dividend yield and payout ratios compares to other firms. Also
discuss recent trends in FPLs dividend growth 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 industrys future, the high payout ratio would limit the firms 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
shareholders current benefit, however, in the long-run, the shareholder will be
compensate by FPLs current financial strategy.

2. Does FPLs 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 managements insider view of the firms 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 years earnings. FPLs managements 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 FPLs stock? Explain

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 FPLs stock holders are individuals, we will address their needs at the
highest level. It would be advantageous for individual investor to have FPLs 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.