Key Takeaways
- The AI infrastructure buildout and robust capital spending have fueled gains for utility companies this year, analysts say.
- The investor flight to safety amid volatility has also driven the sector’s 14% year-to-date return.
- Supportive fundamentals are expected to continue driving the sector’s growth, though concerns about valuations are growing.
Canadian utility stocks are having a banner year, outperforming the broader market amid Iran-war-driven volatility and a fragile economic recovery. Analysts say the sector’s performance has been fueled by increased power demand from the data center buildout and the investor flight to safety amid ongoing market volatility.
The Morningstar Canada Utilities All Cap Target Market Exposure Capped Index has gained 14% in the year to date, outperforming the 11.6% advance of the Morningstar Canada Index and the 11.5% return for the S&P/TSX Composite Index.
“Utilities continue to benefit from their traditional defensive characteristics,” says Jack Nguyen, portfolio manager at Verecan Capital. “But they’re also becoming a structural growth story driven by electrification, artificial-intelligence-related power demand, and grid modernization.”
Fortis FTS, Emera EMA, Capital Power CPX, Hydro One H, and Atco ACO.X have powered the Canada Utilities All Cap Target Market Exposure Capped Index’s gains this year. Fortis, which has the highest weighting in the index at 20.2%, led with the greatest contribution, adding 3.5 percentage points to the index’s year-to-date gain. Emera, with a 17.2% weighting, added 2.8 points.
Riding the Data Center Buildout
Investors have traditionally looked at utility stocks as defensive plays, with slow but steady growth and attractive dividends. But that profile is changing as some utilities benefit from fast-growing demand from data centers across North America, analysts say.
Utilities are “not the sector of old—boring, stable, and consistent. Rather, it appears more like an AI-adjacent play on the tech sector,” explains Philip Petursson, chief investment strategist at IG Wealth Management.
Morningstar analyst Andrew Bischof, who covers both Canadian and US utility stocks, says many of the same factors driving US utilities are also supporting their Canadian peers. “Data centers have been a big driver for US utilities, which has created a step-up in growth for all utilities,” he says. “And similar to US utilities, you’ve seen Canadian capital plans increase, supporting higher growth.”
Power-producing utilities stand to benefit most directly from growing data center energy demand. Regulated utilities are positioned to gain indirectly through transmission and grid infrastructure investment, in part to meet that AI demand. “As utilities invest in expanding and upgrading their networks, they grow their regulated asset base, supporting earnings growth over time,” says Verecan’s Nguyen.
The Investor Flight to Stability
Another catalyst for utilities stocks has been their perception as a haven, thanks to their dividends and generally stable business models. Nguyen says investors have rotated toward utility companies with resilient business models, seeking shelter from heightened volatility caused by the war in the Middle East, trade uncertainty, and slower economic growth. “Utilities have benefited from this shift because demand for essential services like electricity and natural gas tends to remain resilient regardless of the economic cycle, supporting consistent earnings and dependable distributions,” he says.
Rising Bond Yields a Caution
Still, Nguyen warns that a recent rise in long-term bond yields reminds us that the sector remains sensitive to interest rates. Bond yields have been ticking higher on fears that Iran-war-driven energy inflation could spread to the broader economy, forcing the Bank of Canada to combat it by raising interest rates from 2.25%.
This trend could hurt dividend-paying utility stocks, which are considered an alternative to bonds in a lower-yield environment. When bond yields rise, the relative appeal of utility dividends can diminish for income-seeking investors, as bonds offer increasingly high returns, generally with lower volatility than utility stocks.
For comparison, 10-year government bonds currently yield 3.56%, while the highest forward dividend yield by a Canadian utility stock within Morningstar’s coverage stands at 3.82%, offered by Emera, followed by Fortis’ 3.08% and Hydro One’s 2.36%.
Watch for Risks Ahead
Nguyen says the sector’s long-term fundamentals remain supportive, but “returns may moderate after a strong rally.”
Another concern is valuations. The sector’s price/earnings ratio sits at around 22 times earnings, compared with about 16 times for the broader market. “We believe there is better margin of safety in price looking outside that [utilities] group,” says IG Wealth’s Petursson. Within the Canadian market, he prefers “energy and materials as potential risk-off/beneficiaries to the current geopolitical risks.”
Meanwhile, Bischof advises investors to closely monitor company fundamentals and any shifts in the regulatory backdrop. Regulatory moves, such as reductions in allowed returns on equity, could weigh on revenues while providing signals on the sector’s future trajectory. “For the remainder of the year, we think investors must pay attention to regulatory developments and additional announcements supporting and extending utilities growth outlooks,” he says.
Canadian Utilities Stocks Benefiting from the AI Boom
Bischof cites Canadian utility Fortis as a company that’s particularly well-positioned to benefit from the AI infrastructure trend because of its significant US presence. Fortis generates more than 55% of its revenue from the United States. “Fortis is benefiting from increased transmission investments at its US ITC subsidiary,” he says.
Another is independent electricity transmission company ITC, which operates in seven US states. “ITC remains well-positioned for additional data center demand, recently forecasting 18% annual demand growth over the next 20 years,” Bischof explains in an analyst note.
Capital Power CPX and Brookfield Renewable BEP.UN are among the other pure-play exposures to growing data center power demand. Meanwhile, regulated utilities such as Emera and Hydro One benefit indirectly from rising data center power demand through higher transmission and grid modernization capital spending.
Bischof says some utility players, such as Emera, also benefit from US economic growth. Emera benefits from its significant operations in Florida due to the state’s “underlying economic growth [driven by] people continuing to move to Florida,” he says. In a note, Bischof writes that “most of Emera’s earnings growth will continue to be driven by its Florida operations, Tampa Electric and Peoples Gas, where the company is directing 80% of its capital investment.”
Emera generates more than 70% of its revenue from the US. Over time, the company has shifted away from noncore regulated and unregulated operations, and toward investment opportunities at its regulated utilities, Bischof notes.
Verecan’s Nguyen views that transition positively because “regulated frameworks provide stable earnings visibility, which has become increasingly valuable amid market volatility.”
