Data Centers Drive Power Demand, Utilities Preferred Under Rate Cut Cycle

Overview

This research report analyzes the investment prospects for North American regulated utilities and independent power producers (IPPs) in 2026. The core view holds that with accelerated data center construction, power demand is becoming a key force driving industry growth, while the expected Fed rate cut cycle provides valuation support for the sector. Although the sector appears slightly overvalued based on bond spreads, it remains attractive when viewed through earnings growth and relative P/E metrics. UBS uses multi-dimensional valuation models to screen out six preferred stocks with potential for excess returns.

Core views

Demand Side: Data centers are the core driver. The report points out that data centers and large loads are driving peak power demand growth at an annual rate of approximately 4%, causing the power market to approach cycle peaks by the end of this decade. UBS Evidence Lab data shows a significant increase in the number of hyperscale data centers under construction and planned in North America, which will directly translate into huge demand for power generation and transmission infrastructure. Supply and Capital Expenditure: To meet demand growth, utility companies are significantly increasing capital expenditures. The five-year capital expenditure forecast for 2026-2030 totals USD 1.192 trillion, a 26% increase compared to the 2025-2029 forecast. Spending growth focuses mainly on distribution networks and renewable energy. At the same time, many companies have raised their Rate Base growth expectations, averaging an increase from the midpoint of 8% to 9%. Valuation and Macroeconomic Environment: Although from a comparison of regulated utility yields and Baa-rated corporate bond yields the utilities sector seems about 27% overvalued, from the perspective of Forward Year 2 P/E relative to the S&P 500 Index, it is about 24% undervalued. UBS prefers its proprietary multivariate regression valuation model, which shows the sector's overall valuation is reasonable. Macro level, UBS Economics team forecasts the Federal Reserve will conduct three cuts of 25 basis points each in 2026, which usually benefits utilities performance as they often outperform the broader market in historical rate cut cycles. Individual Stock Recommendation Logic: 1. Alliant Energy (LNT): QTS data center project relocation to Iowa reduces capital plan risks, expected Rate Base growth of 12% before 2029, earnings growth expected to exceed guidance. 2. Ameren (AEE): Illinois regulatory uncertainty resolved, investors can focus on Missouri growth and transmission business. 3. CenterPoint Energy (CNP): Good management record, continued capital plan increases, lighter regulatory calendar in coming years. 4. NiSource (NI): Continue investing in data center power generation via GenCo structure, base plan assumes 8-9% earnings growth, with additional upside potential. 5. Xcel Energy (XEL): Viewed as undervalued growth stock, data center driven load growth and transmission opportunities will offset wildfire risks and regulatory concerns, enjoying EPS growth above 9%. 6. NRG Energy (NRG): Unique generation portfolio in Texas and PJM markets, free cash flow yield reaches 11%, valuation only 7.5x EBITDA 2027, below peers.

Analysis framework

UBS adopted a bottom-up and top-down analysis method. First, tracking physical construction of data centers and power demand data via UBS Evidence Lab to quantify industry growth drivers. Second, built proprietary 'Regulatory Ranking' and 'Affordability Matrix' to evaluate friendliness of state regulatory environments and user ability to bear electricity prices, using these as basis for valuation adjustments. In valuation, besides traditional P/E and dividend yield comparisons, also used multivariate regression model including seven adjustment factors (such as regulatory quality, growth quartile, earnings consistency, etc.) to determine fair value. Finally, combined macro interest rate path (Fed rate cut expectations) to judge sector systemic opportunities.

Methodology notes

• Valuation methodsPE/PEG valuation

  Multivariate Regression Valuation Model

  UBS uses a multivariate regression equation based on historical data, combining seven factors such as regulatory ranking, growth expectations, earnings consistency to add/subtract adjustments to standard P/E, evaluating utility stocks' fair value more precisely.

• Industry/Industrial Analysis FrameworkSupply and Demand Framework

  Power Supply and Demand Balance Analysis

  By analyzing matching of new load brought by data centers (demand side) with power generation capacity and transmission construction progress (supply side), judging tightness of power market and electricity price trends.

• Macroeconomic frameworkTaylor rule

  Impact of Fed Interest Rate Path on High-Dividend Assets

  Utility stocks are typically viewed as bond substitutes, valuations sensitive to risk-free rates. Report cites UBS economics team predictions on Fed rate cut path as macro basis for judging possibility of sector valuation expansion.

• Company Fundamentals and Financial FrameworkFree cash flow analysis

  Free Cash Flow Yield Comparison

  When evaluating IPPs (like NRG), focusing on examining Free Cash Flow Yield, comparing it with peers and historical averages to identify undervalued cash cow enterprises.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Alliant Energy (LNT.US)

  Benefited

  Strengths

  Data center project reduces capital risk, high Rate Base growth (12%), improved regulatory environment

  Comparison

  Valuation premium reasonable vs peers

  Risks

  Regulatory results below expectations

• Ameren (AEE.US)

  Benefited

  Strengths

  Illinois regulatory uncertainty eliminated, strong Missouri growth

• CenterPoint Energy (CNP.US)

  Benefited

  Strengths

  Good management record, increased capital plans, light regulatory calendar

• NiSource (NI.US)

  Benefited

  Strengths

  Data center power generation investment, 8-9% earnings growth expectations

• Xcel Energy (XEL.US)

  Benefited

  Strengths

  Undervalued growth stock, data center load growth, 9%+ EPS growth

  Weaknesses

  Wildfire risk, pending regulatory matters

  Comparison

  Trading price has 1% discount vs peers

  Risks

  Wildfire risk

• NRG Energy (NRG.US)

  Benefited

  Strengths

  Unique generation portfolio, 11% free cash flow yield, low valuation (7.5x EBITDA)

  Comparison

  Valuation lower than peers (9x EBITDA)

  Risks

  Electricity market price volatility

Key data

• Capital Expenditure Forecast 2026-2030USD 1.192 TrillionIncrease of 26% vs prior five-year forecast
• Peak Power Demand Annual Growth~4%Driven by data centers and large loads
• Rate Base Growth Expectation Midpoint9%Increased 100bps from previous 8%
• NRG Energy Free Cash Flow Yield11%Higher than peer average of 9%
• Expected Rate Cut Count 20263 TimesUBS Economics prediction, 25bp each

Impact & implications

For the industry, structural demand growth driven by data centers will extend the prosperity cycle of power industry, supporting continuous capital investment and Rate Base growth. For investors, under rate cut expectations, utilities with clear growth paths (such as data center related exposure) and good regulatory environment will get opportunities for valuation re-rating. Particularly IPPs with high free cash flow yield like NRG, and regulated utilities with clear load growth drivers like LNT, XEL are expected to outperform the broad market.

Risks

• Economic resilience risk under continuing inflation or stagflation
• Unfavorable regulatory results or delayed rate cases
• Operational risks caused by natural disasters such as wildfires
• Interest rate path deviating from expectations (e.g., fewer rate cuts than expected)

What to watch

• Results of rate case rulings by state public utility commissions
• Actual grid connection progress of data centers and realization of power loads
• Federal Reserve monetary policy meetings and changes in interest rate dot plot
• Implementation of utilities capital expenditure plans and financing costs