By Al Root

The artificial-intelligence trade boosted dividend-paying utility stocks, giving yield-hungry investors the best of both worlds -- income and growth. Then came a Chinese-built AI chatbot named DeepSeek that upended everything that investors thought they knew about AI -- and they chose to sell first and ask questions later.

But the implications for electricity demand -- the key factor underpinning utility valuations -- are far from dire. In fact, they're quite good.

The sell-first reaction makes sense. Viral posts over the weekend suggested that DeepSeek was created for $5 million to $6 million, a fraction of the cost of OpenAI's ChatGPT and others. That number is probably far too low, but an idea took hold: What if creating useful AI is far cheaper to develop than anyone expected? That would mean less demand for power, and that wouldn't be good for utilities.

"The concern is that leading AI companies will move away from advanced GPUs, which will drastically reduce power demand from AI, which is embedded into market expectations," wrote Citigroup analyst Ryan Levine on Monday.

But there's an optimistic take, as well, says Reaves Asset Management CEO Jay Rhame, who is the co-manager of the Reaves Utility Income fund and the Virtus Reaves Utilities exchange-traded fund: Cheaper AI could end up meaning more AI, not less, and still boost electricity demand growth.

"It kind of feels like we have one of the biggest technological breakthroughs in human history," he says. "Cheaper AI means more use cases...probably good for robotics, self-driving cars, every company in the world developing" AI models.

Who is right? Wells Fargo analyst Michael Blum took a shot at quantifying the numbers, estimating that more-efficient models could cut the power demand needed for AI computing in half. That sounds alarming, but that cut amounts to about 40 gigawatts of electricity-generating capacity, which is a fraction of the near-1,300 gigawatt generating capacity in the country. What's more, under that scenario, there is still AI-related growth, just not as much. And that's the worst-case scenario.

Utility stocks should be fine, but some will be more fine than others. Stocks with the most DeepSeek risk are unregulated independent power producers, or IPPs, which produce about 15% of total U.S. power. Constellation Energy, Vistra, and Talen Energy are three linked to the AI trade, and they carried the premium multiples to prove it. Before the selloff, the trio traded for an average of close to 30 times estimated earnings for the next 12 months, above the Utilities Select Sector SPDR ETF's 18 times and the S&P 500 index's 22 times. Even after dropping an average of 24% on Monday, they still trade for 28 times. They're still risky -- at least until the DeepSeek storm blows over.

But there are plenty of regulated utilities with reasonable valuations, attractive yields, and less AI risk. Three preferred by Rhame are Entergy, Xcel Energy, and natural-gas utility Atmos Energy. They trade below 20 times earnings and yield an average of almost 3%. The average yield for dividend payers in the S&P 500 is 2.3%.

Three regulated utility stocks with relatively fewer AI expectations built into their valuations, according to Citi's Levine, are PPL, DTE Energy, and Evergy. They trade for less than 18 times earnings and yield an average of about 3.7%. About 67% of analysts covering the three rate their shares a Buy.

If you want to bet on one of the IPPs as the DeepSeek saga unfolds, Vistra might be the best. It's cheaper than Talen and Constellation and pays a dividend -- something Talen doesn't do. It yields 0.6%, a little better than Constellation's 0.5%. What's more, nearly 90% of analysts covering Vistra rate its shares a Buy.

Write to Al Root at allen.root@dowjones.com

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(END) Dow Jones Newswires

January 31, 2025 21:30 ET (02:30 GMT)

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