Broker tips: Drax, Rio Tinto, Diageo

11th Sep 2015 13:49

(ShareCast News) - Drax was under the cosh after Goldman Sachs downgraded the stock to 'sell' from 'neutral' and slashed its price target to 230p from 300p.It said that as regards the outcome of the EU's deliberations on whether to permit the proposed fixed price CfD for Drax's third unit conversion to biomass, the current share price is already discounting a best case scenario.GS said it sees more than 60% downside in the stock if the CfD is rejected.It noted that Drax's share price is down 40% year-to-date, closing following the fall in UK power prices in 2014 and 2015."However, we argue that it should have underperformed UK power, as we believe the likelihood of receiving a favourable subsidy for its third unit conversion to biomass has reduced over this period."The bank attributed this to lower power prices and negative read-across from other regulatory developments.While Drax offers a free cash flow yield of more than 10% from 2018 versus a sector average of 7%, this is the result of very low capex and is not sustainable in the long term, added Goldman. Rio Tinto got a boost on Friday after UBS upgraded the stock to 'buy' from 'neutral' with an unchanged price target of 2,850p.The bank said the risk/reward scenario is improving following recent weakness in the share price, with Rio starting to show some discipline in iron ore and prices holding up surprisingly well in a seasonally weaker period.It said Rio offers the most attractive valuation of the UK diversified miners at spot, trading at 7% free cash flow yield, and 11x price-to-earnings, with a dividend yield of 6%.UBS said that if spot prices hold, the dividend looks well covered by cash and the balance sheet robust with 'net fearing' to fall to around 20%."Rio also has the highest near-term growth profile, a strong management team, and some further restructuring potential." Exane BNP Paribas has upgraded Diageo to 'outperform' from 'neutral' and lifted the price target 10% to 1,900p."In a beverage sector which we continue to feel unenthusiastic about, we believe the worst is behind Diageo," said the French bank.It noted that Diageo has performed poorly in recent years, in both an operational and share price sense. Weak consumer demand, de-stocking and poor innovation/execution were all contributory factors, Exane said.In terms of the share price performance, it pointed out that Diageo stock has underperformed the European food, beverages and tobacco sectors by 24% in the last two years, the beverage sector by 12% and the MSCI Europe by 17%.However, Exane said that although it may not be evident in the numbers, "a lot of sensible work" has been done by chief executive officer Ivan Menezes and his team.It said there has been significant management change, cash conversion and sell-out have been prioritised and route to consumer has been strengthened. The bank expects these changes to become increasingly evident in results over the next 12 to 18 months."We see a sizeable opportunity to improve all facets of working capital, and coupled with a more restraint Capex policy, we see materially improved cash conversion in the years ahead."