DBRS Morningstar Assigns a BBB Issuer Rating to Drax Corporate Limited, with a Stable Trend

DBRS Ratings Limited (DBRS Morningstar) assigned an Issuer Rating of BBB, with a Stable trend to Drax Corporate Limited (Drax or the Issuer). The Issuer is a wholly owned subsidiary of Drax Group plc (Drax Group), a holding company with a diverse portfolio of power generation assets in the UK. The rating is supported by Drax’s (1) significant portion of contracted generation (over 85% of its gross margins), primarily under Renewable Obligation Certificates (ROCs) and Contracts for Difference (CfD), providing stable predictable cash flows until 2027; (2) large size and diversification in both fuel mix and within the UK market; (3) limited exposure to commodity price risk; (4) supportive regulatory regime in the UK for renewable generation assets; and (5) solid credit metrics for the assigned rating. DBRS Morningstar’s BBB rating also incorporates the following risks: (1) the relatively high cost of fuel associated with sustainable biomass power generation assets making it less cost competitive post 2027, (2) the limited opportunity to renew the contracts under ROCs or CfD post 2027, and (3) the continuing competition in the UK from smaller energy suppliers and bad debt management in its business-to-business (B2B) energy retail business. The Stable trend reflects DBRS Morningstar’s expectation that the Issuer’s credit metrics will remain resilient over the medium term.

Drax benefits from its significant size and scale following the acquisition of Scottish Power’s generating assets, which consisted of two hydro schemes, a pumped storage plant in Scotland, and four gas power stations (mainly combined cycle gas turbines) in England from Iberdrola S.A in December 2018 (the Acquisition). Currently, Drax is the third-largest power producer in the UK and an important power market participant in the UK, owning approximately 6.5 gigawatts (GW) of capacity, which contributed 7% of the UK’s generating electricity in 2018. Drax operates in three primary activities including power generation and system services, biomass production, and retail B2B energy supply. Drax has also successfully transformed its business profile to a low carbon generator by converting a large portion of their coal generation to biomass to help achieve the UK’s net zero target by 2050.

Drax’s 2018 EBITDA increased over 16.5% from 2017 as a result of higher biomass generation and growth in its Pellet Production business. Moreover, EBITDA in 2017 was impacted by unplanned outages at the Biomass facilities. The LTM 30 June 2019 EBITDA included contributions from Scottish Power assets but did not include capacity market payments deferred by the government because of the capacity market’s temporary suspension (which was reinstated in October 2019 and per company sources, payments fully recovered in January 2020). Total debt at 30 June 2019 was also markedly higher (almost double the debt level at FYE2018) as a result of the Acquisition, which was principally funded by debt. That said, the financial ratios continue to be well within the assigned rating category, and DBRS Morningstar believes that with the recognising of the income in relation to the capacity market payments previously deferred, Drax’s full-year 2019 credit metrics should improve.

DBRS Morningstar expects the company’s overall credit risk profile and its key credit metrics for LTM 30 June 2019 (cash flow to net-debt of 24.2%; EBITDA-to-interest coverage of 6.7x; and net debt-to capital of 37.5%) to remain in line with the BBB rating category in the near-to-medium term. That said, if Drax’s financial metrics and/or its credit risk profile deteriorates beyond a range acceptable for the current rating including: (1) cash flow-to-net debt ratio to drop meaningfully below 20% on a sustained basis and/or (2) weaker-than-expected operating performance due to higher unplanned outages and/or pellet transportation delays, a negative rating action could result. If however Drax’s cash flow-to-net debt ratio improves materially to over 35% on a sustained basis, and/or its cost competitiveness significantly improves through a reduction in the cost of biomass generation, a positive rating action could result.

Notes:
All figures are in British pound sterling unless otherwise noted.

The principal applicable methodology is the Rating Companies in the Independent Power Producer Industry (May 2019). Other applicable methodologies include the DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2019). These can be found at: http://www.dbrs.com/about/methodologies.

The primary sources of information used for this rating include publicly available information from the rated entity’s website as well as information provided directly from Drax including (1) the corporate presentation (dated 24 September 2019); (2) performance data and email clarifications (received 18 October 2019, 4 November 2019, and 17-19 February 2020); (3) the consolidated financial model (dated 2 October 2019); (4) annual reports from 2018 and 2017; and (5) Half Year Result for Six Months Ended 30 June 2019. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is the first DBRS Morningstar rating on this company.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Rana Toukan, Vice President
Rating Committee Chair: Andrew Lin, Managing Director
Initial Rating Date: 25 February 2020
Last Rating Date: Not applicable as no last rating date.

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