Drax Group PLC (LON: DRX) – Building Long-term Prospects with Biomass Self-Supply to Deliver Lower Cost and Zero Carbon Energy Future

Drax Group PLC is a FTSE 250 listed Power Generation Company, which has been listed on the London Stock Exchange since 15^th December 2005. Its core activities are – Pellet production, which produces wood pellets; Power Generation, which provides a portfolio of low-carbon, flexible and renewable power generation in the United Kingdom; B2B Energy Supply, which caters to the supply of renewable energy solutions to business and industrial customers. In FY19, it produces 1,407 kilotonnes (kt) of pellets. The assets of the Company consists of 2 x 525 kt pellet plants, 1 x 450 kt pellet plant, 2.4 Mt (million tonnes) export facility (at Baton Rouge port), and planned expansion of facilities by 350 kt. The Company has a target of becoming carbon negative by 2030.


(Source: Presentation, Company Website)

Key Fundamental Statistics



Segment Analysis

The Company is organized into three business:
 

1. Pellet production: Comprises a wood pellets production in the US at processing facilities.

2. Customers: Manages the supply of gas and electricity in the UK to business customers.

3. Generation: Consists of power generation activities in the UK.
 

 (Source: Presentation, Company Website)

Measuring Performance Against Strategic Objectives by Using Non-Financial KPIs
 

1. Safety: Total Recordable Incident rate stood at 0.22 in FY19, which was same as FY18.

2. Environment: The Company has achieved more than 85 per cent reduction in CO2 (carbon dioxide) emission since 2012.

3. Financing: The Company secured GBP 125 million of a facility for ESG, linked to carbon emission.
 

(Source: Presentation, Company Website)

Synopsis of Recent Developments

12^th June 2020: The Company extended the final maturity of GBP 125 million ESG (Environmental, Social and Governance) facility to 2029 from 2025.

22^nd April 2020: The Company is projecting GBP 60 million of the financial impact on FY20 with respect to its customers business.

Top Shareholders Statistics

 

Trading Update – Reflecting Strong Trading and Operational Performance

On 22nd April 2020, Drax Group released an update on the trading performance for the first three months of the financial year 2020. Overall it reflected arobust trading and operational performance for the first quarter of the financial year 2020, with Adjusted EBITDA for the year 2020 currently in line with expectations. For the first three months of 2020, the Company’s generation portfolio and pallet production performed well. Drax delivered a strong balance sheet, with cash of GBP 454 million and net debt declined to GBP 818 million at 31 March 2020. The Group remained focused on the expansion of the supply chain and reduction of costs. The net debt to EBITDA stood at around 2x for the full year. Including a GBP 315 million RCF (Revolving Credit Facility), the Group has GBP 663 million of available cash and committed facilities.

Financial Highlights – Decent Financial Performance for FY2019 (31st December 2019, GBP, million)


(Source: Annual Report, Company Website)

For the financial year ending 31st December 2019, driven by an increase in the revenue from generation business, the Company’s revenue increased to GBP 4,713.4 million versus GBP 4,229 million in FY2018. The adjusted revenue stood at GBP 4,702.9 million, while the adjusted gross profit stood at GBP 867.1 million for the financial year 2019. The adjusted EBITDA stood at GBP 409.8 million in FY2019 versus GBP 249.6 million in FY2018. The adjusted operating profit increased from GBP 76 million in FY2018 to GBP 203.8 million in the financial year 2019. The Group’s operating profit was at GBP 62 million in FY2019 versus an operating profit of GBP 59.9 million in FY2018. The adjusted PBT (Profit before tax) increased to GBP 142.2 million in the financial year 2019 from GBP 37.1 million in FY2018. The adjusted PAT (Profit after tax) increased to GBP 118.1 million in the financial year 2019 from a PAT (Profit after tax) of GBP 41.9 million in FY2018. The adjusted basic earnings per share stood at 29.9 pence in FY2019 versus 10.4 pence in FY2018. The adjusted diluted earnings per share stood at 29.7 pence in FY2019 versus 10.3 pence in FY2018. The dividend per share stood at 15.9 pence in the financial year 2019 versus 14.1 pence in FY2018.

Financial Ratios – Decent Profitability and Liquidity for FY2019 versus FY2018

 

The reported Gross Margin and EBITDA margin stood at 18.4 per cent and 8.8 per cent, respectively, for the financial year 2019. Reported profitability metrics were higher against the last year data for the same period. On the liquidity front, Drax Group Plc’scurrent ratio was lower than the industry median of 1.41x. On leverage front, the debt-equity ratio of the Drax Group Plc’swas 0.74x, which was lower as compared to the industry median of 1.65x.

Share Price Performance Analysis


Daily Chart as on 22^nd June 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On June 22, 2020, at the time of writing (before the market close, at 8:42 AM GMT+1), Drax Group Plc shares were trading at GBX 232.40, up by 0.09 per cent against the previous day closing price. Stock's 52 weeks High and Low are GBX 364.60/GBX 118.90.

Bullish Technical Indicators

From the technical standpoint, its shares were trading well above short-term support level of 20-day simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further.

