In April last year, I said Draxwas a sell'. It looked expensive on 18 times expected earnings, and I thought future profits would be hit by carbon emissions allowances costs, and as it made its power station comply with regulations.A plan to convert from coal to biomass looked to be stuck in the starting gates.
But events have proved me wrong. Although profits in 2013 are set to be lower than in 2012, Drax's (LSE: DRX)prospects may have been transformed by the government, which last week agreed to let it charge a minimum of £105 per megawatt hour (more than twice the current market price) for the electricity it generates from burning biomass (mainly wood pellets).
This runs until 2021, and looks good enough to underpin its £700m investment in turning half of the power station to biomass.
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UBS reckons it makes Drax a more attractive takeover target: a bidder could justify paying more than £10 a share, or even £12 if four of the six power units are converted. Barclays Capital reckons Drax could end up paying out up to £1.5bn to shareholders in a few years' time.
Drax now trades on over 22 times next year's earnings. But analysts expect profits to almost double over the next three years. With coal-generated electricity a lot more profitable than gas generated, the medium term looks rosy. ]
It may be worth considering how long the price guarantee will last a future government could change its mind, particularly as it will mean higher electricity bills. But no one seems worried at the moment.
Verdict: hold if you own
