The Motley Fool

Why I’d buy shares in this up-and-coming FTSE 250 power producer today

I used to shun Drax Group (LSE: DRX) as a single-asset risk, but the FTSE 250 electricity generator and supplier has travelled a long way since listing on the stock market in 2005. Back then, the firm just operated the Drax coal-fired power station. It’s since spent millions installing equipment to clean up the power station’s emissions and invested in technology to allow the generating units to run on compressed wood pellets (biomass) as well as coal.

Operational diversification

In 2016, the firm declared around 70% of the electricity generated came from biomass, which releases more energy for the carbon dioxide emitted compared to coal. Biomass is also classified as renewable because, after harvesting the timber, biomass providers can grow a new crop.

After making some acquisitions over the years, Drax now generates electricity, sells it to business customers, and operates a biomass production business in the Southern USA. The company also announced in 2016 it intends to build four open cycle gas turbine power stations – two in England and two in Wales – and they will begin to come online and start producing in 2021. Natural gas is the most efficient fossil fuel, which should lower carbon emissions compared to alternatives such as coal.

Today’s full-year results report underlines the company is making further progress diversifying from its core Drax asset. In December, the company signed off the acquisition of a portfolio of pumped storage, hydro and gas generation assets from Scottish Power. The directors expect “high-quality earnings” from the new assets.

A flexible producer

Chief executive Will Gardiner explained in the report the firm’s strategy is aimed at becoming a generator of flexible, low carbon and renewable electricity in the UK. The electricity grid in the UK is getting more and more of its energy from renewables such as wind and solar power. And Drax aims to be there producing too, including when the sun isn’t shining and the wind isn’t blowing. Looking forward, the directors see attractive investment options for growth because of expansion in biomass, gas, and cost-reduction projects.

Today’s figures look good. Adjusted Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) rose 9% compared to the previous year and net debt declined by 13% to £319m. The directors expressed their optimism about the firm’s future by increasing the total dividend for the year by 15%.

Earnings, cash flow and the dividend all dipped lower in the last few years, which isn’t surprising given the huge sums of money the company has been ploughing back in to improve operations and to make acquisitions. But I think a more-attractive and better-diversified operation is emerging from the process.

I find it encouraging that the dividend is rising and earnings look set to rebuild going forward. I’m tempted to hop aboard the emerging growth story with Drax and collect that expanding dividend, which is predicted to yield about 4.3% in 2019 at today’s share price close to 367p.

You Really Could Make A Million

Of course, picking the right shares and the strategy to be successful in the stock market isn't easy. But you can get ahead of the herd by reading the Motley Fool's FREE guide, "10 Steps To Making A Million In The Market".

The Motley Fool's experts show how a seven-figure-sum stock portfolio is within the reach of many ordinary investors in this straightforward step-by-step guide. Simply click here for your free copy.

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.