The utilities sector has made a stunning reversal from its 2023 slump, enjoying a lift from artificial intelligence excitement, and further upside is still ahead, according to Morningstar. Utilities are up about 10% in 2024, surging on expected demand for electricity to power AI data centers . It marks a reversal from last year, when the sector was largely beaten down by higher interest rates and suffered a 10.2% decline. A high interest rate environment not only makes it more costly for utilities to borrow, but it also makes their dividend yields less attractive relative to the risk-free rate investors can get from Treasurys. "We think the market was ignoring and underappreciating what utilities can accomplish," Travis Miller, energy and utilities strategist for Morningstar, told CNBC. Indeed, the sector hit a bottom in early October and has rallied more than 25% since then through Thursday's close. "When a sector rallies 30%, there isn't as much upside, but I think utilities are in a great position financially, and there is a lot of growth opportunity," he added. "Yields are still competitive and that should translate into some attractive returns for investors for the foreseeable future." He highlighted his team's four top picks: NiSource , Entergy , WEC Energy and Duke Energy . Earlier this week, Indiana Gov. Eric Holcomb announced that Microsoft will be constructing a $1 billion data center in La Porte, Indiana. Nipsco, a subsidiary of NiSource, will provide electricity and natural gas to the new facility. "The announcement gives us more confidence that NiSource will invest at least $17 billion in its electric and gas networks during the next five years, supporting our base 7% annual earnings growth estimate," Miller wrote in a report on Wednesday. NiSource is geographically in an ideal position to benefit from further manufacturing and data center development, as it has access to low-cost energy resources, he added, noting that its Virginia utility already provides gas to data centers in that region for on-site power generation. Miller reaffirmed his $34 per share fair value estimate for NiSource this week, reflecting nearly 20% upside from Thursday's close. NiSource has a dividend yield of 3.7%, and shares are up nearly 7% in 2024. Another name that is due to see a boost from AI data center growth is WEC Energy. Last month, Microsoft announced a $3.3 billion expansion of its national cloud and AI infrastructure capacity through the development of a data center campus in Mount Pleasant, Wisconsin. The tech giant already has a data center that is under construction in the area, which is expected to open in 2026. "Microsoft's first data center represents 1,000 [megawatts] of electricity load, or over 10% of WEC's current load in the state," wrote Morningstar analyst Andrew Bischof in May. "It also supports WEC management's 4.5% to 5% annual electricity demand growth expectation in 226-28, among the highest of all US utilities." He has a $96 per share fair value estimate on WEC Energy, reflecting 19.5% upside from Thursday's close. The stock yields 4.2%, and it is down nearly 5% in 2024. Industrial customer growth on the Gulf Coast could be a boon for Entergy, and it also stands to catch a tailwind from growing demand for renewable energy, Miller said. His team expects the company to invest an average of $7 billion annually to upgrade its electrical grid and grow its clean energy portfolio. The company has also been raising its dividend by about 6% in each of the past three years, marking the largest increases since 2010. The stock is currently yielding 4.1%, and shares are up close to 8% in 2024. "We expect dividend increases to track slightly slower than earnings growth as Entergy goes through the peak of its growth investment plan," Miller said. He has a fair value estimate of $123 per share, reflecting about 12% upside from Thursday's close.
