TheChek News Flow

Combination of natural-gas producers could come together as soon as next week

Southwestern Energy SWN 7.34%increase; green up pointing triangle and Chesapeake Energy CHK 2.91%increase; green up pointing triangle are close to a merger that would create a roughly $17 billion company ranking as one of the largest natural-gas producers in the U.S.

A deal could come together as soon as next week, according to people familiar with the situation, provided the talks don’t hit a last-minute snag.

Southwestern had a market capitalization of roughly $7.0 billion and Chesapeake’s was a little more than $10 billion as of Friday afternoon. Southwestern stock then jumped to close up more than 7% after The Wall Street Journal reported a deal is close. Chesapeake shares rose nearly 3%.

Chesapeake produced about 3.4 billion cubic feet of gas per day in the third quarter, while Southwestern produced 4 billion. The two producers combined would leapfrog rival EQT and likely become the largest gas producer in the U.S.

A merger would strengthen Chesapeake’s existing positions in the U.S. Northeast and Louisiana and allow it to further its strategy centered on exports of liquefied natural gas out of the Gulf Coast, where most refrigeration plants sit.

Co-founded in 1989 by charismatic wildcatter Aubrey McClendon, Oklahoma City-based Chesapeake was the poster child for the fracking boom, borrowing lavishly to acquire millions of acres across Louisiana, Texas and Appalachia. But a glut of supply drove down prices in the early 2010s and the company slashed gas drilling and diversified into crude.

The company was laden with debt as it entered the pandemic’s price spiral and in 2020 filed for bankruptcy.

Chesapeake reduced its debt by more than $7 billion through the bankruptcy process and prioritized returning cash to shareholders and solidifying its existing position in the Haynesville Shale, a large gas-producing region in Louisiana and East Texas strategically located close to the Gulf Coast’s LNG export terminals.

The company sold oil assets in Texas and reoriented its production around natural gas. In 2021 it acquired Vine Energy, a Haynesville driller, for $1.1 billion and the following year bought Marcellus Shale producer Chief and associated assets for about $2.6 billion.

The company has since announced a 36-month agreement to supply 300 million cubic feet a day of gas to Golden Pass LNG, an export terminal on the Gulf Coast that is due to come online in 2025. Chesapeake has also signed preliminary agreements to supply LNG to trading houses Gunvor and Vitol.

A predecessor to Spring, Texas-based Southwestern was founded in 1929 to provide natural gas to northwest Arkansas, before expanding into Oklahoma, and eventually the Appalachian Basin. In 2021, Southwestern acquired Haynesville producers Indigo Natural Resources and GEP Haynesville in back-to-back deals collectively worth around $4 billion.

The Southwestern-Chesapeake deal would be the latest tie-up in the energy industry, as investors urge producers to scale up. In October Exxon Mobil struck a $60 billion deal for Pioneer Natural Resources, followed by Chevron’s $53 billion deal for Hess.

Occidental Petroleum in December said it would buy Permian producer CrownRock for nearly $11 billion. This past week, oil producer APA said it had agreed to buy smaller peer Callon Petroleum in a deal valued at around $2.6 billion.

Synopsys and Ansys are in exclusive talks, and a deal could come as soon as next week

Synopsys SNPS -1.10%decrease; red down pointing triangle is in advanced talks to acquire Ansys ANSS -0.02%decrease; red down pointing triangle for around $35 billion in a stock-and-cash deal that could be one of the first big transactions of the new year.

The two companies are in exclusive negotiations, according to people familiar with the matter. A deal could come together as soon as the middle of next week, granted the talks don’t fall apart.

Synopsys is discussing paying around $400 per share for Ansys.

Shares of Ansys, which have run up since news of deal talks broke in late December, closed Friday roughly flat at $344.08, giving the company a market value of about $30 billion. Synopsys had a market value of $73.7 billion at Friday’s close, with the stock ending trading down 1.1%.

Cadence Design Systems, a rival company with a market value of almost $70 billion, initially approached Ansys with an unsolicited offer for the company, thereby putting it into play, the people said.

The Wall Street Journal reported last month that Synopsys was in talks to acquire Ansys and working toward striking a deal in early 2024.

Canonsburg, Penn.-based Ansys makes software that helps predict how products will or won’t work in the real world, according to its website. It is used in the aerospace, healthcare and automotive industries, among others. The company booked revenue of roughly $2.1 billion in 2022.

Sunnyvale, Calif.-based Synopsys makes software that engineers use to design and test silicon chips used in everything from smartphones to self-driving cars and other forms of artificial intelligence. Synopsys’ customers include Nvidia, Advanced Micro Devices and Intel.

The companies have joined forces in the past. In 2017, they announced a partnership to integrate Ansys’ technologies with some of Synopsys’. It was meant to help overlapping customers of the two companies use their products more efficiently.

