Market Report: Bulls seize Drax as Footsie strikes new high

The coal-fired power station operator Drax burned brightly as the wider market swung to its highest level since mid-2008 last night.

The stock strengthened by almost 8 per cent, or 27.8p, to 383.4p after the Royal Bank of Scotland ran the numbers on the value hiding behind the weak outlook for liquefied natural gas (LNG) prices. Higher conventional gas production in the US and the weakness in the world economy has led to a surplus of LNG on world markets, driving down gas prices in the UK. This state of affairs is likely to persist in coming years and bodes ill for Drax, which is a "coal-fired generator in a gas-priced power market", RBS explained. Indeed, though the broker's full-year forecasts currently seem intact, its estimates for 2011 may come under pressure if the strength in forward gas prices persists.

But it is not all bad for Drax, which has been the subject of bid rumours in recent weeks, could be holding up to 275p per share in hidden value. On the broker estimates, the company's coal stocks alone are worth some 46p per share, while the prospective value of the carbon credits it will receive under the UK's National Allocation Plan adds another 74p for investors. Its historical tax losses yield another 64p and its trading book, "which was assembled when prices and spreads were higher than today", adds 107p on top.

Take away the debt, and that leaves investors with an extra 275p per share. "This implies that the physical assets of Drax are only being valued at £330m – around 10 per cent of replacement cost, or 75 per cent of the last three years' capital expenditure," RIBS said, initiating coverage on the stock with a "buy" view and a 560p target price.

Overall, fears of another sovereign credit crisis took a back seat after the indebted Dubai World conglomerate unveiled a restructuring plan, cheering the market by saying that it will repay 100 per cent of its borrowings. The news lifted sentiment, which in turn helped the FTSE 100 close beyond the 5,700-point mark for the first time since June 2008. The benchmark touched a session high of 5,737.65 before relaxing to 5,727.65, up 49.77 points, at the end of play, while the mid-cap FTSE 250 index rallied to its highest level since May 2008, rising by 99.59 points to 10,180.17.

The retail sector was marked up, with a positive update from Next, up 104p at 2,174p, supplementing official data showing the biggest increase in retail sales volumes since May 2008. The read-across helped Marks & Spencer rise by 6.6p to 363.1p, while Home Retail Group edged up by 3.5p to 276.8p. Kingfisher, down 2.7p at 225.8p, was left behind despite beating profit forecasts and raising its payout. Shore Capital said: "While management has announced its first increase in [the] dividend for four years, it announced a 5 per cent increase to 5.5p, which is lower than market consensus of 6.5p."

Elsewhere, the telecoms group Vodafone, down 1.7p at 147.2p, was under pressure after Morgan Stanley turned negative, saying that, unlike others in the market, it does not think that Vodafone Europe can return to growth given it has the greatest exposure to falling returns in mobile compared with other operators. While switching its view to "underweight" from "overweight", the broker explained that though it be would more positive on the stock if was trading below 130p, for now it preferred European peers KPN and Telenet. In the UK, it expressed a preference for BT, which was 1.7p higher at 125.6p.

Further afield, Goldman Sachs aided Shaftesbury, the commercial property group, which ended 6.3p higher at 380p after the broker abandoned its negative view, citing valuation grounds. "We believe that Shaftesbury's portfolio of high-quality assets in London's West End offers good long-term growth potential," Goldman said, moving the shares to "neutral" from "sell" while keeping its target price unchanged at 375p. "Offsetting this in the short term, however, is the exceptional resilience of Shaftesbury's assets in the downturn. This, we believe will mean more limited growth in the recovery phase."

The Chancellor's decision to lift the stamp duty threshold for first-time buyers continued to support housing stocks, with Barratt Developments rising by 1.1p to 129.6p despite some cautious comment from Bank of America Merrill Lynch. "Although the shift away from apartments and the drop in sales to investors are major positives we remain of the view that there is a genuine, underlying, high land-cost structure within the group, which will act as a bigger relative drag on the trajectory and pace of recovery compared with its peers," the broker said, scaling back its estimates and lowering its target for Barratt's shares to 137p from 169p.

Merrill was keener on Bellway, which was 5p firmer at 765p after the broker upped its estimates and raised its target to 1200p to reflect the recent half-yearly results. "We anticipate that sites carrying a [provision or impairment] will account for around 50 per cent of completions in the current year but this will likely fall to 35 per cent next year and just 20 per cent by 2012," Merrill said, repeating its "buy" view on the stock.