The media hype machine is in overdrive, pushing utility stocks as a savvy way to play AI’s growth. You’ve no doubt seen these headlines (or some of the hundreds of others like them):
- “The Unlikely Stocks That Became a Hot Bet on AI” –The Wall Street Journal
- “AI Could Drive a Natural Gas Boom as Power Companies Face Surging Electricity Demand” –CNBC
- “Utility Stocks Could Be Headed for a Decade of Strong Growth, Driven by Data, AI” –Barron’s
Before we go further, let me say right off the hop that we contrarians never chase headlines—we’re always looking to buy value first and foremost—high-yielding stocks that are washed out, in other words.
When it comes to “utes,” we let interest rates be our guide. That’s because utility stocks are basically “bond proxies”—like bonds, they tend to rise as rates fall. In other words, loading up on utilities during a “rate panic” is our No. 1 (and No. 2 and No. 3!) strategy.
You can see that in action when you compare the Utilities Select SPDR ETF (XLU) to the 10-year Treasury rate over the last couple years. When the so-called “long rate” scraped 5% last fall (and “inflation forever” panic filled the air), it almost perfectly nailed the bottom in utes:
Fast-forward to today and we’ve got the Fed set to kick off another rate-cut cycle (despite what Jay Powell said at his presser last week!). Look, inflation is clearly cooling, unemployment is ticking up (if slowly) and even futures traders are calling Jay’s bluff, calling for at least two cuts by the end of the year:
Bottom line? Our buy window on utilities is still open, but with the sector’s recent run-up, we do have to be careful—which means avoiding overcooked, lame payers like XLU (current yield: 3.1%).
Instead we’re looking to lesser-known plays like the Reaves Utility Income Fund (UTG), a closed-end fund (CEF) that holds top utility stocks but pays us a lot more: a sweet 8.2%, to be exact.
UTG, which has returned just under 12% since we added it to our Contrarian Income Report portfolio a little over a year ago, also pays monthly. And management has no reservations about hiking the payout, either:
All right, I know what you’re thinking: “Where the heck does all this leave us with AI?”
Get this: According to an April report by Goldman Sachs (GS), each ChatGPT query burns almost 10 times as much electricity as a Google search! That’s already driving up power bills at the various “server farms” dotting the US, and we can expect even more of these facilities to be built as a result of AI’s continued growth.
According to Goldman, data center power demand will post a compounded annualized growth rate of 15% a year from 2023 to 2030, when it’ll account for 8% of all US power demand, up from 3% today.
That’s a huge jump. And it’ll require a huge investment in the nation’s power grid. Goldman, for its part, says it hasn’t heard any execs fretting over supplying the materials for that kind of expansion at the utilities it covers.
Remember, too, that government investment is high in this area, including $10.5 billion earmarked for grid investments under the Bipartisan Infrastructure Law. And given that politicians love announcing new infrastructure projects (including new generation facilities), we can expect more cash to roll out, no matter what happens in November.
And of course, this demand doesn’t yet factor in things like crypto mining, whose power demand, while tough to get a clear handle on, already accounts for between 0.3% and 2.3% of US power consumption, according to the US Energy Information Administration (EIA).
Finally, let’s talk EVs.
Sure, demand growth has slowed here, but it is still rising. According to the International Energy Agency (IEA), the world’s EV fleet could amount to 6% to 8% of global power demand by 2035. That might not sound like much, but the midpoint (7%) is 1,300% higher than today’s level of 0.5%.
The Bottom Line: “Electrifying Everything” Will Boost Utilities
To be sure, utilities will gain from the so-called “electrification of everything.” And we need to be onboard.
A fund like UTG is a great option. But if individual stocks are more your thing, consider Dominion Energy (D), payer of a rich 5.3% dividend.
We like Dominion because of its scale: It boasts 4.5 million customers in 13 states, setting it up to sell the power those thirsty data centers need. That includes so-called “Data Center Alley” around Ashburn, Virginia. This area has more data centers than anywhere else in the US—and it’s in Dominion’s home state.
D has been in the “dividend doghouse” after cutting its payout in 2020, due to too much debt. But here’s what most mainstream investors miss about dividend cuts: The time following a cut is often the best time to buy.
That’s because, unless management is a total clown show (which D’s is certainly not!), execs want to “measure twice and cut once” when it comes to lowering the payout. No one wants to have to get back in that particular dentist’s chair again.
Moreover, D has slashed its long-term debt by nearly 15% in the last year.
That’s a great sign, and it comes as interest rates are likely to fall, further lowering the company’s borrowing costs—and setting it up to put more cash into its operations as power demand ticks up.
Brett Owens is Chief Investment Strategist for Contrarian Outlook. For more great income ideas, get your free copy his latest special report: Your Early Retirement Portfolio: Huge Dividends—Every Month—Forever.
Disclosure: none
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