SIF Folio April review: Drax is a double bagger + Airtel Africa

It’s the final week of April, so it’s time for my monthly portfolio review. The markets have been fairly quiet over the last few weeks, and this has been reflected in the portfolio’s performance.

Despite this, I’ve been able to add a new stock to the portfolio that I’ve coveted for a long time. I’m also pleased to be celebrating another portfolio double bagger, power group Drax.

SIF trades in April

After a busy March, my SIF buying screen has not provided many new ideas in April. I’ve added just one new stock to SIF, soft drinks group A G Barr (LON:BAG) - the owner of Irn-Bru. You can read my buy report here.

I also reviewed FTSE 100 defence group BAE Systems earlier in the month, but decided not to buy the shares. Find out why here.

Portfolio stocks under review

All stocks in the SIF folio have a default holding period of nine months, after which they’re reviewed to see if they still pass my screening tests.

You can see the criteria I use to decide whether to keep holding a stock here. They’re a little different to the rules I use for buying shares. In brief, if a stock passes these tests, it stays in the portfolio.

This month the portfolio’s top two performers are up for review. Both have delivered gains over more than 90% since they joined the portfolio:

• Drax (LON:DRX) - the former coal power group has made a successful switch to biomass, aided by vast government subsidies. Drax has been a double bagger for SIF, but should I keep holding?
• Airtel Africa (LON:AAF) - I remain excited about the medium-term growth potential for mobile telecoms and banking in Africa. Airtel shares still look affordable to me, but I’m concerned momentum may be slowing.

I’ll look at each of these stocks in more detail in a moment. First, here’s a quick review of the portfolio’s performance in April.

April performance update

So far in April, SIF has lagged slightly behind its FTSE All-Share benchmark.

This continues the trend we’ve seen so far this year. After a strong 2021, progress has slowed somewhat in 2022. I think this is largely because the index has been buoyed by gains for miners and oil stocks – sectors where SIF has limited exposure.

SIF’s cash weighting remains high, in part because the portfolio is below its target of 20 holdings. (I discussed my position sizing rules here.)

Finally, here’s a snapshot of all the SIF folio holdings before any transactions that may result from this review.

You can see what’s changed since last month by looking back at March’s review.

Drax (LON:DRX)

(Buy report: 20 July 2021)

Drax was formerly Western Europe’s largest coal-fired power station. Today, its coal units have been converted to burn wood pellets that are mostly imported from North America. CEO Will Gardiner describes the company as “the UK’s largest producer of renewable energy” and “one of the lowest carbon intensity power generators in Europe”.

However, there’s an ongoing debate among scientists and environmentalists as to whether burning forest biomass can really be carbon neutral. I think it’s fair to say that there’s a material risk that the current subsidy regime won’t be extended beyond its 2027 deadline.

I mention this because Drax received £893m of UK government subsidies in 2021. Interestingly, the company’s gross profit for the same period was almost identical, at £891m.

This seems to suggest that the group’s revenue was only enough to cover the cost of the fuel it burned. All of the remainder of Drax’s outgoings – including overheads and dividends – appear to have been funded by subsidies.

Any change in the current subsidy regime could clearly have serious implications. Visibility for the next few years is good. But the company admits that on a medium-term view, “there is limited certainty around the Group’s markets and regulatory regimes”.

Strong trading: The Drax share price has doubled since it joined the SIF folio in July 2021. But the company’s 2021 results presented a rather mixed picture, with adjusted earnings down 10% to 26.5p per share. Net debt rose by 35% to £1,044m, largely due to the acquisition of US pellet producer Pinnacle Renewable Energy.

However, the outlook for the next two years appears to be much stronger. Broker forecasts show adjusted earnings rising by 140% to 64p per share this year. Debt is expected to fall.

Further strong growth is forecast for 2023, but analysts are cautious on valuation – the target price is broadly in line with the share price today.

Naturally, earnings estimates have been moving higher as energy prices have risen over the last 12 months.

Despite the stock’s strong share price performance, strong earnings growth forecasts mean that the shares still don’t look too expensive to me:

One caveat is that earnings visibility beyond 2027 is currently nil, in my view. So I’d expect the stock to be on a value multiple.

My decision: I’m not a big fan of this business. But despite my concerns, Drax passes all of my screening tests comfortably. This means that the shares will remain in SIF for at least one more month.

Drax is due to publish a trading update later this week, so I’ll be interested to see if there’s any update on the impact of commodity market volatility and high energy prices.

Verdict: Hold

Total return to date: +101%

Airtel Africa (LON:AAF)

(Buy report: 8 June 2021)

I reviewed the latest results from mobile operator Airtel Africa at the end of March, when the stock qualified for a further month in the portfolio.

During April, the only news of note from the company was a warning that revenue in Nigeria, Airtel’s largest market, might be hit by government rules requiring all mobile SIMs to be registered with the users national ID number.

This looked potentially serious at first, but a subsequent update suggests to me that the eventual impact is likely to be quite small.

On 5 April, Airtel said that 79% of its Nigerian revenue now came from customers who had registered their SIMs. Nigeria accounts for around 35% of group revenue, so I estimated that 8% of group revenue could potentially be lost as a result of the restrictions.

However, Airtel posted a further update on 7 April advising that revenue from unregistered SIMs had now fallen to around 3% of group revenue. Presumably there was a last minute rush to register.

I don’t think this is a serious concern, but broker estimates have been tweaked down slightly over the last month. So perhaps there will be a small hit to earnings:

Airtel Africa is due to publish full-year results in May. I’m looking forward to this as it will give my screen a fresh set of financial data to work with. I’ll revisit Airtel at the end of May to see if the company still qualifies for SIF based on this new data.

My decision: For now, Airtel Africa still passes all of my screening tests. The shares will remain in SIF for at least one more month.

Verdict: Hold

Total return to date: +91%

As always, please let me know what you think about Drax and Airtel Africa in the comments below.

Next week I’ll be reviewing the SIF portfolio’s performance in its sixth year since inception in April 2016. I’m looking forward to reviewing the numbers and seeing what’s changed over the last year, which has been a pretty mixed period for UK equity markets.

Disclosure: At the time of publication, Roland owned all the shares listed in the SIF portfolio.