Sharply rising coal price may undermine Drax

Drax

Our view: Hold for now

Share price: 739p (+2.5p)

If the price a company can get for what it produces increases faster than the price of its costs, it makes money. That simple equation has helped the coal power station operator Drax in recent months: the price of coal has surged, but not as quickly as the price it gets for its power.

The company reckons its future is bright, and said in yesterday's trading update that full-year earnings will be ahead of analyst consensus, which the group says is about £400m. What is more, despite the price of coal continuing to rise, the group has managed to lock in the margin it currently generates, by signing plenty of forward sales contracts.

This, the chief executive Dorothy Thompson says, is largely responsible for the stellar performance of the stock in the last six months: the shares have shot upwards from the 486.75p towards the end of January.

The analysts are split on whether now is the time to buy. Merrill Lynch reckons that Drax is the best UK stock to be exposed to "the energy price macro," adding that earnings will have increased 25 per cent by 2010 and that the stock will reach 1000p in the next 12 months. Accordingly, Merrill Lynch has upgraded its recommendation from "hold" to "buy". However, the watchers caveat their predictions by saying: "Drax's valuation remains very sensitive to assumptions surrounding volatile commodity prices, especially given its price-taker business model."

Ms Thompson says that in the last two weeks, coal prices are up sharply, and that the group is unable to pass on these higher costs.

UBS says it is concerned that forward sales may disappoint, and despite earnings showing strong growth, the experts advise clients to sell.

The company says it has a policy of returning excess cash to shareholders, and expects the pot to be worth £100m this year, down from £165m 12 months ago.

Commodity prices are very volatile, and while investors have done well out of Drax in the last year, increasing coal costs have the potential to be damaging. Buyers should be cautious for the time being. Hold for now.

Carillion

Our view: Buy

Share price: 332.75p (+13p)

As the credit crunch bites, outsourcing companies become increasingly attractive. As businesses start to feel the pinch, they try to save costs by letting others take on non-core activities, so the theory goes.

Judging by Carillion's trading statement yesterday, the theory seems to be sound. The company reckons that it will achieve double-digit earnings per share in the first half-year, compared with the same period last year. The group's order book stands at £20bn, compared with £15.8bn last year, with the stock closing up 4 per cent last night.

Most know Carillion as a construction company, but that division now contributes just 10 per cent of UK profits. Yes, the group has a hearty construction division in the Middle East, but that region is booming,and anyway, Carillion does not tender competitively, rather it negotiates its own contracts.

The company is very confident. A spokesman identifies few risks. A full-blown recession may hit construction next year, but that division is a small part of what the company does. World War Three is also a risk, suggests the spokesman, implying there is little to worry about.

The experts like the group, too. Those at Panmure Gordon reckon that the integration of McAlpine, which it bought in February, will help to save costs, and that the group should achieve a share price of 410p within the year. The analysts argue that trading at 9.9 times estimated 2008 earnings, the group looks cheap to rivals such as Balfour Beatty and Interserve. They add that the broader support services sector trades on a forward price earnings ratio of 13 times.

Although of course it can never be ruled entirely, World War Three does not look likely any time soon. As such, investors would be wise to buy Carillion. The sector is one of the safest around, and the opportunity to buy a company that presently trades at a discount to its peers should not be readily passed up. Buy.

Clapham House Group

Our view: Buy

Share price: 109p (+5.5p)

With the UK economy seemingly heading south at a rate of knots, investors would be forgiven for assuming that something as consumer-led as restaurants are to be avoid at all costs.

Not so, says Clapham House, which owns a number of eatery chains, including Gourmet Burger Kitchen and Tootsies. The group yesterday posted a 30 per cent rise in profits, and while the number of new outlet openings has slowed, the group expects to add as many as 18 restaurants this year.

The company did sound a warning that the economic outlook is somewhat uncertain, but the analysts largely brushed this off. Those at Numis say that the stock will reach 123p and that buyers should form a queue to buy.

The chief executive,Paul Campbell, says that Clapham House is founded on venture capital lines,the implication being that it would listen to bids forits constituent parts. The UK economy is certainly going to be rocky regardless of what investors buy. The fact that offers for the group would be welcomed, presumably at a premium to the present price, should encourage buyers whoare happy to take a punt. Buy.

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