Promising derivative plays on AI boom – how to benefit
Traditionally viewed as a defensive sector, utilities have unexpectedly become a hot commodity on Wall Street, thanks to the Artificial Intelligence (AI) revolution. This sector is now poised to benefit from the increasing energy demands driven by the rise of AI applications and data centers. Over the past three months, some utility stocks have surged by more than 15%, drawing significant attention from investors as a promising derivative plays on the AI boom. Below, we share our insights into the top companies most likely to benefit from this AI-driven growth.
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Electricity grid & storage companies to benefit from growing demand from AI and data centers
The utility sector has unexpectedly become a?potential beneficiary?of the artificial intelligence (AI) boom. Below we highlight the main reasons for utilities to benefit:
AI and Energy Demand: The surge in AI applications, especially large language models and data centers powering AI workloads, requires significant energy.?Data centers are major energy consumers, and AI applications consume even more energy than traditional computing.
As of 2024, data centers are significant drivers of electricity demand.?According to International Energy Agency, globally, they consumed an estimated 460 terawatt-hours (TWh) in 2022, and this consumption could reach more than 1,000 TWh by 2026—roughly equivalent to Japan’s total electricity usage.?In the United States, data centers are projected to use up to 9% of total electricity generated by the end of the decade, more than doubling their current consumption.
A closer look at the electricity situation in Europe and the USA in 2024:
Europe:
Despite the impressive growth in wind and solar power generation, the pace of deployment must accelerate between 2025 and 2030 to meet the EU’s 2030 climate targets and stay on track for limiting global warming to 1.5°C. As the share of wind and solar energy continues to grow, the importance of grids, storage, and other enablers of system flexibility will become even more critical, in our view.
Our European picks – potential winners from AI & data centers boom
Enel (XETRA: ENL):
An Italian company, Enel ranks among Europe’s top electric utilities.?It operates in Spain through its subsidiary Endesa and has a global presence in South America, Asia, and Africa. Enel has made substantial investments in renewable energy sources, including wind, solar, and hydroelectric power. They operate numerous renewable energy plants worldwide, contributing to a more sustainable energy mix.
Enel focuses on modernizing power grids through smart technologies. Their projects involve integrating smart meters, improving grid efficiency, and enhancing reliability.
Enel promotes electric mobility by deploying charging infrastructure for electric vehicles (EVs). They collaborate with cities and businesses to create EV-friendly environments.
Enel explores energy storage solutions, such as large-scale battery systems, to enhance grid stability and support renewable energy integration.
By 2026, Enel aims to:
In our view, Enel, as a major energy player, can benefit from the growth in data centers in Europe during 2025-2026 in several ways:
Renewable Energy Demand:
Strategic Partnerships:
Energy Storage Solutions:
Circular Economy Approach:
Enel’s renewable energy expertise, strategic partnerships, and focus on sustainability position it well to benefit from the data center industry’s growth in Europe. We consider Enel attractive for inclusion in an investment portfolio. The company currently trades at Price-to-Book Value ration of 2.0x. Enel underperformed the stock market this year with -6.96% year-to-date. The company delivered solid Q1 2024 financial results. Enel pays attractive dividends with the current dividend yield of 6.72%. Institutional investors?increased?holdings by?+9.53%?last quarter, based on disclosures of 11 investors. Among the top buyers of Enel’s shares are: Hancock Holding Company, Old National Bank, Front Row Advisors, Fulton Bank and other.
Based on estimates of 14 analysts, Enel’s price target stays at EUR 20 per share, thus implying attractive upside potential of almost 20%. The company should report its Q2 2024 financial results on July 25. Although, historically Enel delivered negative earnings’ surprises to the market, we believe that Enel could be considered as strategic long-term investment – a defensive derivative play on AI boom.
E.ON (XETRA: EOAN):
Based in Essen, Germany, E.ON is another significant player in the European energy market.?E.ON operates in 30 countries serving 25+ million customers and has over 79000 employees. The company’s total generating capacity is 70 GW – Thermal Power, nuclear, Hydro and Renewable Power. E.ON has strong market presence, a balanced mix of power plants and also highly efficient and integrated processes. E.ON is included in the DAX stock index of the top 30 German companies. The company has strong financial reputation and brand value.
?E.ON plans to increase its investment by €9 billion ($9.8 billion) from 2024 to 2028.?This boost aims to expand energy networks and connect more renewable energy facilities. The company focuses on customer solutions, including energy infrastructure, smart meters, and e-mobility charging solutions.
In May, 2024 E.ON had Investor Day an highlighted five reasons to invest in E.ON:
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In addition to the above mentioned advantages, we believe that E.ON can capitalize on the surge in AI and data centers demand. The boom in AI technology has led to increased demand for data centers. These centers require substantial electricity to train and host AI programs.?E.ON can benefit from this by providing reliable and sustainable energy solutions to data centers.
E.ON can invest in energy infrastructure to serve these centers.?For instance, a single large data center could require billions of dollars in utility investment.
As data centers grow, E.ON can focus on using clean energy sources. This involves investments in energy storage and grid updates.?By providing eco-friendly solutions, E.ON can position itself as a key player in the AI-driven energy landscape.
Collaborating with data center operators and technology companies can enhance E.ON’s position.?These partnerships can lead to joint ventures, innovative solutions, and shared expertise. In the year 2022 E.ON already established partnerships with Microsoft. One notable initiative centers around a?smart home solution. Together, they’re developing software that sets new standards for home automation.?
