Jefferies says these two utility stocks could benefit from growing demand for data centers

Utilities have been under pressure from high inflation in recent years, facing both customer pushback against rising prices and the burden of higher interest rates, which have driven up borrowing costs, further adding to suppliers’ debt burden .

Still, utility investors can take heart as long-term trends are bullish for utility stocks. Demand for electricity is growing, fueled in part by the AI ​​boom and its reliance on power-guzzling data centers, and in part by the advent of electric vehicles with their own demands on the power grid.

Tracking the electric utilities sector at Jefferies, analyst Julien Dumoulin-Smith sees utility stocks as a good choice for investors.

“It is impossible to underestimate the transformation underway with the proliferation of data centers,” said Dumoulin-Smith. “Unregulated traders can make huge profits and cash flows. There is a wide range of demand growth forecasts from different parties, with the consensus being around 2-4% annual demand growth through 2030, driven primarily by data centers. BCG and others estimate that data center demand will account for 6-8% of total US demand versus 2-3% today.”

The analyst took this general stance and used it to support two specific recommendations on utility stocks based on growing demand for data centers. Opening the TipRanks database, we found that his picks hold Strong Buy consensus ratings from the Street. Let’s take a closer look at them.

Talen Energy (TLN)

The first is Talen Energy, an independent energy and infrastructure company – and one of the largest such companies in North America. Talen focuses on providing safe and reliable energy with the highest value per megawatt of energy produced. The company’s power generation portfolio includes a full range of assets: nuclear, natural gas, oil and coal. These power generation operations are anchored by the company’s Susquehanna Nuclear Power Plant, the sixth largest such plant operating in the US. In addition to Susquehanna, Talen operates power generation facilities and other facilities in five states – Massachusetts, New Jersey, Pennsylvania, Maryland and Montana – and produces up to 10.7 gigawatts of power.

The Talen Susquehanna plant, capable of providing clean and reliable power 24 hours a day, seven days a week, has paved the way for the company to become a leader in providing power for data centers. Talen describes this niche as a “unique growth opportunity” because data centers are notoriously power-hungry. The company has a track record of delivering clean energy on demand and expanding its generation capabilities to meet growing demand, the two prerequisites for meeting the power needs of data centers and their AI applications.

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In the company’s last reported quarter, 2Q24, Talen posted a top line of $489 million. That total revenue grew 62.5% year-over-year and supported EPS of $7.60. Also of note, Talen reported 1H24 adjusted free cash flow of $165 million. We should note here that the company’s stock has been a big winner in 2024, gaining 160% for the year to date.

This energy company’s success in finding and filling a niche caught the attention of analyst Dumoulin-Smith. In his account of the company for Jefferies, he writes: “TLN’s generation-only PJM-based portfolio is well positioned to benefit from a variety of energy trends, including growing demand for electricity, particularly from data centers and the growing value of the firm’s capacity. . These trends translate into multiple sources of potential upside that could lead to both increased profitability and multiple expansion. Although TLN is not the only IPP destined to profit from these market phenomena, some of the company’s characteristics make it susceptible to maximizing relative advantage. In addition, TLN has high visibility of substantial earnings growth over the next several years, driven by dramatic increases in capacity prices.”

Talen earned a Buy rating from Dumoulin-Smith, whose $232 price target on the stock implies additional gains of 38.5% are on the books for the next 12 months. (To follow Dumoulin-Smith’s track record, click here)

Street View is also bullish here, with a Strong Buy consensus rating based on 5 recent unanimously positive analyst reviews. The stock’s trading price of $167.59 and average price target of $195.8 together indicate a one-year upside potential of 17%. (See Talen Stock Forecast)

Vistra Energy (VST)

Next is Vistra Energy, a Texas-based power company that generates utility-scale electricity. Vistra is the largest competitive power generation company operating in the US and can produce approximately 41,000 megawatts of electricity – enough to power 20 million homes. The company operates in all of the nation’s major competitive wholesale markets and has a reputation for focusing on reliability, affordability and durability. Vistra’s power generation portfolio includes natural gas, coal, nuclear and solar plants and even includes battery plants for energy storage. The company is expanding its zero-carbon generation footprint and operates the second largest fleet of competitive nuclear power plants in the country. Vistra has more than 6,800 employees nationwide and supplies energy to more than 5 million customers.

On the retail side, environmentally conscious Vistra customers can choose from more than 50 plans focused on renewable energy and conservation. They are available in 16 states plus DC and are supplied through Vistra’s network of 6 retail power brands. The company is best known as an electric utility, but may also offer natural gas services to customers.

Vistra’s core business, power generation and supply, brought the company $3.85 billion in revenue in its last reported quarter, 2Q24. That was up from $3.19 billion in 2Q23, a year-over-year gain of more than 20%, although the 2Q24 number missed the forecast by $110 million. All told, the company posted net income of $467 million, down from $476 million a year earlier. Cash flow from operations in the quarter came in at just under $1.2 billion. The company ended the second quarter with $3.85 billion in available cash, a total that includes cash and cash equivalents of $1.62 billion.

From Dumoulin-Smith’s point of view, Vistra has a lot to recommend to investors. He writes of the company: “As one of the largest and most diversified IPPs, VST is well positioned to the upside on several fronts, including overall power and capacity price growth, higher plant utilization, as well as potential contracts across the market. with data centers. As we project huge upside over the forecast period, we continue to see value in the stock, which continues to trade at a discount to peers at 15% + FY27 FCF yield.”

Elaborating, the top analyst goes on to explain the quality of Vestra’s power generation assets, adding: “From a data center growth perspective, VST owns a large fleet of CCGTs in Texas and PJM, as well as four nuclear plants as well , in the same two regions. The breadth of the fleet means a greater ability to respond to specific customer needs, which should translate into greater success in signing contracts and generally more favorable terms.”

All things considered, the Jefferies analyst puts a Buy rating here, complemented by a $99 price target that shows his confidence in an 11% gain over a one-year horizon.

Overall, The Street has given this stock a unanimous consensus rating of Strong Buy, based on 6 positive analyst reviews set in recent weeks. Shares are trading at $89.4, and the average price target of $108.17 indicates a 21% 12-month gain, even more bullish than Jefferies’ view. (See Vistra stock forecast)

To find good ideas for trading stocks at attractive valuations, visit TipRanks’s Best Stocks to Buy, a tool that aggregates all of TipRanks stock information.

Disclaimer: The opinions expressed in this article are solely those of the featured analyst. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.