This paper examines Florida Power & Light's (FPL) dividend policy and financial strategy during a period of significant industry change. The analysis reveals that FPL engaged in dividend smoothing—maintaining consistent dividend increases despite volatile earnings—while relying on external funding through debt and stock issuance. Using financial projections assuming a modest 1% annual dividend growth, the paper forecasts FPL's external funding requirements through 1998 and argues that despite short-term market concerns, FPL should reduce its dividend payout to strengthen its balance sheet, reduce debt burden, and prepare for industry deregulation. The paper concludes that a dividend cut, combined with strategic share repurchases, would better position FPL for long-term financial health and competitive challenges ahead.
After plotting earnings per share, dividends per share, and the dividend payout ratio, it becomes clear that FPL is engaged in dividend smoothing. Despite large fluctuations in earnings per share over the past decade—ranging from a low of −$2.86 to a high of $3.42—FPL has consistently increased its dividend payment each year. This pattern reveals that FPL's dividend policy prioritizes maintaining or growing dividends regardless of actual earnings performance.
A striking example of this policy is evident in 1991, when the dividend payout ratio exceeded 1.0. The analysis used after-extraordinary-items earnings per share figures, which were significantly depressed due to realized losses from the sale of non-utility properties. If before-extraordinary-items earnings had been used instead, all payout ratios would have remained below 1.0 and the pattern would have been less pronounced. Nevertheless, the fundamental pattern remains: FPL has prioritized consistent dividend growth over earnings-based payout discipline.
Rather than generating sufficient cash internally, FPL has relied on external funding to cover its dividend payments. During each of the last five years, FPL issued bonds, other long-term debt, and common stock. However, a concerning dynamic has emerged: the new long-term debt issued annually has largely been used to retire maturing long-term debt rather than to fund growth or operations. The amount needed to retire long-term debt has surged dramatically—from $360 million in 1991 to nearly $2.65 billion by 1993.
To address cash shortfalls, FPL has also issued common and preferred stock. This trend has been negative over the past five years, and in 1992 and 1993, FPL Group Capital issued additional long-term debt and preferred stock specifically to help fund dividend payments. This escalating reliance on external capital markets signals growing financial stress and raises questions about the sustainability of the current dividend policy.
Assuming FPL increases its common dividends by 1% annually from 1994 to 1998, financial projections reveal that FPL will be unable to finance this dividend level from internally generated cash flow until 1997. External funding will be required in 1994, 1995, and 1996. By 1997, with the modest 1% annual growth rate, FPL can fund its dividend internally, and the payout ratio is projected to decline to 79% by 1998.
However, an important complication emerged between February and April 1994: interest rates jumped a full percentage point, from 6.3% to 7.3%. As FPL continues to issue debt to bridge the funding gap, the higher cost of borrowing will reduce future cash flows and increase the burden when this newly issued debt approaches maturity. Additionally, as more debt is issued, each successive tranche becomes riskier and more expensive—a dynamic well recognized in corporate finance that will further constrain FPL's financial flexibility.
The analysis reveals a fundamental tension: maintaining or increasing dividends signals financial health and can boost stock price, yet FPL's dividend policy may be unsustainable. Research, such as Charest's work on dividend cuts, demonstrates that reducing dividends can trigger a stock price decline of approximately 3.8%. This risk creates a powerful incentive for FPL's senior management to avoid a dividend reduction, since higher stock prices directly benefit executives holding equity-based compensation.
This dynamic creates a conflict of interest. Management may prioritize short-term stock price support over the long-term financial health of the company. While increasing debt to maintain dividends can work in the near term, the approach becomes increasingly risky as interest rates rise and debt-service obligations mount. FPL's planned shift to an incentive compensation plan focused narrowly on net income targets may worsen this problem by encouraging managers to focus on short-term earnings rather than sustainable capital structure decisions.
There is also a legal risk dimension to consider. When Sierra Pacific Resources reduced its dividend by 39% to bring its payout ratio below 100%, it faced a class-action lawsuit from shareholders. By maintaining or increasing dividends, FPL's managers reduce the likelihood of shareholder litigation. However, this legal shelter comes at the cost of financial stability and limits strategic options when market conditions change.
"Dividend cut with share repurchases to strengthen balance sheet"
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