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The artificial intelligence (AI) investment thesis continues garnering adulation and scrutiny and due to the fact that AI is a new concept in investing terms, those themes are sure to be around for the foreseeable future.
To date, the primary avenue through which market participants have obtained AI exposure is technology stocks or funds. That makes sense because the technology and communication services (tech extended) sectors are homes to many of the current AI leaders. That will be the case for some time, but as the AI investment thesis expands, so do the “backdoor” avenues by which clients can reap rewards from this disruptive technology.
One area of emphasis, as was the case during the early days of the cloud computing boom, has been data centers. That says the real estate sector is a credible indirect play on AI.
“Building on previous paradigm-shifting technologies such as mobile and cloud, AI represents the next era of potential demand growth and disruption for the data center industry. Already, some companies are looking to reconfigure their data centers to account for the additional computing power – and related energy consumption and cooling designs – that AI requires,” according to a 2023 study by EY.
Add utilities to the list of conservative sectors with strong AI credentials.
AI Could Be Growth Driver for Utilities
As advisors know, utilities is NOT the sector to head to when searching for growth. It’s classified as a defensive sector and a bond proxy. To the latter point, the S&P Utilities Select Sector Index is up 13.6% over the past three years while the Bloomberg U.S. Aggregate Bond Index is down 9.1%.
Getting back to utilities as an AI play, the thesis is simple: AI enablers have immense power needs and as the technology evolves, those demands will increase.
“Looking at demand growth, the base case from Morningstar analysts—which considers that electricity demand will continue to lean more toward electric vehicles over data centers—is a 1.4% annualized increase through 2032, the fastest growth in two decades,” notes Morningstar analyst Diana Anghel. “That’s a cumulative 46% increase in data center demand by that year. Morningstar analysts offer a bull case wherein data center growth accelerates demand by 131% through 2032. In that case, data center demand will surpass EV demand.”
Sounds encouraging – it is – and simple enough. Regarding the simplicity of the AI/utilities thesis, it’s there, but it’s not going to be served up on a silver platter, meaning advisors need to perform some due diligence. That includes taking a regional view. Owing to the status of utilities as a regulated industry, even the biggest companies in the space don’t operate in every state. Add to that, some regions are more conducive to AI/utilities investing than others.
“Location plays a key role in which data center companies have the best chance of succeeding. Lower power prices are key, given the electricity requirements of data centers. This gives companies that operate out of the Southeast and some of the Midwest a competitive advantage,” adds Anghel.
Four Potential Standouts
A quartet of utilities stocks stand out as potential winners on the back of AI. In alphabetical order, those are Entergy (ETR), Pinnacle West (PNW), Southern Co. (SO) and WEC Energy (WEC). Entergy and Southern have exposure to the Southeast and while WEC operates in the Midwest.
With data center electricity demand poised to double by the start of the next decade, it’s not surprising that utilities, including those mentioned approve, are spending billions of dollars to upgrade power grids to ensure the energy is there to drive AI ahead.
Should AI continue on or it exceed its bullish trajectory, the potential exists for utilities companies to grow earnings – something that’s often hard to come by in this sector – while firming balance sheets and increasing resources allocated to dividends.
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