As of?2024, Microsoft is a major player in both data centers and AI solutions. Microsoft has?ambitious plans to expand its data center infrastructure in Europe, particularly in Germany. Microsoft recently announced a?doubling of its Azure capacity?in Germany by the end of?2024. The expansion focuses on the?Germany West Central region, which is strategically located in the center of Europe. This region allows?all European companies?to access the Microsoft Cloud?quickly and securely. In our view, expansion into European regions will need more data centers’ capacity which, in turn will stimulate higher demand for electricity – E.ON is one of the key beneficiaries.
We consider E.ON attractive for a long-term investment portfolio. The company currently trades at Price-to-Sales ratio of just 0.40x, P/BV of 2.19x, and P/E of 28.3x. E.ON is rated “Buy” with a 12-month target price of €15.06, a 20.19% upside from the current price of €12.53.
USA:
Driven by AI, broader data demand, and a deceleration in the pace of energy efficiency gains,?global data center power demand?is poised to more than double by 2030 after being relatively flat between 2015 and 2020.?In the United States, data centers are expected to consume?9% of electricity generation?by 2030, which is double the current consumption level. Additionally, the overall consumption of data centers across the U.S.?is likely to reach?35 gigawatts (GW)?by 2030, up from 17 GW in 2022, according to our research.
While the exact proportion attributable to AI applications is difficult to estimate, the trend suggests a significant impact on electricity demand. Some estimates from expert agencies even project that AI data centers could consume?20-25%?of the U.S.?power grid by 2030.?The surge in data center demand will necessitate investment in new power generation capacity, with a mix of gas and renewables expected to meet the growing load.
Our U.S. pick – potential winners from AI & data centers boom
Entergy Corporation (NYSE: ETR):
Entergy Corporation is a Fortune 500 company that provides electric power production and retail distribution operations. It serves nearly 3 million customers across Arkansas, Louisiana, Mississippi, and Texas. Entergy is known for its commitment to building a cleaner, more resilient, and sustainable energy future. The company’s business model focuses on investing in the reliability and resilience of the energy system while transitioning to cleaner and more efficient energy solutions.
Key Revenue Drivers for 2024-2025
Electricity Generation and Distribution: Entergy’s primary revenue driver remains its utility operations, which include the generation, transmission, and distribution of electricity. The company has announced plans to increase its generation capacity by 40% within the next four years to meet significant customer demand in the Gulf region (Entergy Texas).
Capital Investments: Entergy plans to invest approximately $19.6 billion from 2024 to 2026 to improve and expand its infrastructure. These investments are aimed at benefiting customers and aligning with the company’s strategic goals of enhancing grid reliability and integrating more renewable energy sources (Entergy Arkansas).
Onshoring and Economic Growth in the Gulf Region: The economic activities in the Gulf region, including onshoring and industrial growth, are expected to drive demand for electricity. Entergy’s operations in this region are strategically positioned to benefit from these macroeconomic factors (Entergy Analyst Day).
Regulatory Environment and Rate Adjustments: Entergy’s revenue is also influenced by regulatory decisions, such as rate adjustments approved by state commissions. These adjustments allow the company to recover investments and operational costs, ensuring financial stability and enabling further investments in infrastructure and technology (Entergy Arkansas).
Transition to Renewable Energy: Entergy is actively transitioning to cleaner energy sources, which includes integrating more renewable energy into its portfolio. This transition is not only environmentally beneficial but also aligns with regulatory trends and customer preferences for sustainable energy solutions (Entergy Future).
Financial Performance and Guidance
For 2024, Entergy has initiated an adjusted earnings per share (EPS) guidance range of $7.05 to $7.35. The company expects strong growth in its customer base, mainly from industrial sector.
In our view, Entergy Corporation’s key revenue drivers for 2024-2025 include its core utility operations, significant capital investments, the economic growth in the Gulf region, regulatory rate adjustments, and its ongoing transition to renewable energy sources. These factors collectively position Entergy to maintain and potentially grow its revenue in the coming years.
Entergy Corporation has been actively involved in data center projects and partnerships. Below we highlight some promising collaborations:
Amazon Web Services (AWS) in Mississippi:
NextEra Energy Resources Agreement:
Clean Energy Transition Projects:
Our View
ETR is currently trading at P/E ratio of 10.63x, Price-to-Book Value of just 1.53x and P/Sales ratio of 1.9x. In our view, Entergy is a solid candidate for a long-term investment portfolio, as it is strongly positioned to benefit from growing AI and data centers boom in the coming years. ETR is rated “Buy” with a 12-month target price of $116.48, a 9.83% upside from the current price of $106.05. ETR should report Q2 2024 results on August 1 and we believe that many analysts will revise their price target upwards. Our in-house estimated fair price of $123 per share suggest attractive upside potential for Entergy’s shares in the next 12-months. We consider Entergy as an interesting defensive play on AI growth.
We anticipate Entergy will invest an average of $6.97 billion annually over the next five years to upgrade its electric grid and expand its clean energy portfolio. Industrial customers, who make up about half of Entergy’s customer base, generally support these investments aimed at enhancing reliability and reducing carbon emissions.
We project that Entergy’s planned growth investments and customer expansion will drive annual earnings growth towards the upper end of management’s 6%-8% target range (provided during the company’s Investor Day on June 7, 2024). Favorable regulatory outcomes could increase the company’s $20 billion capital investment plan for 2024-2026, potentially boosting earnings growth to close to 8% throughout the decade. Approximately?$2.3 billion?of Entergy’s capital plan for 2022-2026 is earmarked for renewables.?As they aim to grow their clean energy portfolio to?7 GW?over the next five years, favorable regulations can facilitate these investment, in our view.
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