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

DBRS Ratings Limited (Morningstar DBRS) confirmed Drax Group Holdings Limited's (DGH or the Issuer) Long-Term Issuer Rating and Short-Term Issuer Rating at BBB (low) and R-2 (low), respectively. Both trends remain Stable. The Issuer is the sole, direct, wholly owned subsidiary of Drax Group plc (Drax or the Company), the ultimate parent. DGH also owns 100% of Drax Corporate Limited, which holds a portfolio of power generation assets in the UK, as well as the Company's energy solutions and pellet production businesses.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations reflect Drax's continued strong performance in 2024 and solid financial position, supported by a high level of power generation and system support activity, as well as increased earnings in its pellet production segment (including earnings generated in its own use). Morningstar DBRS-adjusted EBITDA was GBP 1,092 million in 2024, up from GBP 1,042 million in 2023. Key credit metrics remained very strong in 2024, including a cash flow-to-net debt ratio of 54% (2023: 45%), and benefitted from a favourable refinancing and debt repayment exercise during the year.

The credit ratings also consider the head of terms agreed with the UK government to extend Drax Power Station's Contract for Difference (CfD) scheme for the period of April 2027 to March 2031. Subject to the required Parliamentary procedures, the mechanism would replace Drax Power Station's existing CfD arrangement and Renewable Obligation Certificates (ROCs), which will both lapse in 2027. Under the proposed CfD to 2031, the cap on subsidised generation would be approximately 6 Terawatt hours (TWh) per annum (p.a.) (with a floor of 5 TWh p.a.). For comparison, in 2024, Drax Power Station produced 14.6 TWh of electricity (including merchant generation). Under the new CfD, Drax would continue to be permitted to generate power on a merchant basis above the subsidised cap.

Over the medium term, Morningstar DBRS expects Drax's earnings and leverage to trend negatively compared with the strong metrics in 2024. Nevertheless, Drax's financial policy, which prioritises balance sheet strength and disciplined investments in its core business, provides flexibility for Drax to maintain its leverage in the Company's target range and supports the Stable trends on the credit ratings.

CREDIT RATING DRIVERS
Morningstar DBRS is unlikely to take a positive credit rating action in the near-to-medium term, as this would require a higher degree of confidence regarding the long-term strategy for Drax Power Station post-2030 along with Drax's key credit metrics exceeding Morningstar DBRS' forecast expectations, such as a cash flow-to-net debt ratio significantly above 35% on a sustainable basis. Morningstar DBRS could take a negative credit rating action if Drax's operating performance lags the Morningstar DBRS forecast and/or the Company undertakes financial policy decisions inconsistent with expectations, resulting in weaker-than-expected financial metrics, including if its cash flow-to-net debt ratio trends negatively toward 25% on a persistent basis.

EARNINGS OUTLOOK
For the forecast period to 2027, based on expectations of lower energy realisations and reduced biomass generation under the new CfD, Morningstar DBRS expects the Company's EBITDA to decrease about 20% to 25% p.a. and to decline towards GBP 540 million by the end of 2027. The Morningstar DBRS forecast takes a conservative view on future third-party pellet production earnings, as profit growth in this segment remains subject to the execution of new contracts and commodity prices.

FINANCIAL OUTLOOK
Morningstar DBRS forecasts favourable cash conversion impacts in 2025 because of tax allowances associated with the Company's new Open Cycle Gas Turbines (OCGTs) expected to start operations this year. Morningstar DBRS expects cash flow from operations (before working capital) to remain relatively stable to 2024 levels in 2025 at around GBP 700 million and to subsequently decrease in line with forecast earnings. Nevertheless, Morningstar DBRS forecasts that operating cash flows will remain sufficient to fund cash capital expenditures (capex) and dividends commensurate with the Company's guidance, resulting in positive free cash flow (after capex, dividends, and working capital). Morningstar DBRS expects Drax to employ free cash flow in line with the Company's capital allocation policy. In 2027, following the roll-off of final ROCs, the Company is expected to benefit from a significant working capital inflow, which will support its financial flexibility in the period of transition away from its current subsidy agreements.

Drax commenced a GBP 300 million share buyback programme in 2024, of which GBP 150 million has been completed as of February 2025; Morningstar DBRS assumes the programme will be completed in early 2026. On 25 March 2025, the Company announced an agreement to acquire Harmony Energy Income Trust Plc, which holds a portfolio of eight two-hour duration battery energy storage system projects totalling 395.4 megawatts, for consideration of GBP 200 million to be funded from Drax's cash reserves. Drax would also assume the target's GBP 130 million seven-year debt facility as part of the transaction.