Valuation Methodology

Method 1: Price/Earnings Approach (NTM)



To compare Drax Group Plc with its peers, Price/Earnings multiple has been used. The peers are Yu Group Plc (NTM Price/Earnings was 7.80), Centrica Plc (NTM Price/Earnings was 11.18), Enel SpA (NTM Price/Earnings was 10.65), National Grid Plc (NTM Price/Earnings was 8.70) and KSK Power Ventur Plc (NTM Price/Earnings was 8.67). The Average of Price/Earnings (NTM) of the company’s peers was 9.40x (approx.).

Method 2: Price/Cash Flow Approach (NTM)



To compare Drax Group Plc with its peers, Price/Cash Flow multiple has been used. The peers are United Utilities Group Plc(NTM Price/Cash Flow was 7.25), ContourGlobal Plc(NTM Price/Cash Flow was 5.04), Suez SA(NTM Price/Cash Flow was 3.49), Centrica Plc(NTM Price/Cash Flow was 2.44) and Electricite de France SA(NTM Price/Cash Flow was 2.05). The Average of Price/Cash Flow (NTM) of the company’s peers was 4.05x (approx.).

Valuation Metrics


(Source: London Stock Exchange)
 
As on 29^th May 2020, EV to EBITDA multiple of the Drax Group Plc was around 3.7x, which was lower as compared to the industry. It reflects, shares are undervalued against its peers. 

Dividend Yield


(Source: Refinitiv, Thomson Reuters)
 

Drax Group Plc has a dividend yield of 6.85 per cent, which is higher than the industry dividend yield of 5.87 per cent. This needs to be considered in view of the recent correction in the stock price. 
 

Drax Group Plc Vs FTSE-Mid 250 Index (1 Month)


(Source: Refinitiv, Thomson Reuters)

In the last one month, Drax Group share price has delivered 15.47 per cent return as compared to 7.56 per cent return of FTSE-Mid 250 index, which shows that the stock has outperformed the index during the last one month.

Industry Outlook Dynamics

As per the June 2020 edition of Market Research Future Report, the market size of the global biomass power is estimated to reach USD 55.84 billion by 2025, representing a compounded annual growth rate of 6.22 per cent from 2019 to 2025. The growth is likely to be driven by favourable government policies and surging demand for renewable source of energy.

Growth Prospects and Risk Assessment

The Company reported a strong operational and financial performance in the first quarter of FY20. It has a flexible and robust balance sheet position to undertake future projects and opportunities. The Company plans to invest GBP 110 to GBP 120 million in biomass self-supply in FY20, which will bolster its position to achieve the carbon negative state by 2030. The underlying growth in the core business reflects attractive opportunities for the Company. Moreover, the Company has a clear capital allocation plan, while maintaining a strong financial position. Furthermore, it remained focused on reducing the cost of biomass to GBP 50 per MWh (megawatt hour) by 2027. DRX is following renewable, low carbon and flexible approach to deliver higher operational growth with high-quality earnings. The Company is actively looking forward to investment opportunities for growth in its core businesses. Drax Group is looking forward to expanding its generation portfolio and system support services provisions for the period. The Group had delivered significant growth during the FY2019, with Adjusted EBITDA improved by 64 per cent to GBP 410 million from GBP 250 million in 2018. The Company has a strong financial position to tackle the impact of Covid-19 pandemic.
 
Furthermore, the sector is exposed to political, financial and operational risks, each of which has the potential to significantly impact company’s performance. The potential change in the political environment and regulatory frameworks, failure to meet all legal and regulatory obligations and inability to provide appropriate resources will negatively impact the operational and financial performance.  

Business Outlook Scenario

With a resilient, sustainable biomass supply chain and strong balance sheet, the Company has delivered a strong trading and operational performance. In the current period, the Company has reduced its net debt. Moreover, it seeks to ensure its biomass power generation stays viable in the long term by supplying more of its own biomass, which will also cut costs and reduce supply chain risks, with a greater scope for optimizing operational leverage. Among the electricity businesses listed on the LSE, DRX shares are the decent outperformer amid COVID-19 pandemic. Its shares have surged about 38.28 per cent on a QTD basis and relatively outperformed the benchmark index. Despite a solid price return amid bearish market trend, the Company is offering a lucrative dividend yield of 7.19 per cent. From the above scenario, the Company’s prospects look good, and it could be an attractive opportunity to invest in the long term. The goal to achieve net-zero carbon emissions by 2050 will give a leg-up to the operations of the group as it believes sustainable biomass has a long-term critical role to play. Moreover, it seeks to ensure its biomass power generation remains viable in the long term by supplying more of its own biomass, which will also cut costs and reduce supply chain risks, with greater scope for cost reduction plans. By the Year 2027, Drax is targeting a self-supply capacity of five million tonnes and intends to supply 80 per cent of biomass from its own sources.


(Source: Presentation, Company Website)
 
Over the course of 3 years (FY16 - FY19), the Company’s revenue surged from GBP 2,949.80 million in FY16 to GBP 4,702.9 million in FY19. Compounded annual growth rate (CAGR) stood at around 16.82 per cent.

Based on the decent fundamental prospects and support from the valuation as done using the above two methods, we have given a “BUY” recommendation at the current market price of GBX 232.40 (as on 22^nd June 2020, before the market close at 8:42 AM GMT+1), with lower double-digit upside potential based on 9.40x Price/Earnings (approx.) on FY20E earnings per share (approx.) and 4.05x NTM Price/Cash Flow (approx.) on FY20E cash flow per share (approx.). 
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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