Dividend

Policy
FPL Group Inc

Financial Management - I
Group 11
Kinnari 20121026 | Krutika P 20121028 | Tushar 20121058 | Vijay 20121062

Agenda

Case Background
Decision Rationale

Financial Analysis
Reflection and conclusion

Financial Management I | Dividend Policy at FPL Group Inc.

Case Backgound

Synopsis
Current Situation

Case
Description

Recommendation

Competitive
Position

Financial Management I | Dividend Policy at FPL Group Inc.

Background behind FPLs decision in dividend

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.

Financial Management I | Dividend Policy at FPL Group Inc.

Possible Alternatives

Increase dividend
Remain the same! ($2.48 per share)

Cut dividend

Financial Management I | Dividend Policy at FPL Group Inc.

Key Assumptions
Efficient Market Hypothesis apply
Analysts investment rating are limited to 3 options
Buy
Sell
Hold
Signaling exists in market place

Financial Management I | Dividend Policy at FPL Group Inc.

Decision Rationale

Why would FPL want to increase dividend

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

Financial Management I | Dividend Policy at FPL Group Inc.

Why would FPL want to decrease dividend

To signal worsening industry prospect.

Increased competition leads to increased volatility in

earnings.

Other concerns than signaling. Taxes, transaction cost, or

agency conflicts.

Financial Management I | Dividend Policy at FPL Group Inc.

FPLs competitive advantages

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

FPLs 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 FPLs risk to the threat of
competition.
S&P ranked FPLs competitive position among the top 10% of
investor-owned utilities.

Financial Management I | Dividend Policy at FPL Group Inc.

FPLs financial Strength

FPLs 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.

Financial Management I | Dividend Policy at FPL Group Inc.

FPLs Income Statement Analysis

Financial Management I | Dividend Policy at FPL Group Inc.

FPLs competitive disadvantages

FPL is a high cost utility in a commodity business.
FPLs 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 FPLs future profitability.

Financial Management I | Dividend Policy at FPL Group Inc.

Financial Analysis

Does signaling play a role in FPLs dividend policy

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

Taxes and dividends for FPL

Non-tax paying institutions (36%) generally dont 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.

Financial Management I | Dividend Policy at FPL Group Inc.

Transactions Costs
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.

Financial Management I | Dividend Policy at FPL Group Inc.

Agency 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.

Financial Management I | Dividend Policy at FPL Group Inc.

What Will Broadhead do?

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

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

Reflections and Conclusion

Dividend reduction and capital market expectation

FPLs 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.
FPLs 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

Financial Management I | Dividend Policy at FPL Group Inc.

Reflection
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.

Financial Management I | Dividend Policy at FPL Group Inc.