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UK renewable energy stocks: 1 I’d buy and 1 I’d avoid

Zaven Boyrazian
·3-min read
Risk reward ratio / risk management concept
Risk reward ratio / risk management concept

The share price of some renewable energy stocks surged last year, primarily due to new legislation aiming to eliminate carbon emissions. The UK government has promised to be carbon-free by 2050, focusing mainly on the automotive and energy sectors.

This has made the share price of one particular hydrogen company explode by almost 450% in 12 months. But is this a market bubble waiting to burst, or is the high valuation justified? Let’s take closer a look.

One renewable energy stock I’d avoid today

The hydrogen stock in question is ITM Power (LSE:ITM). One part of the UK government’s ‘Green Industrial Revolution’ includes expanding hydrogen use, which is fantastic news for this business.

Traditionally, hydrogen is extracted from fossil fuels. But this process isn’t exactly environmentally-friendly. So, ITM Power found and patented an alternative method that converts water into oxygen and hydrogen without emitting any greenhouse gases.

That certainly sounds like promising technology to me, and investors seem to agree given that its share price has skyrocketed. Unfortunately, just like Tesla, the valuation has reached absurd and unsustainable levels in my eyes.

Today the renewable energy stock has a market cap of £3.1bn. When comparing this to its 2020 gross revenue of £3.3m, I begin to question the sanity of some investors. That’s a price-to-sales ratio of 939! In other words, investors are paying £939 for every £1 of revenue. And since the firm continues to lose money each year, it could be a long time before any profits are made.

Much like my opinion of Tesla, ITM Power looks like another case of ‘great business, bad stock’. But if the share price crashes, I’d certainly be looking to add the company to my portfolio.

Turning wind into cash

A different renewable energy stock that has caught my attention is Greencoat UK Wind (LSE:UKW). Another goal of the UK government is to provide electricity to every house using wind power by 2030. Since Greencoat owns and operates wind farms scattered across Britain, this is excellent news for it.

The business sells the electricity it generates to the national grid and returns the profits to shareholders using dividends. As maintaining wind turbines is a relatively inexpensive process, the stock has an 80% operating profit margin. Put simply, every £1 of revenue is turned into £0.8 of profit (before taxes).

This level of profitability is rare to come by and creates a large, reliable cash flow. As such, Greencoat can easily take advantage of opportunities to expand its wind portfolio.

At its current share price, the stock provides a dividend yield of 5.2%. And since it pays dividends every quarter, it offers income investors the ability to maximise the benefits of compounding through automatic dividend reinvestment.

Windmills for electric power production.
Windmills for electric power production.

The future of renewable energy stocks

Today, around 46% of electricity is generated using renewable energy technology (33% of which is generated by wind turbines). That’s quite a lot of space to grow within the UK alone. Hydrogen technology is also finding new applications, from refuelling vehicles to cleaning the gas supply.

The bottom line is, I think renewable energy stocks are only just getting started. But I’d always pay close attention to the price before I buy.

The post UK renewable energy stocks: 1 I’d buy and 1 I’d avoid appeared first on The Motley Fool UK.

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Zaven Boyrazian does not own shares in ITM Power or Greencoat UK Wind. 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.

Motley Fool UK 2021