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

By Natalia Kniazhevich

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 colors. It’s also driving the latest stock market rally, as investors saw this past week.

On Thursday, 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 Friday, Google parent Alphabet Inc. soared past $2 trillion in market valuation while Microsoft Corp’s stock also gained after the firms 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 centers has already been humongous, then came the AI hype and the need for power skyrocketed,” said Manju Naglapur, senior vice president and general manager for cloud, applications and infrastructure solutions at Unisys Corp. “With all the money spent on data centers, 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 4.4 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 centers required for AI’s expansion.

Biggest Driver

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

Across the US, utilities are preparing for historic increases in electricity demand led by data centers and AI. Even outside Data Center Alley in Northern Virginia, where Dominion Energy Inc. temporarily paused new data center connections in 2022 due to grid constraints, the companies are planning new power plants and transmission lines.

Artificial intelligence is poised to help drive a 900 per cent jump in power demand from data centers in the Chicago area, which will potentially require as much electricity as around four nuclear power plants can produce, Exelon Corp Chief Executive Officer Calvin Butler said recently. Southern Co predicts its electricity sales will rise to 6 per cent annual growth with about 80 per cent coming from data centers.

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 US custom baskets, said in a phone interview.

So far this year, the Power Up basket has soared almost 28 per cent and the Data Center Equipment basket is up more than 18 per cent. Those are some lofty numbers considering the usually high-flying S&P 500 tech sector has gained just 8.3 per cent in 2024, and communication services, which includes social media firms, is the best performing group in the index with a 17 per cent rise.

Meanwhile, Mourad expects Power Up America basket’s 2024 year-end earnings to be 21per 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 center 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 centers and other businesses.

“We’re recommending buying Southern Co. on this thesis,” Citigroup’s 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 CEO John Ketchum said during the company’s first-quarter earnings call on Tuesday. “The U.S. renewables and storage market opportunity has the potential to be 3x bigger over the next seven years compared to the last seven.”

With data center 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 center and has other companies looking to build in Michigan.

Of course, all of this demand can only benefit utilities if they can produce the electricity to meet it. Many energy experts are concerned that the US 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, which owns stocks like Eaton Corp. and Hubbell Inc. “The real beneficiaries of this data center electricity usage are those that will benefit from money spent to upgrade the grid.”