Shares in the UK’s biggest coal-fired power station, Drax (LSE: DRX), tumbled by 13% last week. They had been quite popular up until then.
Investors seemed to like the company’s plans to convert three of its six power generating units from burning coal to biomass products, such as wood pellets. With lots of old coal power stations closing soon, Drax is well placed to make more money as Britain’s generating capacity becomes scarcer.
It was assumed that these three units would all qualify for a subsidy that would guarantee them a selling price of £105 per megawatt hour under an agreement known as a contract for difference (CFD).
CFDs work by topping up the amount of money received by Drax if the market price of electricity was less than £105 and Drax repaying money if the price was more than £105, effectively underwriting the value of its proposed biomass investment.
But the government said last week that one of the units didn’t qualify for the CFD subsidy, so Drax’s shares have lost some of their popularity.
Despite the sharp fall, however, Drax shares do not look cheap, trading on over twenty times this year’s earnings. Profits may still go up a lot, which will mean bigger dividends, but this still looks priced in to the shares. Now is not the time to jump on board.