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... voting the nations electric utility sector, and FPL would face serious challenges in the event such a plan was passed in Florida. FPL must be prepared for this eventuality, and preparation entails using current financial stability to protect future profitability. The industry as a whole has a relatively high payout ratio, but Fpl's ratio is at the high end of the industry's spectrum, further increasing its vulnerability to prospective competitors. A lower payout ratio would allow FPL to increase its growth potential and insulate itself from competition. 7. Current Payout Ratio from Investors Perspective Now lets revisit the FPL case to see whether coupling the positive stock repurchase signal with the dividend cut had any impact on investor opinion.
There were interesting market events surrounding the FPL announcement of the change in dividend policy. On March 3 rd, 1994 FPL suggested that it would be difficult to increase the dividend. Then on May 9 th, 1994 FPL announced the dividend cut with the stock repurchase program and the stock price fell $ 4. 375 to $ 27. 50 (5). Then on May 31 st, 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. One explanation would be that the market effectively over punished the stocks of companies when they announced both a stock repurchase program and a dividend cut as they did with FPL. Then once they realized that the company made a strategic move, and signaled to the public that the company's basic earning power was still strong the stock rebounded Another possible explanation is that when the company cut the dividend, the clientele of investors who desire a high dividend payout left and the stock dropped. Soon after the old clientele left, a new clientele that desired a lower dividend payout replaced them, and the stock rebounded.
Another question is whether companies added an announcement for stock repurchases as they cut the dividend level to appear as if they were making a strategic move as FPL did. In reality however, perhaps the companies were facing problems and the management was trying to appear strong to the public in order to protect their firm's stock price. 8. Recommendation: We would maintain a hold recommendation on Fpl's stock. The previous hold recommendation was based on the belief that FPL would keep its dividends at $ 2. 48 per share or increase it slightly, and there little reason to believe that this will not be the case. Merrill Lynch's own downgrade of FLP was based on the belief that FPL would keep its dividend at $ 2. 48. Fpl's management has suggested that the dividend payout ratio is excessive given the conditions facing the industry, but has not indicated a bias toward cutting the dividend.
FPL could maintain a dividend of $ 2. 48 while reducing the payout ratio provided that earnings increase at a faster rate than dividends, and Fpl's strength in recent and expected sales combined with its declining expenditures suggests that earnings will continue to grow. The only evidence arguing in favor of a change in the hold recommendation is the 6 % drop in Fpl's price, but that drop may be unrelated to Merrill Lynch's report. Fpl's stock has already decreased by 19. 6 % over the past nine months in response to rising interest rates, and the 6 % drop may be a continuation of this precipitous decline. A hold recommendation remains the best course of action despite the days events.
The uncertainty pervading the electric utilities industry in general and FPL in particular precludes a buy or sell recommendation. The absence of a consensus regarding Fpl's future revealed in the analysts reports demonstrates that FPL has a number of upcoming important decisions, and that there is no uniform way to interpret all the relevant information. 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 stocks 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. Managements 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 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. There is no reason to believe either that FPL will undertake a drastic dividend cut or that it is in any immediate financial difficulty. There is also no reason to believe both that FPL does not face the same risks as all electric utilities in the context of industry deregulation, and that FPL will not continue to prepare for threats from competitors.
Kate Stark believed that FPL would keep its dividend at $ 2. 48 per share, and issued a hold recommendation based on that assumption. Both that assumption and the consequent recommendation remain sound. Entergy and FPL Group Agree To A $ 27 Billion Merger Of Equals Creating The Nation's Largest Power Company. 9. Conclusion The significance of this case is that FPL was the first company to drop the dividend payout without the typical negative reasons, but for strategic reasons. Also, FPL supplemented the dividend cut with a stock repurchase in order to boost investors' confidence in the company. Finally, FPL's stock had increased over a long period after the announcement, and has more than offset the temporary price decline from the dividend cut The new company, which will be named at a later date, will be the largest U.
S. electric utility and the largest power producer. Based on the closing stock prices of both companies on Friday, July 28, 2000, the combined company will have a total enterpris...
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