With consideration of an expected declining trend in Drax's earnings and cash flows in the period to 2027, as well as the Company's shareholder-friendly initiatives and its capacity to complete bolt-on acquisitions within its financial policies, Morningstar DBRS expects that Drax's credit metrics will weaken from the very strong metrics as of 2024. Notwithstanding, Drax's key credits metrics are forecast to remain supportive of the credit ratings including a cash flow-to-net debt ratio greater than or broadly equal to 30%, an EBITDA-to-interest ratio of at least 5x, and a net debt-to-capital ratio in the approximately range of 30% to 40%.

CREDIT RATING RATIONALE
The credit ratings are supported by Drax's portfolio of dispatchable power generating assets, which are backed by contractual arrangements and hedging programmes and enable high visibility on future earnings. The Company's largest asset, Drax Power Station, has a biomass capacity of 2.6 gigawatts (GW) and is the UK's largest power station and source of renewable power. The Company reports that its generation accounted for about 5% of UK power and 10% of UK renewables in 2024. Drax Power Station's remuneration remains supported by the current CfD arrangement and ROCs to April 2027. Drax also has a growing portfolio in its flexible generation and energy solutions business, which includes pumped storage, hydro, and OCGT assets with a combined capacity of about 1.4 GW supported by capacity and system support agreements. Morningstar DBRS believes Drax will continue to invest in growing its flexible generation business via development and bolt-on acquisition opportunities.

The Company continues to evaluate options for Drax Power Station post-2030 including a potential on-site data centre and/or bioenergy with carbon capture and storage; however, such investments remain subject to various factors including commercial and regulatory/political considerations. The long-term uncertainty for this key asset remains a constraint on the credit ratings.

The credit ratings also consider the relatively high cost of fuel associated with sustainable biomass power generation assets, which renders Drax less cost-competitive on power generated outside of its current contractual arrangements and limits its merchanting opportunities. Further, Drax's pellet production and trading activities could expose it to demand and market risks, especially considering the Company's ambition to grow third-party sales into emerging markets such as sustainable aviation fuel. However, Morningstar DBRS remains satisfied that Drax's pellet production earnings remain weighted to self-supply and that future expansion of its production capacity would be commensurate with confirmed demand.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG considerations had a relevant effect on the credit analysis.

Environmental (E) Factors
The following E factor had a relevant effect on the credit analysis:

The carbon and greenhouse gas (GHG) costs factor had a relevant effect on the Issuer's credit ratings. The UK's plans to achieve net zero by 2050 as well as public scrutiny on the classification of biomass as renewable energy in the UK could result in regulatory pressure for the Company to reduce its GHG emissions, which may result in additional costs to invest in and develop new technology. If there were to be a reclassification of biomass as a nonrenewable energy source in the UK, this could result in reputational risks and further reduced demand for the Company's biomass generation. The head of terms agreed with the UK government for Drax Power Station for the period of April 2027 to March 2031 is expected to reduce Drax's biomass generation earnings over the medium term compared with 2024 levels. The new head of terms also tightens the proportion of biomass that must come from sustainable sources to 100% from 70%; Drax has noted that its supply chain already satisfies this requirement and will not require an operational change to comply.

There were no Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024), https://dbrs.morningstar.com/research/437781.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
A) Weighting of BRA Factors
In the analysis of DGH, the BRA factors were considered in the order of importance contemplated in the methodology.

B) Weighting of FRA Factors
In the analysis of DGH, the FRA factors were considered in the order of importance contemplated in the methodology.

C) Weighting of the BRA and the FRA
In the analysis of DGH, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Regulated Utility and Independent Power Producer Industries (25 November 2024), https://dbrs.morningstar.com/research/443429.

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (3 February 2025; https://dbrs.morningstar.com/research/447186), which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies have also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024), https://dbrs.morningstar.com/research/437781.
-- Morningstar DBRS Global Corporate Criteria (3 February 2025), https://dbrs.morningstar.com/research/447186.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

The primary sources of information used for these credit ratings include Drax's 2024 results announcement and presentation, the Company's public announcements, as well as information obtained in a meeting between Drax and Morningstar DBRS, and subsequent exchanges between Drax's management and Morningstar DBRS. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

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

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/451395/.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Chloe Blais, Vice President
Credit Rating Committee Chair: Anke Rindermann, Managing Director
Initial Credit Rating Date: 25 February 2020
Last Credit Rating Date: 2 April 2024

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com or contact us at info@dbrsmorningstar.com.

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