Dividend Policy at FPL Group Inc.

Problem: On May 5, 1994 the utilities analyst of Merrill Lynch downgraded FPL Group Inc. due to an expectation of adjustment in dividend payments. The report also acknowledged the probability of a cut in the dividend. Kate Stark of First Equity Securities Corporation analyzes the situation and she has to predict what is going to happen. This investment alert was published dropped the stock price by 6% on the same day. 3 weeks ago Kate Stark has recommended a “hold” position for FPL Group. With the new report should she change her recommendation?
Electric Utility Industry: The electric utility industry is formed by three segments: generation, transmission and distribution. Securities and Exchange
Based on these criteria FPL had a business position above average, placing it in the top 10% of investor-owned utilities. Senior secured debt with A+ rating, senior unsecured debt with single A rating.
Since September 1993, company’s long term interest rates have increased by 1.4%. During this period stock price had fallen by 19.6% (S&P electric utilities index fell by 22.1%).
Dividend Policy
Although FPL had 47-year streak of dividend increases, which is a record, management has suggested that it feels that its dividend payout is inappropriately high. When we look at the competitors’ data we see that FPL has the highest dividend payout ratio (1993: 107.52%, 1994:91%).
Management has to decrease the dividend payout ratio for the following reasons: * FPL has to be ready for the unexpected results of the expected deregulation and increased competition. When we look at the Annual load factor figure in Exhibit 7, we see that FPL is utilizing its capacity at the same rate as its competitors but making the highest dividend payments. FPL needs to bring this down to a more feasible rate. On the other hand the capacity margin of FPL is the second lowest compared to its competitors. These imply that in case of deregulation, all utilities are in similar conditions and it would be so easy for any one of them to run FPL out of business just because of the high dividend payments. * FPL Group is