A rising gas price has not been bad news for everyone. Indeed, FTSE 250-listed Drax Group (LON: DRX) share price has soared by around 20% in the past two weeks.
It has been boosted by the prospect of higher electricity prices that could prompt greater profitability for the business in the short run.
The company is the UK’s largest source of renewable electricity. Its biomass assets, which burn wood pellets instead of coal or gas to produce electricity, and hydro assets, together delivered 12% of the country’s renewable electricity in the first half of the year. During that time, it also sold off its remaining gas assets and ended commercial operations at what was previously Western Europe’s largest coal power station.
In fact, according to the International Renewable Energy Agency (IRENA), global biomass use could double by 2030 and account for 60% of final renewable energy use. The use of carbon capture and storage technology, in which Drax is investing heavily, could even mean biomass ultimately produces negative emissions. Indeed, the company is aiming to become a carbon negative business by the end of the current decade.
In addition, biomass may offer a more reliable alternative to fossil fuels than other renewable assets. Recent calm weather has meant that wind farms have produced less electricity than expected. This has led to higher demand for gas to produce electricity to plug the gap, which has contributed to its rising price. By contrast, biomass could offer a more stable electricity generation profile that may hold increasing appeal should the price of gas remain persistently high.
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Potential threats to Drax Group
Clearly, Drax faces several risks in the short term and in the long run. In the near term, its share price could come under pressure following its sharp recent rise because of demand and supply changes within the gas market. In addition, political risk could build over coming months. The government has not ruled out a windfall tax for energy producers, although it remains unclear who this would affect.
In the long run, uncertainty regarding which technologies will be the greatest contributors to the world’s pivot towards renewable energy assets is likely to persist. As such, there is no guarantee that Drax’s assets will deliver on their potential. Indeed, any existing renewable energy asset could be superseded by new technology or be replaced because of political or economic factors that are impossible to accurately predict.
Drax Group valuation and income prospects
The company’s valuation suggests that it continues to offer a margin of safety even after its recent share price rise. It currently trades on a forward price-earnings ratio of 19, which is forecast to fall to 9 due to rising profits expected in the next financial year.
Moreover, Drax Group is expected to raise dividends per share by 10% in the current year so that it has a forward yield of 3.7%. Further rises of a similar amount are forecast over the next two financial years.
As such, it could offer long-term capital growth and income potential as the world seeks to deliver on its carbon-neutral aims. In the meantime, it would be unsurprising for volatility in the gas price to be mirrored in the firm’s share price performance.