Utility stocks are being touted as a smart investment opportunity as artificial intelligence (AI) continues to grow. The media is hyping these stocks as a way to capitalize on the AI boom, with headlines from publications like The Wall Street Journal and CNBC highlighting the potential for growth in the utility sector. However, contrarians caution against chasing headlines and emphasize the importance of buying value and high-yielding stocks that are undervalued.
Interest rates play a crucial role in the performance of utility stocks, as they are often seen as “bond proxies” that tend to rise when interest rates fall. During times of rate panic, investing in utilities can be a strategic move. With the Federal Reserve expected to begin a rate-cut cycle, inflation cooling, and unemployment trends, the buy window on utility stocks remains open. Contrarians recommend avoiding overvalued options like the Utilities Select SPDR ETF (XLU) and seeking out lesser-known plays with higher yields, such as the Reaves Utility Income Fund (UTG).
AI’s growth is driving up electricity demand, particularly in the data center sector. Reports show that AI queries consume significant amounts of electricity, leading to higher power bills for companies operating server farms. Goldman Sachs predicts a substantial increase in data center power demand over the next decade, necessitating significant investments in the nation’s power grid. Government support for grid investments, including funds allocated under the Bipartisan Infrastructure Law, will play a crucial role in meeting the growing power demands driven by AI and other technologies.
The electrification of various industries, including electric vehicles (EVs), will further boost demand for power and benefit utility companies. While EV demand growth has slowed, the International Energy Agency projects a significant increase in the global EV fleet’s power demand by 2035. This shift towards electrification presents opportunities for utilities to capitalize on the increased power needs of emerging technologies. Funds like UTG and individual stocks like Dominion Energy (D) are recommended as options for investors looking to benefit from this trend.
Dominion Energy, in particular, stands out for its scale and customer base, which positions it well to supply power to data centers and other high-demand areas. Despite a dividend cut in 2020 due to high debt levels, Dominion has taken steps to reduce its long-term debt and improve its financial position. As interest rates are expected to fall, the company’s borrowing costs will decrease, allowing it to invest in operations to meet growing power demands. Contrarians see the period following a dividend cut as an attractive time to invest, as companies work to strengthen their financial standing and grow their dividends over time.
In conclusion, the potential growth in power demand driven by AI, data centers, and the electrification of industries presents an opportunity for utility stocks to outperform in the coming years. Investors are advised to look beyond mainstream options like XLU and consider alternative plays with higher yields and growth potential. By staying informed about industry trends and selecting undervalued stocks with strong long-term prospects, investors can position themselves to benefit from the evolving energy landscape.
