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 Commission (SEC) is the regulating authority for the utilities with interstate systems or substantial investments in assets not related to the core operation of the utility. In order to avoid SEC supervision, the industry had evolved into a large number of intrastate, and relatively undiversified, utility companies operating under extensive regulation. Public Utilities Regulatory Policies Act (PURPA) encourages the creation of plants using renewable/non-traditional energy sources and gives Federal Energy Regulatory Commission the regulatory power. These plants were classified as “qualifying facilities” and local utilities were required to buy all of the electricity produced by these qualifying facilities. Once deregulation is introduced, FPL Group will not be very affected by increased competition in the generation segment because of the previous investments in these qualifying facilities. Deregulation: In the 1970s and 1980s deregulation eliminated the monopoly rights in industries such as trucking, airlines, banking and communications. In the 1990s ideas about deregulating the electricity utilities were floating around. Deregulation brings increased competition and short term costs in terms of layoffs and business failures while eliminating inefficiencies. Deregulation of the transmission systems took place in 1992 with the National Energy Policy Act (NEPA). NEPA required the utilities to make their transmission systems available to third party users at the same level of quality and cost enjoyed by the utilities themselves. Deregulation of the distribution system was beginning in the early 1994. In California they proposed to launch “retail wheeling” in 1996: The customers would be allowed to buy power from utilities other than the local supplier. Also the local utility would be required to open its transmission and distribution network to outside utilities wishing to sell power in that market. Industrial customers would be targeted first who would choose the lowest bidder for their utility. As the system proves to be efficient, others would be able to participate in this competitive market. A utility executive from Arizona commented: “What happens in California will create a domino effect across the country. Utility managers will have to be prepared for competition from new as well as existing players in the market.” Based on this expected deregulation, FPL Group Inc. will operate in tough competition and it needs to be prepared. We can expect similar behaviour across the industry. FPL Group Inc. Background: Company has experienced steady growth since 1925 and has a record of increased dividend for 47 years. Before 1989 the FPL Group undertook a quality control program. With 1700 quality control teams unscheduled blackouts were reduced from 18% to 4% and customer complaints were reduced by 60%. FPL was awarded for quality in 1989 and it was viewed as “one of the best-managed US corporations.” In 1989 James Broadhead, an industry outsider who have seen the deregulation in telecommunications, took control of the FPL Group and focused on the core operation, utilities industry, while expanding capacity and improving the cost position. He scaled back the quality program by cutting the number of...
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