RBC Capital double upgrades Drax to 'outperform'
RBC Capital Markets upgraded Drax to 'outperform' from 'underperform' and lifted the price target to 400p from 340p.
The bank, which has been negative on Drax since the start of the year due in part to concerns about the lack of clarity on dividends, noted that the group generates strong and increasingly commodity-independent cash flows, and said it reckons the company can pay cumulative dividends over the next five years of £675-775m while remaining within the targeted 2x net debt/EBITDA metric.
This represents a return to shareholders of around 55% of the current market capitalisation and represents an average dividend yield of around 12%.
RBC argued that higher dividends can be accommodated alongside continued capex on the core generation asset and the capex required to diversify Drax’s operations. This includes plans to add a further 1m tonnes of capacity in biomass pelleting facilities to hit a target of at least 30% self-supply.
The bank noted that it is 5-10% ahead of consensus at the EBITDA level out to 2020. However, as far as dividends are concerned, it's at double the amount currently forecast by consensus, hence the upgrade.
"Unfortunately positive news on the dividend is unlikely to be confirmed until full year results for 2018E. In the interim period continued progress on the growth strategies in Retail and Biomass Supply will be important."
RBC said risks to investment thesis include unexpected weakness in commodity prices that could hamper performance, even though Drax is less commodity sensitive than in the past.
Other risks include unexpected generation outages, interruptions to the biomass supply chain, political intervention into retail markets and prolonged weakness in GBP pushing up the unhedged price of biomass supplies.
At 1250 BST, the shares were up 1.7% to 321p.