The boom in artificial intelligence technology is expected to spread beyond semiconductor and software stocks. Data centers that train and host AI programs require large amounts of power.
Data center expansion therefore represents a new source of demand growth for utilities. Morningstar analysts believe this factor has not yet been factored into utility stock prices. This comes at a time when electricity demand is increasing due to the growth of electric vehicles. “We expect power demand growth to be faster than market expectations, requiring significant energy infrastructure investment and driving earnings growth for utilities,” said Morningstar strategist Travis Miller.
The utilities sector was undervalued by 9% as of April 9, Miller said, and many companies are expected to benefit from increased power demand. He and Morningstar strategist Andrew Bischoff believe the following four stocks are best positioned to benefit from data center growth.
- Entergy ETR
- Southern Company SO
- Pinnacle West Capital PNW
- WEC Energy Group WEC
Of the three, Entergy, Pinnacle, and WEC are considered undervalued by Morningstar, while Southern is considered to be a good value.
Data center power demand skyrockets
A data center is a dedicated space that houses computer systems that include data processing hardware. To keep up with this boom, utilities will face the challenge of meeting summer and winter peak demand while aiming to use clean energy, which will require significant investments in energy storage and grid upgrades. Is required. “To set up one large data center could require billions of dollars in public investment,” Miller explains.
Looking at demand growth, Morningstar analysts' base scenario predicts that electricity demand will continue to lean toward electric vehicles rather than data centers, with an annual increase of 1.4% until 2032, the highest growth rate in the past 20 years. becomes. This represents a cumulative 46% increase in data center demand by that year. Morningstar analysts make a bullish case that data center growth will accelerate demand by 131% through 2032. In that case, demand for data centers will exceed demand for EVs.
“The outlook for data center power demand is trending toward a bullish scenario,” Miller said. “If anticipated data center developments materialize, we will consider increasing our fair value estimates for certain of our U.S. electric distribution companies.”
Which utility stocks stand to benefit most from data center demand?
Location plays a key role in ensuring a data center company has the best chance of success. Considering data center power requirements, reducing power costs is key. This gives companies operating in parts of the Southeast and Midwest a competitive advantage. In addition, Bischoff said investors should look for “utilities that operate in positive regulatory jurisdictions with the support of key stakeholders in highly economically developed regions.”
Here's a closer look at Morningstar's picks for utility stocks expected to benefit from data center growth.
entertainment
“Entergy's growing energy-intensive customer base and constructive rate regulation in the Southeast United States position the company for a long path to revenue and dividend growth.
“We expect Entergy to invest an average of nearly $7 billion annually over the next five years to upgrade its power grid and expand its clean energy portfolio. Industries make up about half of Entergy’s customer base. Customers generally support these investments in reliable, low-carbon power generation.
“We expect Entergy's planned growth investments and customer additions to increase annual earnings in the upper half of management's 6% to 8% target.Constructive Regulatory Outcomes That could further boost management's $20 billion capital spending plan for 2024-26, pushing earnings growth to nearly 8% over the decade.”
read more Click here for analyst comments from Travis Miller.
southern company
“Southern is in the process of a dramatic clean energy transformation. Our $43 billion capital investment plan over the next five years will reduce greenhouse gas emissions, expand renewable energy, strengthen our gas systems, and improve our Southeast region. The country's rapidly growing energy needs will be supported.
“In 2000, almost 80% of the electricity sold by Southern was generated using coal. That share is now below 20% and declining. The goal is to eliminate all coal-fired power plants except for coal-fired power plants, and to reduce carbon dioxide emissions from power generation to net zero by 2050. I am.
“With a renewed focus on smaller projects, we believe Southern can generate stable 6% earnings growth.Due to Southern's large investments, dividend growth has continued to track earnings growth in recent years. However, we expect dividend growth to accelerate and match profit growth from 2024, when Vogtl ends.
read more Click here for analyst comments from Travis Miller.
Pinnacle West Capital
“Pinnacle West posted solid profits through 2021 and rewarded shareholders with increased dividends as customer and energy usage growth in Arizona outpaced most other utilities. However, regulatory rollbacks , making it difficult for Pinnacle West to translate these favorable fundamentals into earnings and dividend growth.
“Arizona regulators' decision to reduce Pinnacle West's allowable return on equity from 10% to 8.7% contributed to a $200 million rate cut in 2022. Earnings will return to 2021 levels through 2025. However, Pinnacle West reversed some of that rate.'' A successful appeal resulted in a lower rate, with the new regulator paying an annual rate of $253 million in March 2024. approved an interest rate hike. ”
read more Click here for analyst comments from Travis Miller.
WEC Energy Group
“WEC Energy Group is the largest electric utility company in the Midwest, with approximately $29 billion in tariffs, and derives most of its revenue from regulated operations. Nearly 75% of its revenue comes from Wisconsin and federal energy regulations. The remainder of the revenue comes from areas with constructive regulation by the Commission.
“The company expects to invest $23.7 billion in capital through 2028, including the investment in American Transmission. This investment plan is based on management's narrow annual earnings growth target of 6.5% to 7%. This confirms our prediction that the cap will be achieved.”
read more Click here for analyst comments from Andrew Bischoff.