1 UK renewable energy stock I’d buy and another I’d avoid

Renewable energy stocks are gaining in popularity, but not all of them will be winners. Zaven Boyrazian investigates two opportunities.

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As the world slowly shifts away from its dependence on fossil fuels, renewable energy stocks are receiving increased interest from investors. There are countless businesses operating within this space. And in the end, not all of them are going to be winners.

But let’s take a look at one company I think will thrive and another whose fate is still unknown.

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Wind power growth

In 2020, the UK government unveiled its Green Industrial Revolution. As part of this plan, an additional 40GW of offshore wind farms will be constructed. If successful, that’s enough to power roughly 12 million homes, or half of all households in the country.

This government tailwind is terrific news for renewable energy stock Greencoat UK Wind (LSE:UKW). This business has an expanding portfolio of on- and offshore wind farms that generate the bottom line. With increased investment into the space, management could easily find new opportunities to expand and deliver value as well as dividends to shareholders over the long term.

Like all investments, Greencoat has its risks. Most notably is the lack of pricing power. As energy prices are regulated, the company has next-to-no control over how much it can charge for its green energy. Suppose price caps are dropped again in the future. In that case, profit margins will likely get squeezed as operations have a largely fixed cost.

Personally, I feel this is a risk worth taking. While watching profitability get squeezed is unpleasant, the group currently has an operating margin of 87%. At this level, I think the company can withstand a fair amount of pressure. Therefore, I’m tempted to add this UK renewable energy stock to my portfolio.

A renewable energy stock I’d avoid today

The rise of green energy isn’t limited to just electricity generation. AFC Energy (LSE:AFC) is an expert in alkaline fuel cell technology that can be used to power buildings as well as vehicles. There are other companies like it. However, what gives this group the competitive edge is its patented technology to use lower-purity hydrogen fuel without any loss of efficiency.

That certainly sounds promising to me. So why am I avoiding it? While the technology may be proven, the same cannot be said for the business.

As it stands, AFC Energy doesn’t have any meaningful revenue. In December 2021, management announced the group had secured £4.5m worth of commercial agreements. This is undoubtedly a step in the right direction. However, compared to its £262m market capitalisation, the renewable energy stock seems to be disconnected from its fundamentals, in my opinion.

Needless to say, when a valuation is driven by expectation, it can open the door to a lot of volatility. And that’s not something I’m interested in adding to my portfolio today. Therefore, I’ll be keeping this renewable energy stock on my watchlist for now.

But there are several other renewable energy stocks that could be even more promising than both of these...

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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Greencoat UK Wind. 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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