Citigroup upgrades Drax, says risk/reward more balanced

Citigroup upgraded Drax to ‘neutral’ from ‘sell’ as an 8% drop in the share price since the beginning of the month has left the shares trading near the bank’s unchanged 305p price target.

Citi noted that despite the recent rally in oil and gas prices, Drax shares have underperformed and it is now more fairly valued.

“We believe the current valuation now fairly reflects the risk/reward profile of the shares and therefore we upgrade,” it said.

Citi said its downgrade of the stock had been a call on inconsistency between commodity prices and Drax valuation, which in its view have played out.

“News flow relating to the European Commission approval of Drax’s third unit biomass conversion into contract-for-difference could still surprise on the downside. However, given Drax’s recent share price movement despite higher oil and gas prices, we now believe more risk is being priced in for a lower CfD.”

The bank said the maximum level the EC has indicated it will allow Drax to earn on the CfD is £100 per megawatt-hour, and it assumes £99/MWh within its forecast and valuation.

On the upside, Citi noted the UK government is currently reviewing the case for new nuclear in the UK.

“If a decision to scrap plans for new nuclear were to come, we believe the UK government could also announce plans to introduce additional incentives to build new combined cycle gas turbines or they could postpone the closure of coal to beyond 2025. Such move could support gas prices (therefore UK power prices), which could benefit Drax’s earnings and valuation in the longer term.”

At 0940 BST, Drax shares were up 0.6% to 309.40p.