Stocks to buy: this FTSE 250 energy company’s rising dividend yield is near 4.4%

I think this is a stock to buy because of its strong niche in the UK’s modern-day energy infrastructure and its high, cash-backed dividend yield.

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With the share price near 388p, FTSE 250 energy company Drax (LSE: DRX) is paying a shareholder dividend yielding around 4.4%. And there’s a record of robust cash generation supporting the shareholder payments.

The dividend has been rising since 2017. And City analysts expect a further generous single-digit increase in 2021. Meanwhile, since listing on the stock market in 2005, Drax has transformed itself into a cleaner energy company.

Why I think Drax is a stock to buy

The Drax coal-fired power station used to belch out great quantities of harmful emissions. But these days, we can forget about its business hurting the environment as much as it once did. In 2020, the company announced that coal-fired electricity generation would end in March 2021, after almost 50 years of operation.

In today’s full-year results report, chairman Philip Cox said the company’s purpose is to enable a zero-carbon, lower-cost energy future.” And now, the Drax power station is fired by sustainable biomass. And it’s all because of a remarkable and sustained policy of investment over the past few years.

Since becoming a listed company, Drax has expanded its operations and diversified beyond its single-site power station in North Yorkshire. The business even includes biomass production facilities in the US. But in January, the firm sold its gas generation portfolio, thus further reducing its carbon emissions. And on 8 February, the directors announced the proposed acquisition of Pinnacle Renewable Energy. The firm manufactures and distributes sustainable, low-cost biomass industrial wood pellets in Canada and the US.

Cox reckons Pinnacle will “position Drax as the world’s leading biomass generation and supply business.”  The company aims to become not merely a carbon-neutral business but a carbon-negative operation by 2030.  And the key to that ambition is the use of Bioenergy with Carbon Capture and Storage (BECCS) technology. The idea is to fire the boilers in power stations with biomass and capture the CO2 emissions for permanent storage (as the name suggests!)

A strong niche in the UK’s energy market

I think Drax has carved out a strong and relevant niche for itself in the UK’s modern-day energy infrastructure. Cox expects Drax to play a major role in delivering the UK’s legally binding objective to achieve net-zero carbon emissions by 2050.”

And I’m attracted to Drax as an investment proposition. Today’s figures for 2020 show a small increase in adjusted Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) from £410m in 2019 to £412m. And the directors increased the total shareholder dividend for the year by just over 7.5%, signalling their confidence in the outlook.

However, the share price has more than tripled since the lows of last spring. And the company has a fair amount of debt. As with all shares, this is not without risk. Perhaps the biggest is the possibility of a fluctuating share price ahead. Indeed, City analysts predict a decline in earnings of around 15% in the current trading year. The company continues to plough a lot of money back into the business and growth in earnings could be hard to achieve ahead. But I’m focused on the dividend and see this as a potential stock to buy and hold for the long term in a diversified portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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