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 (low) and R-2 (low), 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 portfolio of power generation assets in the UK.
The rating confirmation was driven by Drax’s strong operating performance in 2022, supported mainly by the generation business’ almost doubled EBITDA contribution, the increase in pellet production and, to a smaller extent, recovered profitability in the customer business. Adjusted consolidated EBITDA reached approximately GBP 731 million in 2022, an 84% increase year over year (YOY). In 2022, the full-year contribution of Pinnacle Renewable Energy Inc.’s (Pinnacle) pellet production, which Drax acquired in 2021, was included in results for the first time, thus increasing the segment’s production by approximately 26% to 3.9 million tonnes (Mt) and EBITDA by 56% to GBP 134 million YOY.
DBRS Morningstar expects the Issuer’s overall key credit metrics to remain strong in the near term, but expects its credit risk profile to weaken somewhat in the long run because of its increased exposure to the higher-risk non-generation business. DBRS Morningstar notes that the higher risk inherent in the merchant pellet production business is somewhat mitigated because, in 2022, the Issuer's pellet production business sourced and shipped 2.5 Mt of biomass to the UK for use in the operation activity of generating electricity. Furthermore, over the same period, the Issuer entered into commercial contracts to supply 2.2 Mt of sourced biomass to third parties. The self-supply proportion of pellet production will continue to be a key consideration going forward in assessing the risks posed to the Issuer’s overall credit profile. Additionally, DBRS Morningstar notes the expiry of some of Drax's contracted portfolio by 2027 with limited opportunity to renew or replace these contracts, but also notes that the favourable regulatory environment for renewable energy production in the UK should continue to support Drax’s credit profile.
The ratings are supported by (1) the significant portion of near-term contracted generation (approximately 85% of gross margins), 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) the supportive regulatory regime in the UK for renewable generation assets; (4) Drax's size as the largest renewable energy company in the UK; and (5) currently strong credit metrics for the ratings. The ratings also reflect: (1) the higher business risk associated with the increased exposure to the non-generation business, particularly pellet production; (2) the limited opportunity to renew the generation contracts under ROCs or CfDs beyond 2027, although Drax will have the ability to participate in capacity market auctions; (3) the relatively high cost of fuel associated with sustainable biomass power generation assets, making Drax less cost competitive after 2027 when the majority of its contracts expire; (4) the continuing competition in the UK from smaller energy suppliers and bad debt management in the Issuer’s customer business (although DBRS Morningstar notes that this segment has a smaller overall contribution to EBITDA and has been streamlined since the losses incurred during the Coronavirus Disease (COVID-19) pandemic); and (5) the operational risk stemming from unplanned outages and unforeseen transportation delays. The Stable trends reflect DBRS Morningstar’s expectation that the Issuer’s credit metrics will remain consistent with the ratings over the medium term.
Drax is an important power market participant in the UK with approximately 3.2 gigawatts (GW) of capacity, and contributed about 5% to the UK's electricity in 2022. The Issuer is the UK's largest renewable energy producer, providing about 11% of the UK renewable power. The Issuer is involved in three primary activities: (1) power generation and system support services, (2) pellet production, and (3) customer business. Since 2012, Drax has transformed its business to a low-carbon generator, reducing carbon emissions by over 99% with its long-term investment in sustainable biomass. In line with the UK’s 2050 net-zero carbon emissions targets, Drax ended commercial coal generation in 2021, although some units remained available to support the grid until March 2023. Additionally, in 2021, Drax sold its combined-cycle gas turbine assets with a capacity of approximately 2.0 GW and acquired Pinnacle, a Canadian producer and supplier of sustainable biomass. The acquisition is part of Drax’s strategy to increase its biomass production capacity for the purposes of self-supply.
If Drax’s financial metrics and/or its credit risk profile deteriorates beyond a range acceptable for the current ratings, including if (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 its exposure to higher-risk business reduces to predominantly self-supply, DBRS Morningstar may take a positive rating action.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
DBRS Morningstar considers the environmental risk factor to have a reasonable possibility of a credit impact on the Issuer in terms of the carbon and greenhouse gas (GHG) costs. DBRS Morningstar considers that the Issuer faces increased regulatory pressure to reduce GHG emissions in line with the UK's legislative commitment to net-zero emissions by 2050, which may result in additional costs incurred to close coal plants and/or invest in schemes to develop technology to reduce carbon dioxide emissions.
There were no Social or Governance factors that had a significant or relevant effect on the credit analysis.
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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022).
All figures are in British pounds sterling unless otherwise noted.
DBRS Morningstar applied the following principal methodology:
-- Rating Companies in the Independent Power Producer Industry (18 May 2022), https://www.dbrsmorningstar.com/research/396971/rating-companies-in-the-independent-power-producer-industry.
The following methodologies have also been applied:
-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (28 March 2023), https://www.dbrsmorningstar.com/research/411694/dbrs-morningstar-global-criteria-guarantees-and-other-forms-of-support.
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
A description of how DBRS Morningstar analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.
The primary sources of information used for this rating include Drax’s annual report, interim financial statements, trading updates, as well as a presentation from Drax to DBRS Morningstar and subsequent exchanges between Drax’s management and DBRS Morningstar. 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.
The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. For further information on DBRS Morningstar 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 rating assumptions can be found at: https://www.dbrsmorningstar.com/research/413238.
This rating is endorsed by DBRS Ratings GmbH for use in the European Union.
Lead Analyst: Amaury Baudouin, Senior Vice President
Rating Committee Chair: Victor Vallance, Managing Director
Initial Rating Date: 30 March 2020
Last Rating Date: 4 May 2022
Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at firstname.lastname@example.org.
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