1) What are two reasons why FPL should cut the dividend? Don\'t just give generi
ID: 2785246 • Letter: 1
Question
1) What are two reasons why FPL should cut the dividend? Don't just give generic answers, tie your response to something specific related to FPL in the case - show that you read the case itself. Each explanation has to include at least one number. 2) What are two reasons why FPL should either keep the dividend unchanged, or, increase it just a little? (Same rules as above - relate the reasons to a specific fact or calculation in the case.) And, because it would be fun to see the vote, the following "ungraded" question: 3) Answer in one sentence: what should Kate Stark do, and why? ___________________________________________________________________________________________ Case Study: In the late afternoon of Thursday, May 5, 1994, Kate Stark, the electric utilties analyst at First Equity Securities Corporation, received an investment alert on one of the companies she fellowed. According to the report, Merrill Lynch's utilties analyst was dwongrading FPL Group, Inc., Florida's largest electric utiltiy. The report began: "We are [lowering] the investment rating for FPL Group... due to our expectation that the Directors will choose not to raise the annual divident from $2.48 at [the annual meeting on] May 9th. FPL's sharehodlers face the possiblity that the divdent is not entirely secure, as we believe FPL may seriously review its dividend policy at this time... Management has suggested that it feels that its divident payout is inappropriately high (in excess of 90% in 1993) given the increasing risks facing the industry... when asked specifically what might be done about the high dividend payout levels, amagement suggested that there are two ways to address high payout levels: 1) a company can grow out of a high payout; 2) a company can cut its dividen... we expect the company to keep the divdent at the $2.48 per share level through 1997." Although this analyst was predicting the dividend would not change, this was the first time Stark had seen one of her peers suggest the possibility of a divident cut. Only three weeks earlier, Stark herself had issued a report on FPL Group with a "hold" recommendation based on the assuption that FPL would keep its divident at $2.48 per share or increase it slightly. What concerned her, however, was the fact that FPL's stock price had fallen by more than 6% that day. While she could not be sure the drop was related to the report, she wondered what, if anything, she should say to her clients regarding FPL's stock and whether she should issue an updated report.
Explanation / Answer
1) a)The Electric Utility industry is facing high risks and cash flow can be a challenge in bad times given the high risk. FPL already had been paying out 90% of its earnings as dividends which are cash flows that can be reivested instead of resorting to external financing.
b) FPL's stock price also had fallen by more than 6% and keeping a cut on the dividend payout can signal to the market of higher reinvestment possibility in the future and prospects of higher earnings.
2)
a)Cutting dividends can send wrong signals to the market even though managements intention may be in tune with the market realities. This can pose shareholder activism due to lesser cash flows that they now have every year due to lower payout
b) From the case, it is seen that FPL never signalled an intention to cut its dividends an Stark herself recommended a hold decision considering that FPL would keep its dividend unchanged at $2.48 per share or increase it slightly. An increase in dividends can provide the signal to the market that the management cares about its shareholders and in tune with good corporate goverance principles.
3) Stark should maintain her Hold rating as it was only one peer which had suggested the change and change in dividends alone would not necesarily change the fundamentals of the company, instead it could also be viewed positively in light of future risk mitigation measures due to challenges in the industry.
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