Utilities Are Meant to Be Sleepy. They're the New Growth Stocks. -- Barrons.com

By Ian Salisbury

Utilities are supposed to be the S&P 500's sleepiest sector. This year, they are the biggest winner.

The Utilities Select Sector SPDR exchange-traded fund has returned 14.5% in 2024, more than any other slice of the market. That should give investors pause.

What gives? For the past few years, the story in the markets has been all about artificial intelligence, and now, that excitement has spread to some of the companies that promise to generate the vast quantities of electricity required by AI data centers.

The sector's outstanding performance is largely driven by a handful of firms, all of which have a strong AI story. As a recent research report from Bespoke Investment Group points out, just three stocks -- Constellation Energy, Vistra, and NRG Energy -- have all surged more than 60% this year. Most utilities have lagged behind the market.

Constellation Energy, by far the largest of the three with a market value of nearly $70 billion, appears to be in a sweet spot for AI. It boasts the biggest fleet of nuclear power plants in the U.S., allowing it to produce clean energy around the clock, two features highly prized by data centers. And unlike its former parent Exelon, which operates in the regulated market, Constellation can sell its power at competitive prices, without needing government permission to raise rates.

The company hasn't been shy about touting its opportunity. "The data economy and Constellation's nuclear energy go together like peanut butter and jelly," CEO Joseph Dominguez said on an earnings call last week. The company was in "advanced conversations with multiple clients, large, well-known companies" about coming power deals, he said.

Vistra and NRG have benefited from similar dynamics. Both companies recently offered rosy outlooks based on expected demand from data centers.

But while it isn't hard to see the promise around AI, the financial benefit it could offer is very much a bird in the bush. In fact, all three companies -- Constellation Energy, NRG, and Vistra -- posted year-over-year revenue declines in the first quarter. The AI bonanza investors are counting on isn't expected to materialize until 2026 or later.

That long lead time inevitably adds uncertainty. CFRA utility analyst Daniel Rich says long-term projections for AI's impact on energy demand are "all over the place," with some forecasts suggesting demand could double in coming years and others seeing growth of up to 10 times.

Unfortunately for investors, the stocks' big gains have cut the margin for error, says Rich, who follows Constellation and NRG. He rates both at Hold.

With Constellation stock at $216, up from just $80 a year ago, it is trading at nearly 30 times the per-share earnings expected for the coming year, Rich points out. That compares to just 16 to 17 times for regulated utilities. While the company's clean nuclear fleet and ability to raise its prices are significant advantages, investors enjoy a lot less upside than they did 12 months ago.

"It's hard to tell investors to buy the stock at this level," he says.

Write to Ian Salisbury at ian.salisbury@barrons.com

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May 17, 2024 02:00 ET (06:00 GMT)

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