DBRS Morningstar Confirms Drax Group Holdings Limited’s Long-Term and Short-Term Issuer Ratings at BBB and R-2 (middle), Stable Trends

DBRS Ratings Limited (DBRS Morningstar) confirmed Drax Group Holdings Limited’s (Drax or the Issuer) Long-Term Issuer Rating and Short-Term Issuer Rating at BBB and R-2 (middle), respectively. Both trends are Stable. The Issuer is the sole, direct wholly owned subsidiary of Drax Group plc, the ultimate parent. The Issuer also owns 100% of Drax Corporate Limited, which holds a diverse portfolio of power generation assets in the UK.

The ratings are supported by Drax’s (1) significant portion of near-term contracted generation (over 85% of gross margin), primarily under the UK government's renewable obligation certificates (ROC) and contracts for difference (CFD) schemes, providing stable predictable cash flows until 2027; (2) limited exposure to commodity price risk; (3) supportive regulatory regime in the UK for renewable generation assets; (4) large size as the largest renewable energy and fifth-largest power generation company in the UK; and (5) solid credit metrics for the assigned ratings. The ratings also reflect the following risks: (1) the relatively high cost of fuel associated with sustainable biomass power generation assets, making Drax less cost competitive after 2027 when the majority of the contracts expire yet also recognising its efforts to achieve cost-reduction targets of GBP 50/megawatt hour (MWh) from GBP 75/MWh by 2027; (2) potential integration risk from Drax’s acquisition of Pinnacle Renewable Energy Inc. (Pinnacle), which is considered a relatively higher business risk; (3) the limited opportunity to renew the contracts under ROCs or CFDs after 2027, although Drax will have the ability to participate in capacity market auctions; (4) the continuing competition in the UK from smaller energy suppliers and bad debt management in the Issuer’s business-to-business (B2B) energy retail business; and (5) the operational risk originating from unplanned outages and unforeseen transportation delays. The Stable trends reflect DBRS Morningstar’s expectation that the Issuer’s credit metrics will remain resilient over the medium term.

Drax is an important power market participant in the UK with approximately 4.5 gigawatts (GW) of capacity. The Issuer is the largest renewable energy producer and fifth-largest power generator company in the UK. As of 2020, Drax was the largest source of renewable electricity by output in the UK, providing 11% from its biomass and hydro generation assets. The Issuer is involved in three primary activities: power generation and system support services, biomass production, and retail B2B energy supply. Since 2012, Drax has transformed its business profile to a low-carbon generator, reducing carbon emissions by over 85% with its long-term investment in sustainable biomass. In February 2020, the Issuer announced an end to commercial coal generation effective in March 2021 in line with the UK’s 2050 net zero carbon targets. Additionally, Drax announced that it will not develop any new combined-cycle gas power stations, but will maintain options to develop flexible, small open-cycle gas (OCGT) assets to meet peak demand and provide system support services. Drax is evaluating possible options for all four OCGT plants subject to its decarbonisation plans, including their potential sale. In January 2021, Drax completed the sale of its combined cycle gas turbine assets consisting of four power stations with a capacity of approximately 2 GW, which Drax acquired from Iberdrola in 2018 for GBP 193.3 million. Following this sale, Drax announced its acquisition of Pinnacle, a Canadian producer and supplier of sustainable biomass. The acquisition is part of Drax’s strategy to increase its biomass production capacity and self-supply to significantly reduce its cost of biomass.

Drax’s 2020 financial results confirmed strong operating performance, driven by its generation and pellet production businesses. EBITDA in 2020 remained in line with the previous year, even after factoring in the impact of the Coronavirus Disease (COVID-19), which included an estimated GBP 60 million loss primarily from its retail business. EBITDA from continued and discontinued operations was approximately GBP 412 million in 2020 versus GBP 410 million in 2019. After adjusting for realised losses on derivatives, the DBRS Morningstar-adjusted EBITDA for 2020 was GBP 377 million versus GBP 356 million in 2019.

DBRS Morningstar expects the Issuer’s overall credit risk profile and its key credit metrics to deteriorate slightly in the near term because of the disposal of the gas generation assets as well as the increase in overall debt of the combined group following the Pinnacle acquisition, however, this is expected to be repaid in the near term. As such, DBRS Morningstar expects Drax’s credit metrics to improve starting in 2022 and onward. That said, if Drax’s financial metrics and/or its credit risk profile deteriorates beyond a range acceptable for the current ratings, 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, DBRS Morningstar may take a negative rating action. Although not likely, if Drax’s cash flow-to-net debt ratio improves materially to over 35% on a sustained basis and/or its cost competitiveness significantly improves, DBRS Morningstar could take a positive rating action.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is Rating Companies in the Independent Power Producer Industry (19 May 2020), https://www.dbrsmorningstar.com/research/361185/rating-companies-in-the-independent-power-producer-industry, which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include DBRS Morningstar Criteria: Guarantees and Other Forms of Support (14 January 2021), https://www.dbrsmorningstar.com/research/372344/dbrs-morningstar-criteria-guarantees-and-other-forms-of-support, and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021), https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

The primary sources of information used for these ratings include publicly available information from the Issuer’s website as well as information provided by Drax, including (1) the corporate presentation (dated 26 March 2021); (2) consolidated financial model (dated 6 April 2021); and (3) performance data and email clarifications (up to and including 14 April 2021). DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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 12-month period. DBRS Morningstar trends 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/378207.

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Rana Toukan, Vice President
Rating Committee Chair: Andrew Lin, Managing Director
Initial Rating Date: 30 March 2020
Last Rating Date: 30 March 2020

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-- Rating Companies in the Independent Power Producer Industry (19 May 2020), https://www.dbrsmorningstar.com/research/361185/rating-companies-in-the-independent-power-producer-industry.
-- DBRS Morningstar Criteria: Guarantees and Other Forms of Support (14 January 2021), https://www.dbrsmorningstar.com/research/372344/dbrs-morningstar-criteria-guarantees-and-other-forms-of-support.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021), https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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