Its cooling towers have been a fixture on the Yorkshire skyline for decades, but inside Britain’s biggest power plant things have been changing apace. After years of burning polluting coal, Drax has switched to renewable biomass at three of its six units and recently won permission to convert a fourth.
All four biomass units are supported by green energy subsidies that should last until 2027, but the future after that is uncertain. The remaining two units still burn coal, due to be banned by 2025 and becoming increasingly uneconomic.
Drax has made a series of bold bets to diversify: it bought Opus Energy, a business energy supplier, and options to build four new open-cycle gas “peaking” power plants (OCGT) that could help to fill the gaps between intermittent wind and solar output.
It is also looking at converting the two remaining coal units at Drax into a new large-scale combined-cycle gas power plant (CCGT) and building one of the world’s largest batteries.
Last year Drax unveiled a strategy to increase earnings before interest, taxation, depreciation and amortisation (ebitda) to £425 million by 2025 from £140 million in 2016. It said that this should support a growing dividend and that any cash surplus to its investment needs could be returned to shareholders.
Drax made a good start in 2017, yesterday reporting ebitda of £229 million, driven by the start of the most lucrative subsidy contract for its third biomass unit. It declared a full-year dividend of £50 million, or 12.3p per share, as well as a £50 million share buyback, and said it was “on course” to hit its 2025 target. There are questions over some of the plans that underpin this growth, however.
The majority of earnings will continue to come from generation. Some of these should be fairly reliable out to 2027 owing to subsidies it has secured for biomass power, but Drax also gets income from extra “ancillary services” schemes that are subject to change.
Its 2025 forecast also assumes that it gets £60 million ebitda from the four new OCGT plants. However, these will depend on securing subsidies through the government’s “capacity market” scheme. So far, it has failed to do so.
Drax believes the strategic case for the plants is clear and that ministers will make it happen. Investors may be nervous about assuming that the government does what Drax thinks it should. The company’s shares were trading at more than £8 in early 2014 before a series of government decisions went against it, making the conversion to biomass far less lucrative than had been envisaged.
A new CCGT and battery plant will be similarly dependent on subsidies, but, with a whole host of proposed CCGTs at the drawing board stage around Britain, there is no guarantee Drax’s would win out.
Another core element of the growth plan is in business energy supply. Drax has described this as “an annuity-like income stream”, thanks to its strong performance retaining customers. This seems optimistic for a market facing increasing competition from new entrants, such as Shell.
The good news is that in the near term the income from burning biomass should continue to support the dividend, which, with the shares trading at only 242¼p, is yielding 5 per cent. If the new investment options do not materialise, Drax can continue to return cash to shareholders through buybacks and special dividends. But that would still leave question marks over its long-term future.
Will Gardiner, chief executive, admitted yesterday that the company’s power generation business remained “very dependent on government regulation”. That is not always a happy place to be.
ADVICE Hold
WHY Near-term earnings underpinned but questions over longer-term growth.
Croda International
Croda International rarely sets pulses racing among investors, but that’s part of its appeal. The speciality chemicals maker unveiled record full-year results yesterday that were bang in line with consensus forecasts in the City. Adjusted pre-tax profit rose by 11.1 per cent to £320.3 million in the year to December 31, up from £288.3 million a year earlier, on sales up 10.4 per cent at £1.37 billion.
With about 95 per cent of Croda’s sales taking place outside Britain, the weakness of sterling in the first half of the year boosted its reported currency results. On a constant currency basis, profits and sales were up by a respectable 6.5 per cent and 4.6 per cent, respectively.
Croda, which boasts a market value of about £6 billion, makes chemicals for products ranging from eye drops to pesticides for crops. Its customers include the likes of Procter & Gamble and Unilever, the consumer goods groups.
It delivered growth across its three main businesses of life sciences, performance technologies and personal care. The latter, its largest, making ingredients for skin, hair and sun protection products, was a particular bright spot, instilling confidence among investors that management’s “self-help” measures had helped to boost its performance.
Croda has a strong balance sheet, with net debt of £381.5 million, up by £17.4 million but at the bottom of its range of one to one and a half times earnings before deductions. Free cashflow of £98.5 million was down year-on-year, but capital investment peaked at more than £150 million.
Several analysts had been expecting a special dividend and the absence of one was likely to have been behind the shares, already close to record highs, being largely becalmed yesterday, fallinga penny to £45.50. An ordinary dividend of 81p per share was 9.5 per cent higher than last year.
Management retains the flexibility to return to cash to investors and acquisitions. One potential material deal was aborted this month when talks ended over a possible merger with Ashland Global Holdings, a Kentucky-based rival, which would have created a combined group with a market capitalisation of more than $11 billion.
ADVICE Buy
WHY Scope for shareholder returns or material M&A