Dividend Policy at Fpl Group, Inc.
Question 1
We believe that Ms Stark should not revise her recommendation regarding FPL. The HOLD recommendation seems to be the most appropriate. Our judgement assumes a dividend cut from FPL. However, this dividend cut would be a precise strategic choice rather than one dictated by financing difficulties. Specifically, the dividend cut will raise future growth, with little effect on the stock price.
By cutting dividends, FPL can react better to future threats. After an initial panic selling triggered by the news shock (FPL never cut its dividend in the past 47 years), investors will process the new information realized that the dividend cut is balanced by an increased growth rate in the future. To justify the HOLD recommendation on the stock, we need to figure out what is the necessary increase in the growth rate to compensate a specific dividend cut.
Assuming a risk free rate of 7.5% (30 years Treasury yields in May 1994) and a market premium of 6%, we estimated an expected return on equity for FPL of 11.1%. Using a Dividend Discount Model and given the current stock price of $32, we can imply a growth rate of 3.14%. With these estimates, we can have an idea of the necessary growth rate for each dividend cut (as a % of current dividend assumed at $2.47) to sustain a stock price of $32. The results of this exercise are in Figure 1. Figure 1 Dividend cut scenario analysis
For example, a 25% decrease in dividends would correspond to a new dividend per share of $1.853. In order to sustain a share price of $32, FPL needs to convince investor it can grow dividends at roughly 5% per year. This analysis assumes that the leverage ratio of the company does not change, so that the return on equity remains constant.
We believe that the likely dividend cut would be in the region of 20%. Such a cut implies a payout ratio of 72%, putting FPL below the industry average. The implied growth rate of 4.64% seems achievable. During the period from 1984 to 1989 inclusive,
We believe that Ms Stark should not revise her recommendation regarding FPL. The HOLD recommendation seems to be the most appropriate. Our judgement assumes a dividend cut from FPL. However, this dividend cut would be a precise strategic choice rather than one dictated by financing difficulties. Specifically, the dividend cut will raise future growth, with little effect on the stock price.
By cutting dividends, FPL can react better to future threats. After an initial panic selling triggered by the news shock (FPL never cut its dividend in the past 47 years), investors will process the new information realized that the dividend cut is balanced by an increased growth rate in the future. To justify the HOLD recommendation on the stock, we need to figure out what is the necessary increase in the growth rate to compensate a specific dividend cut.
Assuming a risk free rate of 7.5% (30 years Treasury yields in May 1994) and a market premium of 6%, we estimated an expected return on equity for FPL of 11.1%. Using a Dividend Discount Model and given the current stock price of $32, we can imply a growth rate of 3.14%. With these estimates, we can have an idea of the necessary growth rate for each dividend cut (as a % of current dividend assumed at $2.47) to sustain a stock price of $32. The results of this exercise are in Figure 1. Figure 1 Dividend cut scenario analysis
For example, a 25% decrease in dividends would correspond to a new dividend per share of $1.853. In order to sustain a share price of $32, FPL needs to convince investor it can grow dividends at roughly 5% per year. This analysis assumes that the leverage ratio of the company does not change, so that the return on equity remains constant.
We believe that the likely dividend cut would be in the region of 20%. Such a cut implies a payout ratio of 72%, putting FPL below the industry average. The implied growth rate of 4.64% seems achievable. During the period from 1984 to 1989 inclusive,