Policy Changes And Subsidy Losses Will Cripple Biomass Generation

Key Takeaways

• Regulatory changes and waning biomass support threaten Drax's subsidy access, asset utilization, and financial flexibility across its power and pellet businesses.
  
• Shifting to zero-emission energy and sustainability skepticism erode competitiveness, increase reputational risks, and jeopardize growth-focused funding and shareholder value.
  
• Strong government backing, expanding revenue streams, and disciplined capital returns position Drax for stable cash flows, enhanced shareholder returns, and improved long-term earnings resilience.

Catalysts

Engages in renewable power generation in the United Kingdom.

• Looming regulatory and policy changes to climate frameworks increasingly risk excluding biomass from favourable treatment, threatening Drax's current and future subsidies, power purchase agreements, and eligibility for government-backed contracts. This could erode long-term revenue and put the entire GPB 100-200 million EBITDA from Drax Power Station's post-2027 CfD at risk.
  
• Accelerating global shifts toward true zero-emission energy sources, such as wind, solar, and advanced battery storage, are expected to diminish the strategic relevance and competitiveness of biomass generation, potentially resulting in reduced capacity market prices and lower utilization of Drax's assets, directly impacting future net margins and earnings.
  
• Persistent skepticism over the sustainability profile of biomass within the investment community and among consumers is likely to intensify scrutiny of Drax's green claims, posing a sustained threat to its reputation and reducing access to sustainable finance and attractive funding rates, thereby diminishing financial flexibility for growth initiatives.
  
• With the expiration of key subsidy schemes post-2027 and a structural oversupply of global pellets predicted as European generators phase out demand, Drax's pellet production business faces declining pricing power and potential asset write-downs, amplifying risks for group-level cash flow and overall EBITDA delivery.
  
• Large-scale capital commitments required for BECCS and next-generation carbon removal projects expose Drax to substantial technology, permitting, and regulatory risks. Persistent delays, policy uncertainty, or cost overruns could lead to asset impairments and lower than projected returns, jeopardizing the company's targeted GPB 600-700 million EBITDA and challenging future shareholder distributions.

Drax Group Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Drax Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Drax Group's revenue will decrease by 11.7% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 7.2% today to 3.8% in 3 years time.
• The bearish analysts expect earnings to reach £148.0 million (and earnings per share of £0.52) by about August 2028, down from £407.7 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 15.2x on those 2028 earnings, up from 5.9x today. This future PE is greater than the current PE for the GB Renewable Energy industry at 6.6x.
• Analysts expect the number of shares outstanding to decline by 6.55% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.45%, as per the Simply Wall St company report.

Drax Group Future Earnings Per Share Growth

Risks

• Drax has strong, long-term government support, including progress on a multi-year low-carbon dispatchable CfD contract through 2031, which will underpin predictable cash flows and earnings stability, directly supporting both revenue and net margins.
  
• The company is aggressively returning capital to shareholders through share buybacks extending the program by £450 million and is growing its dividend by 11.5 percent for 2025, both underpinned by robust free cash flow, which typically puts upward pressure on share price and supports total shareholder returns.
  
• Future opportunities for new revenue streams are emerging, notably in carbon removals (BECCS), sustainable aviation fuels, data centers leveraging excess grid capacity, and system support services, broadening the addressable market and potentially improving long-term earnings.
  
• Drax is adapting to energy transition trends by investing in flexible generation, battery storage, and system support services, positioning itself to benefit from power system volatility and the rising need for flexible solutions as renewables penetration increases, thereby improving revenue diversity and risk mitigation.
  
• The company maintains a low net debt to EBITDA ratio of 1.1x, with strong liquidity, a well-hedged power sales book through 2027, and substantial capacity market agreements extending to 2042, all of which de-risk cash flows, protect net margins, and provide a solid foundation for future earnings growth.

Valuation

• The assumed bearish price target for Drax Group is £6.2, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Drax Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £10.0, and the most bearish reporting a price target of just £6.2.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be £3.9 billion, earnings will come to £148.0 million, and it would be trading on a PE ratio of 15.2x, assuming you use a discount rate of 8.5%.
  
• Given the current share price of £6.85, the bearish analyst price target of £6.2 is 10.5% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.