Energy company and power station operator Drax Group (LSE: DRX) is my favourite FTSE 250 share to buy now.
I think this enterprise is perfectly positioned to navigate the current energy crisis. It could even emerge stronger on the other side, thanks to its position in the green energy market.
A company positioned for growth
2021 was a transformational year for the energy group. It reported adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) of £398m for the year ending 31 December 2021, compared to £412m in 2020.
However, these numbers do not present the whole picture. Adjusted EBITDA from continuing operations grew to £378m from £366m. It recorded pre-tax profit on continuing operations of £122m, compared to a £235m loss the year before.
The company’s numbers are a bit mixed because it is in the middle of a massive transition plan. Over the past decade, the business, which used to own the largest coal-fired power stations in the country, has been converting its units to biomass. This has come with substantial costs, but the business is making notable progress.
FTSE 250 growth
Over the past 10 years, Drax has invested over £2bn in renewable energy and has plans to invest a further £3bn this decade. On top of this, the firm has reduced emissions from power generation by over 95%. It is the UK’s largest producer of renewable power by output.
The FTSE 250 company burns biomass in its power stations, which is currently labelled as renewable and green energy. However, there is some debate around whether or not cutting trees down to turn them into pellets, which are then burned to create energy, is actually a green initiative.
Possibly the most considerable risk to the company’s future growth is the risk that regulators may decide to remove the green label from this sort of power generation. If there is a substantial change on this front, the corporation may have to invest more to move away from biomass energy generation to other power sources.
This could have a significant impact on its growth potential. It would also mean that the billions of pounds the company has spent over the past decade would be for nothing, and future spending commitments might also be wasted.
Still, for the time being, the company is a green energy champion. And the firm is doubling down on its position in the market.
Vertical integration
Drax has been investing billions to boost its supply chain of biomass pellets. Indeed, last year, it acquired Pinnacle Renewable Energy Inc for C$385m (£222m), representing an enterprise value of C$796m.
Following this deal, the group now has 17 biomass pellet plants and developments, with production capacity of about 5Mt per year. That is enough to meet virtually all of the firm’s annual consumption.
Further, the group also divested its Combined Cycle Gas Turbine (CCGT) generation assets for £186m last year.
Although the FTSE 250 power company is probably best known for its biomass generation assets, there is another reason why I think this business has fantastic potential over the next decade or so.
CCS tech
Carbon capture storage (CCS) is one of the technologies that can help the world reduce its emissions. The process essentially involves capturing carbon emitted in the process of generating power and then storing this underground.
As you might imagine, this is quite a technologically complex and expensive process. It was too costly to be a viable solution to carbon emissions until recently.
But rising power prices have changed the equation. This means it is now more economical for companies like Drax to invest in these technologies. And management is not wasting any time cracking on with new initiatives.
Last year, the group started the process for the installation of its CCS technology at its power station in North Yorkshire. Other projects are also in the works. They could start to deliver meaningful results in the next couple of years.
FTSE 250 green energy
Over the longer term, the company is looking to deliver 12m tonnes of negative emissions by 2030. If the technology proves successful, I think there is also scope for the enterprise to sell its tech on the international market. This could become a vital income stream for the firm.
Still, as I noted above, the company could encounter several challenges going forward. The biggest potential risk is the possible reclassification of biomass pellets. This would have a huge impact on the firm’s green credentials.
CCS Technology is also relatively new and quite expensive.
While the company does believe it has the potential to make a success of this technology, there is no guarantee it will achieve the desired aims.
This could end up becoming an expensive folly, and shareholders may have to foot the bill for the company’s mistakes.
The bottom line
Even after considering these potential challenges, I think there is huge potential for the business over the next couple of years.
It has the potential to be a leader in the renewable energy space. It is also capitalising on high energy prices to make significant investments in its energy system and guarantee the company’s future potential.
As FTSE 250 businesses go, the group is also well positioned to navigate the current energy crisis.
These are the reasons why I would be happy to add the company to my portfolio as a growth investment. In fact, I think it is one of the best stocks to buy in the FTSE 250 index, considering its growth prospects and defensive nature.
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Rupert Hargreaves 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.
