Shares of utility stock Drax Group (LSE: DRX) fell by 6% after the group published its full-year results on Thursday.
I have to admit that the attractions of this company haven’t always been clear to me over the last couple of years. In this article I’ll take a closer look at last year’s figures and at the firm’s plans for diversification.
I’ll also consider an alternative utility stock, which I believe is well-positioned to provide a generous dividend yield.
Drax diversifies but profits halve
UK government policy is for coal-fired power stations to be phased out by 2025. To avoid being forced out of business, Drax has already converted three of its generating units to burn wood pellets. In 2016, 65% of power generation came from biomass fuel, up from 43% in 2015.
The firm’s financial figures were less impressive. Underlying earnings fell from £46m to just £21m, which equates to 5p per share. The group’s dividend was cut by 56% to 2.5p, giving a yield of just 0.7%.
However, cash generation was good and Drax managed to reduce net debt by 50% to just £93m, while still investing in diversification.
Drax recently paid £340m to acquire energy supplier Opus Energy. Opus will work with Drax’s existing Haven Power business to expand the group’s market share of the business energy supply sector.
Four open cycle gas turbines have also been acquired at a cost of £18.5m. Drax plans to develop four new gas plants around these turbines in order to provide rapid response power. This will be used to fill gaps in the UK’s electricity supply — for example when renewable output from wind power falls short of demand.
Is Drax a buy?
Perhaps the most important statement in Drax’s results was that 2017 earnings are expected to be in line with current market expectations.
This implies that earnings will rise to 17p per share this year. The group’s 50% payout ratio suggests that a dividend of about 8.5p per share is likely, giving a yield of about 2.4%.
I have to admit that I’m not totally convinced. But if you are attracted to the group’s increasingly diverse business, then now might be a reasonable time to consider buying.
I’d rather have a 5% yield
British Gas owner Centrica (LSE: CNA) is an obvious alternative to Drax. It makes money from energy supply, power generation and oil and gas production. Centrica’s ownership of British Gas means that it often gets bad press, but in my view the stock looks reasonably priced and quite attractive at current levels.
Centrica was forced to cut its dividend in 2014 and 2015. That’s not ideal for an income stock, but the dividend now looks much more affordable and sustainable.
Centrica shares currently trade on a P/E of 14.5 and offer a prospective yield of 5.2%. Earnings are expected to rise by 3.7% in 2017. But broker consensus forecasts have been climbing steadily over the last three months.
I suspect that if the recovery in the oil market continues during the second half of 2017, Centrica’s profits could be higher than expected this year. Even without this potential attraction, I’d rate this stock as an income buy in today’s market.
