AI and cloud computing drive data centre stocks

"I’M very bullish on the outlook for data centres,” says Pendal Aussie equities analyst Elise McKay, who’s just returned from a US trip where she met with participants across the “DC” supply chain.

Data centres are facilities which house heavy-duty computer systems and components used to support resource-intensive applications such cloud computing, artificial intelligence training and data storage.

In Australia an example would be NEXTDC (ASX: NXT), which is held in a number of Pendal Aussie equity portfolios.

The accelerating shift to cloud computing (on-demand access to computing resources over the internet) is driving demand, along with “generative AI” applications such as ChatGPT.

But some data centre stocks are better positioned than others, cautions McKay.

She prefers established DC owners with existing capacity — due to the time it takes to acquire land, undertake construction and manage power requirement and other complexities.

“There’s strengthening demand for DCs and supply is tightening,” McKay says.

“In some major DC locations, such as Northern Virginia in the US, vacancy rates are at one per cent. In Australia it’s closer to 17 per cent.”

Demand for energy and water

Strong demand and tight supply are conditions ripe for data centre owners to outperform — though there is a potential emerging constraint.

“There is not enough power available, especially for artificial intelligence (AI) applications,” Elise says.

Data centres use huge amounts of energy, estimated to be more than one per cent of global energy markets — and power requirements will grow demand is expected to grow inline with DC footprints.

Access to power will a significant constraint for some players, particularly as the world focuses on the energy transition.

“It means that providers of data centres with available capacity will benefit while new entrants will be constrained by access to power,” she says.

“Power constraints are very material and data centre players need to be planning five to ten years out.

“They are now looking for solutions that go behind the meter. They are thinking about self-generation – in the future can they do small scale nuclear reactors to power data centres?

“US data centre giant Equinix is powering two Dublin two facilities with gas. This is a complex issue that needs to be solved.”

Data centres also need large amounts of water. The energy used in data centres produce heat, and the servers need to be cooled.

Technology is addressing some of the water challenges in data centres.

“New cooling technologies are being deployed with limited need to retrofit. While this is slightly more expensive, I don’t expect it to change return targets.”

“Because data centres are both power and water hungry, sustainability is now an increasing focus,” Elise says.

Elise believes it will ultimately result in stronger pricing and better returns for data centres with capacity.

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