AI boom’s secret winners? The firms expected to power it

Investors looking for a unique way into the stock market’s artificial-intelligence boom are finding an intriguing bank shot in what’s traditionally the most boring corner of the equities universe: utilities.

AI is the buzzword these days, with everyone from chipmakers to computer equipment manufacturers to car companies trying to paint themselves in its hopeful colours. It’s also driving the latest stock market rally, as investors saw last week.

On April 25, Meta Platforms Inc. shares had their worst performance since October 2022 after the company said it would spend far more than expected on developing AI. Then on April 26, Google parent Alphabet Inc. soared past US$2 trillion in market valuation while Microsoft Corp.’s stock also gained after the companies showed progress on AI in their quarterly results.

But here’s the thing about AI technology: It requires an enormous amount of energy to develop and run. And that’s where utilities come in.

“Power demand from data centres has already been humongous, then came the AI hype and the need for power skyrocketed,” Manju Naglapur, senior vice-president and general manager for cloud, applications and infrastructure solutions at Unisys Corp., said “With all the money spent on data centres, the power consumption will increase massively.”

The S&P 500 index’s utilities sector fell 10 per cent in 2023, its worst year since 2008, making it the weakest group in the equities benchmark, which soared 24 per cent overall. That wasn’t exactly a shock considering the companies tend to do poorly during periods of persistently high interest rates.

The stocks have recovered somewhat in 2024, rising 5.7 per cent as cost controls offset higher refinancing expenses and record capital spending. But the biggest change in sentiment for utilities is the hope for surging demand from the new power-sucking data centres required for AI’S expansion.

BIGGEST DRIVER

“The AI narrative is capturing the biggest amount of investor interest,” Ryan Levine, who heads utilities coverage at Citigroup Inc., said. “It has the potential to be the biggest driver of the industry.”

Across the U.S., utilities are preparing for historic increases in electricity demand led by data centres and AI. Artificial intelligence is poised to help drive a 900 per cent jump in power demand from data centres in the Chicago area, which will potentially require as much electricity as around four nuclear power plants can produce, Exelon Corp. chief executive Calvin Butler recently said. Southern Co. predicts its electricity sales will rise to six per cent annual growth with about 80 per cent coming from data centres.

This explains why Goldman Sachs Group Inc. set up two investment baskets — Power Up America and Data Center Equipment — for clients seeking alternative ways to play the coming AI explosion. While the bank doesn’t disclose the stocks in its baskets, it’s picking companies based on four categories: unregulated and regulated utilities, smart-grid infrastructure and power-generating raw materials.

“We consider these themes, along with Goldman’s Broad AI basket, to be the most popular in the next few years,” Faris Mourad, the firm’s vice-president of U.S. custom baskets, said.

He expects the Power Up America basket’s 2024 yearend earnings to be 21 per cent higher than what was originally forecast in January 2023. And he sees more gains ahead.

EXPANDING SOURCES

Energy availability is a key consideration when data centre operators decide where to build. Typically, they go to a local utility to discuss how much power they need, and then the utility seeks approval to build a new plant or buy electricity from third parties.

For example, Georgia Power, the largest subsidiary of utility holding company Southern, recently won approval from the Georgia Public Service Commission to expand its capacity by 1.4 gigawatts to meet demand from data centres and other businesses.

“We’re recommending buying Southern Co. on this thesis,” Levine said.

Access to renewable power sources also is an advantage. Aaron Dunn, co-head of value equity and portfolio manager at Morgan Stanley Investment Management, likes Nextera Energy Inc. because it builds renewable generation for its own utility unit and develops renewables for others.

“We believe renewables and storage are a key enabler to help meet this increased demand” Nextera chief executive John Ketchum said. “The U.S. renewables and storage market opportunity has the potential to be three times bigger over the next seven years compared to the last seven.”

With data centre developers looking for inexpensive locations, Dunn expects the Midwest to become a hub of activity since land is cheaper than in other parts of the country.

“That also benefits a company like CMS Energy Corp., which operates out of Michigan,” he said.

Indeed, CMS said on its earnings call Thursday that it signed a contract for a new 230-megawatt data centre and has other companies looking to build in Michigan.

Of course, all this demand can only benefit utilities if they can produce the electricity to meet it. Many energy experts are concerned that the U.S. power grid isn’t prepared to handle the wave coming its way. And that has some investors turning to the companies that will be brought in to strengthen the grid so utilities can adapt to the new high-energy environment.

“This is going to be a real challenge for traditional utilities,” said Walter Todd, chief investment officer at Greenwood Capital Associates LLC, which owns stocks such as Eaton Corp. and Hubbell Inc.

“The real beneficiaries of this data centre electricity usage are those that will benefit from money spent to upgrade the grid.”