TEXT-S&P puts Drax Power 'BB+' rating on watch negative

Tue Nov 13, 2012 9:54am EST

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Overview
     -- U.K.-based power generator Drax Power Ltd. plans to convert three of 
its six generation units to biomass within five years to reduce its dependence 
on coal.
     -- Drax plans to fund part of the required capital investment of GBP650 
million-GBP700 million--the majority of which it will spend in 2012-2014--with 
about GBP200 million of term debt. We believe this will cause Drax's Standard & 
Poor's-adjusted credit metrics to weaken.
     -- We are therefore placing our 'BB+' long-term corporate credit rating 
and 'BBB-' senior secured debt rating on Drax on CreditWatch negative. 
     -- The CreditWatch placement reflects the likelihood of us lowering our 
long-term corporate credit and senior secured debt ratings by one notch if the 
debt financing closes in accordance with Drax's current plans.

Rating Action
On Nov. 13, 2012, Standard & Poor's Ratings Services placed the 'BB+' 
long-term corporate credit rating on U.K.-based power generator Drax Power 
Ltd. (Drax) on CreditWatch negative. 

At the same time, we placed on CreditWatch negative our 'BBB-' issue rating on 
Drax's senior secured credit facility. The recovery rating on this debt is 
unchanged at '2', indicating our expectation of substantial (70%-90%) recovery 
in the event of a payment default.

Rationale
The CreditWatch placement follows Drax's announcement, on Oct. 25, 2012, that 
it will fund part of the GBP650 million-GBP700 million capital investment--the 
majority of which is required over 2012-2014--to convert three of its six 
generation units to biomass with GBP190 million of equity and about GBP200
million 
of term debt. 

In our view, Drax's Standard & Poor's-adjusted credit metrics will weaken as a 
result of the debt issuance. In addition, we believe that the increase in 
financial risk as a result of the debt issuance may not be offset by a 
commensurate reduction in business risk in the near term. This is because we 
consider that biomass conversion on the scale that Drax plans entails 
significant execution risk. 

The ratings on Drax continue to reflect our assessment of the company's "weak" 
business risk profile and "intermediate" financial risk profile. The "weak" 
business risk profile reflects:
     -- Drax's inherently risky merchant business model and resulting exposure 
to wholesale electricity prices; 
     -- Its single asset base and primary focus on coal, which is subject to 
increasing regulatory and environmental constraints; 
     -- Its exposure to coal and carbon costs, and therefore the dark green 
spread (the difference between the power price and the prices of coal and 
carbon); and 
     -- Execution risk associated with the company's biomass expansion 
strategy. 

These weaknesses are partly offset by:
     -- Drax's important position in the U.K. power markets, accounting for 
about 7% of generation capacity; 
     -- Its well-maintained, efficient, and flexible power turbines; 
     -- Its good operational track record; and 
     -- Its increasing proportion of biomass-fired generation capacity, which 
will benefit from regulatory support. 

We view the U.K. government's recent confirmation of regulatory support for 
biomass conversion as a positive development that allows coal-based generators 
like Drax to diversify away from coal and increase the proportion of earnings 
from relatively profitable and stable renewables-based generation. We believe 
that, in the longer term, a decreasing dependence on coal might help 
strengthen Drax's business risk profile. In the near term, however, we 
consider that there are a range of execution risks associated with biomass 
conversion, including construction, operational, logistical, and biomass 
procurement risks. 

Drax's "intermediate" financial risk profile is supported by strong debt 
coverage ratios due to a current lack of term debt; positive, albeit volatile, 
discretionary cash flows; and strong liquidity. Drax's transition to negative 
discretionary cash flow as it moves into a period of high investment, and the 
introduction of term debt into the capital structure, will in our opinion 
weaken the company's adjusted ratios significantly, particularly in 2013. 
However, we forecast that the ratios will remain commensurate with an 
"intermediate" financial risk profile over the medium term. The recent equity 
placement, which raised GBP190 million, will support Drax's strong liquidity 
position and in our view may help cover any unexpected financial costs.

Liquidity
We assess Drax's liquidity as "strong" under our criteria, and calculate that 
liquidity sources should exceed liquidity uses by more than 1.5x to June 2013.

As of June 30, 2012, we estimate that liquidity sources include the following:
     -- Unrestricted cash and equivalents of about GBP245 million;
     -- Availability of GBP90 million under Drax's GBP100 million revolving
credit 
facility (RCF). The RCF expires in December 2013, but we anticipate that Drax 
will refinance it by the end of this year; and
     -- Funds from operations, which in the 12 months to Dec. 31, 2011, were 
about GBP245 million. 

We estimate that Drax's liquidity needs over the next 12 months will include 
the following:
     -- Capital expenditure of about GBP250 million;
     -- Borrowings under the RCF of GBP10 million; and 
     -- Dividends, which in the 12 months to Dec. 31, 2011, were about GBP124 
million.

Our view of "strong" liquidity under our criteria derives further support from 
our opinion that sources of liquidity will exceed uses even if EBITDA falls by 
more than 30%. We consider that Drax has a good standing in the capital 
markets, and that its liquidity management is prudent.

Recovery analysis
The 'BBB-' issue rating on Drax's GBP310 million senior secured credit facility 
due April 2014--including a sublimit of GBP100 million for the senior secured 
RCF--is on CreditWatch negative, in line with the CreditWatch placement on the 
corporate credit rating. The recovery rating on this credit facility is 
unchanged at '2', indicating our expectation of substantial (70%-90%) recovery 
in the event of a payment default. 

We intend to review our recovery assumptions when Drax finalizes its new debt 
structure, including the issuance of additional term debt and the refinancing 
of the existing senior credit facility. As a result of our revised analysis, 
we are likely to lower the issue rating on the new debt facilities by one 
notch, in line with any action on the corporate credit rating, and to reflect 
the higher total amount of debt.

For our existing recovery analysis, please see the recovery section of our 
full analysis on Drax, "Drax Power Ltd.," published June 29, 2012, on 
RatingsDirect on the Global Credit Portal.

CreditWatch
We aim to resolve the CreditWatch placement within 90 days. During this 
period, we will monitor the execution of Drax's funding strategy, including 
the additional debt issuance that we anticipate Drax will complete by the end 
of this year.

We are likely to lower by one notch the long-term corporate credit rating on 
Drax, and the issue rating on its senior secured debt, if the company raises 
about GBP200 million of new term debt.

Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit 
Portal, unless otherwise stated.
     -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 
2012
     -- Credit FAQ: How Electricity Market Reform Could Affect The Ratings On 
U.K. Generators, May 24, 2011 
     -- Criteria Guidelines For Recovery Ratings On Global Industrial Issuers' 
Speculative-Grade Debt, Aug. 10, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008


Ratings List
Ratings Affirmed; CreditWatch/Outlook Action
                                        To                 From
Drax Power Ltd.
 Corporate Credit Rating                BB+/Watch Neg/--   BB+/Stable/--

Drax Finance Ltd.
 Senior Secured Debt*                   BBB-/Watch Neg     BBB-
  Recovery Rating                       2                  2

*Guaranteed by Drax Power Ltd.


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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