Drax Group: Utility midcap with opportunities and challenges aplenty

London-listed utility firm Drax Group (LON:DRX) is good at catching the attention of individual investors and money managers alike. According to government data, the group accounts for around 6% of UK power generation, and what’s not to like about a company known to have historically drawn its power from coal-fired plants, but is currently adopting rigorous low carbon targets with the incremental deployment of biomass.

In 2017, Drax had a 65% to 35% biomass to coal power generation mix and its recently appointed Chief Executive Officer Will Gardiner is committed to gradually phasing out coal in his pursuit of a greener corporate pathway. 

The group has converted four of its six coal-fired units to burning biomass wood pellets, which it often procures internally from business subsidiaries. In step with its utility sector peers, both large and small, Drax is a dividend stock with a recent yield range of 3.25% to 4.55%. Big question is - can the group keep it up?

At its most recent market update, Drax left its full-year earnings forecast unchanged after having posted a 16% drop in H1 earnings for the six months to 30 June to £102m, down from £121m for the same period in 2017. 

Much of it was down to two outages in the company’s fiscal first quarter. Right at the start of the year, a rail loading outage hit deliveries of pellets that led to lower power generation at two of the company’s biomass units. It was followed by another outage at one of its biomass units in February.

Despite challenges the company raised its interim dividend to £22.4m, or 5.6p per share, from 4.9p last year. Chief executive Will Gardiner adds: “We remain focused on safe and efficient operations and returns to shareholders and expect to declare a full year dividend of £56m for 2018." 

For many market commentators, perhaps Drax is trying too hard to keep up and remain an attractive dividend yielding stock. And admittedly, other larger utility sector stocks such as Centrica, United Utilities and Severn Trent, have higher yields. 

Yet, there is little evidence to suggest Drax is falling out of favour with investors. At the time of writing, the group had a market capitalisation of £1.52bn with a 52-week share price range of 218p to 387p. On a year-to-date basis, the share price is up by over 40% having risen from 272.20p on the first trading day of the year (2 January) to 382.20p on 24 August. 

In the wake of Drax's lukewarm H1 financials, Woodford Investment Management cut its stake the company to “less than 5%” from 9.89%. But in a matter of weeks Deutsche Bank disclosed a 6.13% stake in Drax, and Credit Suisse gave the company an "outperform" rating with 410p price target. 

While few deny that Drax faces challenges in its inexorable march towards a low carbon future, the company does offer investors some enticing opportunities.