Smart Investor: how my Drax tip fared

About a year ago, I wrote that that ‘in terms of value, financial viability and performance Drax (DRX.L) is attractive at current share price levels’. So, how has it performed since then?

Over the past 11 months, Drax’s share price has nudged up slightly from 515p to its current level of 543p, a gain of 5.4%. However, Drax has also paid two dividends since the original article: one interim dividend of 16p per share on 14 October and a final dividend of 11.8p per share on 11 May. This equates to a yield of 5.4% and, when added to the capital growth of the shares, gives a total return of 10.8%.

Over the same period, the FTSE 250 (the index in which Drax is listed) has fallen from around 11,580 points to its current level of around 10,540, a fall of 9%. However when a yield of roughly 3.5% is added to this, it equates to a total return of minus 5.5% versus Drax’s gain of 10.8%.

Buy, sell or hold?

So, Drax has outperformed the index, but does this mean that you should buy, sell or hold?

In terms of performance, Drax had an excellent 2011, with net profit increasing from £188 million in 2010 to £464 million in 2011. This equates to a superb return on equity of 35.6%, although the net profit figure includes an exceptional tax item of £197 million.

If this exceptional item is removed from the sheet, the net profit figure falls to around £267 million – still hugely impressive – and return on equity drops to 20.5%, which is still a great improvement on last year’s 19%. So, performance remained strong through 2011, with interim results for the first half of 2012 due out at the end of July.

Financial health report

In my previous article, I noted the financial strength of Drax: its debt-to-equity ratio was just 13% while interest coverage was a very healthy 12.4. Encouragingly, these figures remain impressive, with financial gearing now standing at just 0.6% and interest coverage exceptionally high at 18.8. Indeed, it appears as though Drax is financially stronger than it was 11 months ago.

As mentioned, Drax has substantially outperformed the FTSE 250 over the period, and it is reasonable to assume that this could mean shares are less attractive than they were when I wrote my previous article.

However, with a price-to-earnings (P/E) ratio of just 7.4 (using the net profit figure, which excludes the exceptional tax item) and a price-to-book ratio of only 1.5, Drax still offers excellent value for money. In fact, it appears to offer even more value than it did 11 months ago, since both of these ratios have improved over the period.

It's a buy

Of course, Drax is not perfect. As mentioned in my previous article, Drax comes with various risks such as being heavily dependent upon the prices of coal and gas, the fact that the company is based at a single site, and future government policy on C0₂ emissions.

However, in spite of these risks Drax remains an attractive investment, with the company appearing to be performing well, financially viable and, moreover, reasonably priced at current levels.