Dividend Policy At Fpl Group, Inc.

FPL - An Overview

FPL Group, Inc. is Florida's largest electric utility company. In 1925, through the consolidation of numerous electric and gas companies, they formed Florida Power & Light Company (FP&L). FP&L grew steadily over the next 50 years until rising fuel costs, operating issues, and construction costs began to decrease profitability. In the mid-1980s, FPL diversified with four major acquisitions - Colonial Penn Life Insurance Company, Telesat Cablevision, Inc., CBR Information Group Inc., and Turner Foods Corporation- in order to minimize the potential risk within the utilities industry.

To address problems in operations, FPL began a rigorous program of Japanese-inspired quality control. Management succeeded in transforming FPL into a lean operational system resulting in a drop in scheduled downtime from 18% to 4%, while customer complaints also fell by 60%. By 1989, FPL was recognized as "one of the best-managed U.S. corporations." Despite the progress in quality, FPL was still dealing with problems: Colonial Penn was losing money, there were safety concerns about a particular nuclear plant, and demand was growing faster than capacity.

In 1989, James Broadhead succeeded Chairman Marshall McDonald. Broadhead placed an emphasis on commitment to quality and customer service, increasing focus on the utilities industry, expanding capacity, and improving cost positions. He took measures to scale back the intense quality controls while still working to preserve the high level of operational efficiency. Furthermore, Broadhead brought focus back to FPL's core business - utilities, by selling off many of its non-utility businesses. FPL also budgeted $6.6 billion, spread over five years, for expansion. They funded the development through internal profits and by issuing $3.7 billion of long-term debt and $1.9 billion of common stock.

The Electric Utility Industry

FPL is an established leader in the utility industry. They have proven their ability to survive and succeed in the dynamic and evolving competitive market. The electric utility industry has established itself as a vital public service within today's society. Until the 1970s and 1980s, the government played a major role in determining the rates, returns, and capacity planning of the power industry. Congress passed several laws regulating the sale of wholesale energy and even formed committees to monitor utility companies' dealings.

Deregulation

In the 1970s and 1980s deregulation weakened the monopolies that had dominated the trucking, banking, airlines, natural gas, telecommunication, and eventually the electric utilities industry. By 1978 most major segments were faced with mandatory changes. In 1992 the National Energy Policy Act (NEPA) was passed requiring utility companies to make their transmission systems available to third-party users at the same level of cost. A clatter of legal quarrels ensued thereafter and FPL was accused of charging excessive rates and denying fair access to its system.

In 1994, the industry was facing deregulation of the last segment - distribution. While states such as California and Michigan had toyed with the "retail wheeling" concept in the past as a way to increase competition, Florida had not yet adopted this method. Retail wheeling allows customers to buy power from any utility, not just their local monopoly supplier. Data from the California experimentation with retail wheeling indicated an average loss of 8% of market value per utility company once this method was initiated

Recent Happenings in the Electric Utility Industry

Despite California's proposal on retail wheeling, as of May 1994, the Florida Public Service Commission was not considering implementing the policy. Although FPL is the largest electric utility in the state, retail wheeling would greatly increase the amount of competitors in the market. The industry faces a challenging future full of change, and shareholders would benefit from understanding the potential risks and rewards of their investment. The Standard & Poor's Ratings Group declared a revision to their guidelines for evaluating utilities in October of 1993. This revision included the utilities' competitive position as part of its financial rating. FPL's positions rose based on the new criteria, placing them in the top 10% of publicly owned utilities.

Major Issues Confronting FPL in 1994

In spite of a favorable position rating, FPL cannot ignore the deregulation movements threatening their current business landscape. The most important issues facing FPL in May 1994 are potential competition resulting from industry deregulation and their high payout ratio.

1) Retail Wheeling

The threat of retail wheeling within FPL's market forces management to consider whether or not they can maintain high payout ratios. Retail wheeling is reshaping the utilities industry and if enacted in Florida, it will bring grave challenges to the future of FPL.

2) Low Capacity Margin

FPL must prepare for increased competition from the establishment of retail wheeling and other forms of distribution deregulation. FPL is an old firm which is running at roughly 92% capacity. Their low capacity margin (8.6%) suggests that they have less room for growth compared to their competitors. FPL must work to foster growth in order to survive in an evolving industry.

3) Transmission & Power Costs

FPL carries a transmission cost of nearly double the industry average. FPL's cost is $.0019 compared to the $.0010 of their peers. With the potential onslaught of competitors, these high costs will hinder FPL's ability to compete. Furthermore, FPL's power generation costs are high because they purchase 30% of their power used in the generation process from outside sources. Thus, they are subject to any price sensitivity in the power market.

4) High Payout Ratio

The payout ratio interprets the amount of earnings paid out in dividends from earnings available to shareholders. Currently, FPL has a payout ratio of 90%. While it is true that firms in the utilities industry typically have a high payout ratio, FPL's ratio is abnormally high. Given the possibility of expansion due to increased competition, FPL cannot afford to carry on such a high payout ratio. By decreasing the payout ratio, FPL can use a higher portion of earnings to encourage growth and safeguard against competition.

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