DBRS Morningstar Assigns a Long-Term Issuer Rating of BBB and a Short-Term Issuer Rating of R-2 (mid) to Drax Group Holdings Limited with Stable Trends, Discontinues Drax Corporate Limited Rating

DBRS Ratings Limited (DBRS Morningstar) assigned a long-term issuer rating of BBB and a short-term issuer rating of R-2 (mid)*, both with a Stable trend, to Drax Global Holdings Limited (Drax or the Issuer). At the same time, it discontinued its issuer rating on Drax Corporate Limited.

The Issuer is a wholly owned subsidiary of Drax Group plc (Drax Group), the ultimate parent 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 the government's Renewable Obligation Certificates (ROCs) and Contracts for Difference (CfD) schemes, 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/R-2(mid) ratings 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 ScottishPower’s generating assets, which consisted of 126 MW of hydro plants, 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 fourth-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 12% of the UK’s electricity renewable generation in 2019. Drax is involved in three primary activities: 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 its coal generation to biomass to help achieve the UK’s net zero carbon target by 2050.

Drax’s 2019 EBITDA increased 64% from 2018 as a result of the full benefit of the successful integration of the newly acquired assets, which contributed approximately GBP 114 million, as well as the result of higher biomass generation and growth in the Pellet Production business. B2B energy retail business (its customers business) saw a reduction in EBITDA because of challenging market conditions as well as a GBP 8 million restructuring cost to consolidate the retail supply entities of Haven Power to Opus Energy into one. The financial ratios continue to be well within the assigned rating category. DBRS Morningstar believes that Drax’s full-year 2019 credit metrics should improve after recognising the income in relation to the capacity market payments previously deferred (of GBP 72 million; received in January 2020).

DBRS Morningstar expects the company’s overall credit risk profile and its key credit metrics to remain in line with the BBB/R-2(mid) rating category in the near-to-medium term. That said, if Drax’s financial metrics and/or its credit risk profile deteriorate beyond a range acceptable for the current rating, including (1) its cash flow-to-net debt ratio drops meaningfully below 20% on a sustained basis and/or (2) it reports a weaker-than-expected operating performance because of 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.

*The short-term issuer rating, unlike a Commercial Paper rating, does not require DBRS Morningstar’s assessment of backup liquidity support.

ESG Considerations
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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 (9 May 2019). Other applicable methodologies include the DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (25 November 2019). These can be found at: http://www.dbrsmorningstar.com/about/methodologies.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press releases: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for these ratings 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 these ratings to be of satisfactory quality.

These are the first DBRS Morningstar ratings on Drax Global Holdings Limited.

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.

The sensitivity analysis of the relevant key rating assumptions can be found at:
https://www.dbrsmorningstar.com/research/361425

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 for Drax Corporate Limited: 25 February 2020
Last Rating Date: Not applicable as no last rating date.

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DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at [email protected].

The rating methodologies used in the analysis of this transaction are listed below:
-- Rating Companies in the Independent Power Producer Industry (9 May 2019),
https://www.dbrsmorningstar.com/research/344922/rating-companies-in-the-independent-power-producer-industry
-- DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (25 November 2019), https://www.dbrsmorningstar.com/research/353260/dbrs-morningstar-criteria-rating-corporate-holding-companies-and-parentsubsidiary-rating-relationships

Information regarding DBRS Morningstar ratings, including definitions, policies and methodologies, is available on www.dbrsmorningstar.com.

DBRS Morningstar notes that this press release was amended on 26 May 2020 to include the link to Drax sensitivity analysis of the relevant key rating assumptions.