This is a good day for investors in Drax Group (LSE: DRX). Its share price soared 7.60% to 326.90p this morning, after a positive analyst note from Barclays. Long-suffering investors deserve some good news after a difficult few years. Is the stock now set to start firing on all cylinders?
FTSE 250-listed Drax, which generates 7% of the UK’s electricity, is heating up after Barclays upgraded it from equalweight to overweight, and lifted its price target to 410p from 400p. Its analysts claim the £1.31bn company’s recent weakness, which has seen it underperform the Stoxx Europe 600 utilities index by 24%, is unjustified and the future now looks notably brighter.
Barclays said the firm’s share price slump was based on “little more than disappointment that Drax didn’t immediately announce a new higher dividend policy”, saying instead that it would consult shareholders. However, the bank says this is a genuine attempt to balance priorities of growth capex and increased returns to shareholders. “We thus see no justification for the scale of Drax’s recent share price reversion, and upgrade,” it concluded.
Drax has worked hard to shift the UK’s largest power station from its dirty coal-burning origins to become a predominantly biomass-fuelled generator. Its reward: the government removed the Climate Change Levy exemption in 2015, hammering its share price. The commodity sector meltdown only made things worse.
The company’s luck may have changed as it looks set to benefit from recent Ofgem proposals to capacity payments for its remaining coal operations and open cycle gas turbine projects. Barclays reckons its acquisition of US biomass pellet plant capacity should be earnings/valuation-accretive.
It has endured double-digit drops in earnings per share (EPS) for the last four consecutive years but there are signs of a turnaround. This calendar year, EPS will rise 130%, with a further 45% growth pencilled in for 2018. That will steadily erode the company’s over-mighty valuation, currently 60 times earnings. That will fall to 29.6 times by the end of this year, and a more sensible 18.3 times in 2018. Drax is back.
The news on BP (LSE: BP) isn’t as good. The stock is down more than 9% over the last three months, as the oil price rally runs out of steam. I was always sceptical about the rally, predicting that US shale would wipe out the benefit of the OPEC and non-OPEC production freeze, and that is exactly what has happened, as inventories remain sky-high. At time of writing WTI oil trades at just below $50 a barrel.
That could change, with new figures from the International Energy Agency showing the volume of new oil discoveries hit a record low in 2016, following severe cuts to exploration budgets caused by plummeting oil prices.
However, BP has positioned itself for cheap oil with rigorous cost-cutting, while EPS are forecast to rise 5,579% this calendar year to 27.05p, then another 28% to 34.59p in 2018. It’s precious 7% dividend yield looks safe, at least for the next year or two. This is rather more generous than Drax’s 0.7 yield of just 0.78%, making no contest for income seekers. However, if you are after growth, Drax might just have the power.
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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended BP. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.