3 renewable energy shares on my radar

Our writer is thinking of buying renewable energy shares for his portfolio. Here he looks at three such UK stocks.

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With an increase in fossil fuel alternatives expected in coming years, I have been thinking about the sorts of investments I can make that may benefit from that trend. For example, if I can find some renewable energy shares that are exposed to growth areas like hydrogen energy, I think that could help me build up my exposure to the space.

But there is more to succeeding as an investor than simply spotting a coming trend. After all, a lot of the companies that appear first in a new business area end up spending huge sums on research and development but do not create a successful business to show for it. Later entrants are able to build on those foundations, scale up production, and make sales without the initial startup costs.

So rather than just investing in any old hydrogen energy company, I think I need to assess each one individually. As well as its business prospects, I would consider its valuation. After all, even a great business can make a lousy investment when purchased at too high a price.

AFC Energy

One of the names on my list of UK shares that could give me exposure to hydrogen power is AFC Energy (LSE: AFC).

The firm develops alkaline fuel cells that are powered by hydrogen. For now, business is small. Last year’s revenue from customer contracts came in at just under £600,000. For a company with a market capitalisation of almost £300m that is a minuscule amount. The consistently loss-making operation saw its post-tax loss balloon to £9.4m.

However, not all the news at AFC is bad. For a start, although the revenue was small it was an improvement on the past few years when the number was zero. This suggests that AFC is starting to commercialise its technology. On top of that, the company’s order pipeline is growing. For example, last month it announced that construction group Keltbray has agreed to lease a hydrogen fuel cell power generator from AFC. This could act as a proof of concept for deploying AFC’s products on building sites. If successful, that may lead to more orders in future. Indeed, AFC and Keltbray have already been considering how they might deploy other generators later this year.

AFC’s technology is attractive and it has caught the eye of customers including engineering giant ABB, which ordered a fuel cell system for a high-power electric vehicle charging system. If AFC is able to land more orders like that from well-regarded companies like ABB, not only will it be good for revenue but it could also further boost the credibility of its technology.

For now, however, such prospects remain unproven. Meanwhile, the company continues to burn cash. Although it has a sizeable cash cushion, there is the risk that extended cash burn could force AFC to boost liquidity by diluting shareholders. At its current valuation, I think it looks pricy, so will not be adding it to my portfolio.

ITM Power

Another British company vying to succeed in the hydrogen energy space is ITM Power (LSE: ITM).

It designs and produces electrolysers that produce hydrogen for use as an energy source. The company has one factory already operating in Sheffield and is planning another. It is also eyeing up the potential for an overseas factory.

The output from this manufacturing footprint needs to find a home for the company to make money. Things are looking up in that respect. In its interim results, the company reported revenue of £4.2m. That was sharply up from £0.2m in the prior year period, although that had been hurt by pandemic restrictions. In January it had a contracted backlog of 86 megawatts of capacity. That was more than triple the backlog 12 months before.

Why I am not buying these renewable energy shares

Since then there has been further good news on the sales front. For example, ITM has reported a 24 megawatt sale to a Norwegian customer. But there have been problems, too, which illustrate some of the risks in the business. Progress on another 24 megawatt contract has been delayed by supply chain constraints. Such challenges are typical in scaling up commercialisation and I would not be surprised to see more ahead.

Like with AFC, although I think the technology here is promising and there are signs of growing commercialisation, I do not see value in the company at its current market capitalisation of £2.2bn. So I will not be buying the shares for my portfolio.

Ceres Power

A third UK renewable energy share I have been considering is Ceres Power (LSE: CWR).

The company has been scaling up its commercial operations, much like AFC Energy. Last year, total revenue and other operating income jumped 44% to £31.7m. I particularly appreciate the fact that £16.6m – over half – of that sum came from licence fees. Licence fees can be a profitable way to exploit research and development, as they do not typically carry the costs and risks involved in exploiting the technology directly. Instead, a company can sit back and wait for licence fees to arrive.

But it was not just revenues that grew strongly – so did losses. The annual operating loss increased from £14.8m to £23.4m. As revenues grow, I would hope losses will shrink and then profits emerge. That may happen in future, but for now, Ceres remains heavily loss-making.

Liquidity is not a pressing concern, with the company having net cash and investments of almost a quarter of a billion pounds. But it has built that cash pile partly through diluting shareholders when issuing new shares. I see that as an ongoing risk if Ceres decides to raise more capital.

The Ceres Power share price has fallen 39% in the past year. But the company still has a market capitalisation of £1.4bn. Despite its growing sales, I see that as expensive for the loss-making business so will not be buying Ceres Power shares for my 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 assessed. Consider taking independent financial advice.

Christopher Ruane has no position in any of the shares 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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