Drax Group plc (LON:DRX) shares are under pressure today as Deutsche Bank reiterated a ‘hold’ rating and target price of 280p, citing uncertainty on cost savings in biomass procurement.
The company, which owns the UK’s largest power station, yesterday reported a 17% decline in 2016 underlying earnings (EBITDA) to £140mln and a 3% drop in consolidated revenue to £2.0bn.
Drax blamed challenging commodity markets and changes to climate change regulations. The new regulations mean renewable energy that includes power from biomass will no longer be exempt from the Climate Change Levy.
In an effort to offset the impact of lost income from its levy exemption certificates in biomass supply, the group said it lowered its spending on its transformation of coal-fired generators to biomass plants.
“Uncertainty around scope for biomass procurement savings is the main reason for our 'hold' rating in spite of the shares trading meaningfully above our target price,” according to Deutsche Bank, which added that the full year results were “slightly disappointing”.
The European Commission in December approved subsidies for the company’s conversion to burn wood pellets instead of coal. It followed the commission’s investigation into the UK government’s decision to award state aid to Drax in 2014 to switch the third unit of its coal power station in North Yorkshire over to biomass.
The commission was concerned that the estimates for the plant’s performance were too lavish and Drax would be overcompensated.
“With Drax having secured state aid approval for its fixed price biomass contract in December 2016, it is in a position to provide more details around its biomass procurement,” Deutsche Bank added.
“One of the hopes for the shares it that it can deliver savings against its guidance of £8 per gigajoule, and we factor in medium-term biomass purchase costs around 2.5% lower than guidance (although its costs should rise from 2021 as its currency hedges roll off).”
While Drax gave no formal update on its cost guidance, it said that the European market remains over supplied and said it has reduced its own pellet production to take advanage of this in 2016, the bank noted. Deutsche Bank believes if Drax can reduce its procurement costs further this could have a "significant benefit".
Shares in Drax fell 3.79% to 345.70p in morning trade.