Dividend Policy at Florida Power and
Light (FPL) Group, Inc.
Presented by:
Dominic A. Labitzky
Electric Utility Industry
• The concept of a public utility developed in the late 19th century to refer
to a monopoly supplier of a vital public service. The public service in this
case is the generation, transmission and distribution of electricity.
• In exchange for the monopoly right to supply electricity, power
companies agreed to let government agencies regulate their prices and
returns.
• In 1935 the Federal Power Act gave the Federal Power Commission the
authority to oversee wholesale transactions (sales) of electricity to utilities
rather than to consumers.
• Congress also passed the Public Utilities Holding Company Act (PUHCA)
which gave the Securities and Exchange Commission the authority to
regulate the utilities with inter-state systems or substantial investments in
assets not related to electricity.
•Consequently, the industry evolved into a large number of intra-state,
and relatively un-diversified, utility companies operating under extensive
Federal and State regulation.
Rise of Deregulation
•
In 1978 Congress passed The Utilities Regulatory Policies Act. The act
required local utilities to buy all their electrical output.
•
Fourteen years later, Congress introduced competition into the second
segment of the industry (transmission) with the passage of the
National Energy Policy Act of 1992. This act made it possible for utilities
to demand access to another utility’s transmission system.
•
Deregulation of the final segment of the industry (distribution) had
begun in early 1994. This brought a proposal by the State of California
to the table introducing the notion of retail wheeling.
•
Under retail wheeling, customers would be allowed to purchase power
from utilities other than their local utility company. The local utility
would be required to open it’s transmission and distribution network to
outside utilities wishing to sell power to consumers in that market.
•
Over time, the other major customer segments, commercial users and
eventually residential users would get the right to pick their electricity
suppliers.
Effects of Deregulation
•
As a result of retail wheeling initiative, California’s three largest utilities
lost total of $1.8 billion in market value in one week.
•
23 other states began to consider variations of the California retail
wheeling proposal.
•
These proposal had a profound effect on the competitive landscape of
the utilities industry.
•
As a result of the now competitive landscape, Standard and Poor’s
rating group announced a revision of its guidelines for evaluating
investor owned electric utilities.
•
Factors in the new guidelines included customer and sales growth
prospects, revenue vulnerability and dependencies as well rates by
consumer class relative to competing utilities among others.
What does all this mean?
•
The rise of deregulation in an industry that historically has been
highly regulated causes new competition in the industry.
•
As of a result of this new competition, companies must reevaluate
their business strategies to accommodate this new competitive
environment and remain successful.
•
A previously mature industry is now transforming into an industry
with prospects for growth.
•
Analyst will begin to follow the S&P guidelines to evaluate firms in
this industry. In order to maintain or increase their stock’s
attractiveness electricity utilities will have to developed competitive
advantages over their peers.
Dividend Policy at FPL Group, Inc.
•
“On May 5th , Merrill Lynch downgraded FPL’s stock because of their
expectations that the directors of FPL will choose not to raise the
annual dividend from $2.48.”
•
“Management has suggested that if feels that the dividend payout
ratio is inappropriately high (in excess of 90% in 1993) given the
increasing risk in the industry.”
Dividends and Growth
•
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.
•
With deregulation giving rise to competition FPL Group, Inc. needs to
focus its operations and begin to grow its business in order to survive.
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.
Why do firms pay dividends? Advantages/ Disadvantages
of Cash Dividends
•
A dividend is a payment made out of a firm’s earnings to its owners or
stockholders. Firms pay dividends to satisfy their investors’ desire for
current income.
•
A common type of dividend is a cash dividend, a cash payment made
directly to investors from the firm’s earnings.
•
Cash dividends are more tangible to investors. $1 in dividends is only
subject to tax. An investor incurs no transaction cost in receiving the
dividend.
•
However, cash dividends are subject to personal income tax rates
which in some cases can be higher than capital gains taxes. So, some
investors will stand to benefit more from cash dividends than others.
Also, cash dividends decrease the share price while dividends in the
form of a stock repurchase preserves share value.
A lower payout ratio is advantageous for FPL
•
It is clear that the current payout ratio of 91% is too high. For FPL
Group, Inc. lowering the pay out 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. Stay Tuned…
•
The firm could use this capital to expand and grow the company as
well as improve the firm’s capital structure. As stated in the case, the
debt rating of FPL has been upgraded. This should make their cost of
debt decrease. FPL can now pay off their high cost debt and use the
savings created by the lower dividend to obtain debt at a lower cost if
they so choose.
A lower payout ratio is advantageous for Investors
•
First we must consider who the FPL investor is!
(as shown in table 10)
Individuals 51.9%
Institutions
36.9%
ESOP 11.1%
•
Because individuals make up the majority of FPL’s investors, we will
address their needs at the highest level.
•
It would be advantageous for individual investors to have FPL’s
Dividend payout ratio at a lower level for the following reasons:
– Tax advantages: 28% capital gains tax Vs. Up to 39.6% personal
income tax
– Possibility of stock repurchase plan in the future
– Allows dividend payout ratio to grow in the future
– Possibility for increase in stock price caused by higher growth rates
Some calculations
•
IGR under current dividend payout (1993 data)
Plowback Ratio = b = 1- Dividend Payout = 1 - .91 = .09
ROA = Net Income / Total Assets = $514 million / $13,078 million = .0393 or 3.93%
=> IGR = (ROA * b) / (1 – ROA * b) = (.0393 * .09) / (1 - .0393 * .09) = .0035 or .35%
Obviously, the firm depends on outside sources of financing!
•
IGR under a lower dividend payout (1993 data)
Our analysis and facts from case point to a reduced dividend payout ratio of around 65%.
Plowback Ratio = b = 1- Dividend Payout = 1 - .65 = .35
ROA = Net Income / Total Assets = $514 million / $13,078 million = .0393 or 3.93%
=> IGR = (ROA * b) / (1 – ROA * b) = (.0393 * .35) / (1 - .0393 * .35) = .014 or 1.4%
The firm depends on outside sources of financing but its ability to grow from
with in is increased by 400%!
How much cash does this actually translate into?
A few more calculations
•
With net income of $514 million (1993) the current plowback ratio
translates into $46.26 million of retained earnings. With a reduced
dividend payout ratio leading to a higher plowback ratio the resulting
increase to the firm’s retained earnings is roughly $134 million.
NI = $514 million
At a 9% plowback ratio: $514 million * 9% = $46.26 million
At a 35% plowback ratio: $514 million * 35% = $179.90 million
$179.90 million
-$ 46.26 million
_____________
$133.64 million => roughly $134 million
Analyst perspective and recommendations
•
As analyst we would like to see a reduction in FPL’s dividend payout
ratio. In this new competitive environment we feel that FPL would be
better served with a lower dividend payout ratio because it makes no
sense to have a high payout ratio in a growth industry.
•
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.
The End
That’s all Folks