The UK government has set out plans to eliminate the country’s carbon footprint within the next 30 years. But in order for the energy sector to transform itself into a carbon-neutral powerhouse, some technological innovations from renewable energy stocks are needed. At least that’s what I think.
With that in mind, I’ve spotted one renewable energy stock that I think deserves a closer look as a potential addition to my portfolio.
A renewable energy stock using biomass
While most energy companies seek to become net-zero carbon by 2050, Drax Group (LSE:DRX) is being a bit more radical. The energy generation business is aiming to become carbon negative by 2030. This means that it intends to remove more carbon dioxide from the atmosphere than it produces in less than a decade.
Whether it will achieve that goal remains to be seen. But the renewable energy stock does appear to be on track. The business can be broken down into three segments.
The first is biomass production. The firm manufactures compressed wooden pellets from sustainable working forests. These pellets are subsequently used in the second business segment – electrical power generation.
The Drax power station was originally a coal-powered plant. Today it uses its own manufactured biomass as an alternative fuel source. This switch resulted in an 80% reduction in Drax’s carbon footprint, while also making it the UK’s largest renewable power station.
The company’s final segment is a business-to-business (B2B) energy supply solution where it’s Power Haven and Opus Energy teams negotiate with other firms to supply all their power needs.
Renewable energy does carry risks
Investing in a clean energy company that consistently increases its dividends sounds interesting to me. But there are some risks to be aware of.
First, this renewable energy stock does not currently produce 100% clean energy. Of the 17.3TWh of electricity generated in 2019, only 79% was sourced from its biomass or hydro-power plants. The remaining 21% came from burning coal. And since coal-powered plants will be made illegal in 2025, that gives Drax only a few short years to eliminate it from its portfolio.
Yes, that 21% may not seem like much. But the firm is dependent on government subsidies for its biomass power production (in 2019, it received £790m). These subsidies are expected to end in 2027, but they could be ended sooner. This adds a lot of pressure to not only become 100% renewable but to make biomass power production economically viable in a relatively short space of time.
The Bottom line
As a business, Drax looks quite compelling in my eyes. But as an investment, not so much… at least not at the moment.
It has achieved a respectable 11% average annual revenue growth over the last five years. However, the problem I have is the operating profit margins. They’re incredibly tight and haven’t shown any real sign of improvement, which correlates with the firm’s dependence on government subsidies.
Until it can reduce the operating costs of generating electricity with biomass, I won’t be considering Drax for my portfolio. But I’m definitely keeping an eye on it.
