Drax Group PLC (LON:DRX) has been downgraded to a ‘hold’ from a ‘buy’ rating by Jefferies after the broker said it was unconvinced rising power prices, which have driven its share price growth, would continue.
Jefferies said it was also wary of integration risks around Drax’s recent £702mln acquisition of Scottish Power’s UK power generation assets from Iberdrola.
READ: Drax Group confirms £700mln UK power acquisition
“Drax's share price has increased by around 50% in the year to date, mainly due to rising power prices, but we are unconvinced that this will continue,” Jefferies analysts said in a note to clients.
“The recently announced acquisition should be highly EPS accretive and diversify the business. However, we also see integration risks and expect earnings of new assets to step down in 2022,” they continued, adding that they see Drax as fair value under current power market conditions.
Jefferies said the Scottish Power deal doesn't appear to be an obvious bargain compared with valuations of listed generators and transaction multiples. Drax expects the 2019 earnings of its new assets to come in at between £90mln and 110mln, but Jefferies expects earnings to fall in 2022 as capacity market revenues fall by 50%.
“Longer term, earnings of new assets could come under pressure from growing competition in the system support market. The scale of the deal could also create integration challenges,” they said.
UK winter forward power prices are up a quarter so far this year, mainly driven by higher gas and carbon prices. However, with recovering EU gas storage volumes, more normalised weather and higher LNG carrier rates, Jefferies sees some moderation in UK gas prices.
The broker added that for carbon prices, it estimates a €15-30/t range, with the mid-point broadly in-line with current forward levels, which suggests that benefits of future EU policy reforms are largely priced-in.
Shares in Drax were 2.7% down at 398.20p in mid-afternoon trade.