A deal for Ansys would also give Synopsys certain solutions around simulation and analysis that it previously wasn’t able to offer at scale, and ones that its customers require.

Plane returned safely to Portland, Ore., shortly after takeoff; FAA is investigating

An Alaska Airlines flight made an emergency landing in Portland, Ore., Friday night after a section of the new Boeing 737 MAX ripped away in midair.

The plane, with more than 170 passengers and six crew, returned to Portland safely after experiencing an unspecified incident shortly after its departure, Alaska said. The airline said it is investigating.

“While this type of occurrence is rare, our flight crew was trained and prepared to safely manage the situation,” the airline said.

Photos and video that passengers posted on social media showed a gaping opening in the plane. Oxygen masks dangled down.

The Federal Aviation Administration said that the plane returned after its crew reported a pressurization issue. The FAA and the National Transportation Safety Board both said they are investigating.

The Boeing 737 MAX plane was certified by the FAA in November.

Boeing said it is aware of the incident and was gathering information. “A Boeing technical team stands ready to support the investigation,” the company said. A spokeswoman declined to comment further.

The Alaska flight departed shortly after 8 p.m. ET en route to Ontario, Calif., and reached a maximum altitude of about 16,000 feet before flying back to Portland International, according to aviation tracker Flightradar24. The airline used the Boeing 737 MAX-9 model for the flight, Flightradar24 said.

Two crashes of the 737 MAX in 2018 and 2019 grounded the jets around the world for almost two years. The accidents took 346 lives and drew scrutiny from federal regulators and lawmakers. Both crashes were of the smaller MAX-8 variant.

Alaska has 65 of the MAX-9 aircraft type involved in the incident Friday night, which it has said are ideal for long-haul routes with high demand. United Airlines, which also operates the MAX-9, didn’t immediately comment.

Given existing options to gain listed exposure like MicroStrategy, the real problem is finding a use for the crypto assets

The cryptoworld has been abuzz in recent weeks about the likelihood that the Securities and Exchange Commission will soon greenlight a bitcoin exchange-traded fund.

The idea that such an ETF will soon be offered to hungry, if misguided, US investors has helped provide a year-end kicker to the remarkable rally in bitcoin from the depths of its latest “winter” in late 2022. It became one of the best performing investments of 2023, rising around 160 per cent over the past year to nearly $44,000.

That is quite a turnaround given the crypto world has been on the ropes reputationally often during the past year or so. Not only has there been the bankruptcy of crypto exchange FTX and the criminal conviction of its founder Sam Bankman-Fried, but also its chief rival Binance agreeing to pay $4.3bn in penalties related to money laundering and breaching international sanctions. That was one of the largest corporate penalties in US history. Binance founder Changpeng Zhao also pleaded guilty to failing to protect against money laundering and resigned from his position.

But if you think about it, there has already been a way for investors to play the bitcoin rollercoaster for years: by buying, or selling, the stock of enterprise software company MicroStrategy which has hitched its fortunes to bitcoin, rendering its sales of enterprise software somewhat irrelevant to its stock market valuation.

Under a strategy driven by the company’s 58-year-old, MIT-educated executive chair Michael Saylor, MicroStrategy has been buying bitcoin since 2000. “Due to its limited supply, bitcoin offers the opportunity for appreciation in value if its adoption increases and has the potential to serve as a hedge against inflation in the long term,” it said at the time. MicroStrategy is thought to be the largest listed holder of bitcoin in the world. The company owns 189,150 bitcoins, purchased over the years at an aggregate price of around $5.9bn, as of the end of December.

MicroStrategy’s software operations have brought Saylor into the regulatory spotlight. In 2000, he agreed to pay $8.3mn plus a $350,000 penalty to settle SEC charges of materially overstating software revenues and earnings. But when bitcoin was riding high, say around November 2021, when its price hit $69,000, he drew a lot of attention. He even bedazzled Tucker Carlson for more than an hour about the wisdom of the cryptocurrency before the television anchor was defenestrated from Fox.

Saylor is a true believer, and an articulate one at that. His interviews about bitcoin are lengthy and spellbinding. He speaks in complete paragraphs. You come away from listening to him convinced that bitcoin is the next great innovation in the financial world. And then, you step back, give it a thought or two and remember that Jamie Dimon, CEO of JPMorgan, said of cryptocurrency, “If I was the government, I’d shut it down.”

Saylor relinquished the role of the CEO of MicroStrategy in August 2022 to become executive chair after yet another bitcoin plunge. At the time, the company had reported cumulative impairment losses of nearly $2bn on its digital assets since acquisition.

But thanks to the run-up in the price of bitcoin in 2023, MicroStrategy’s hoard is now worth more than $8bn, giving the company a gain of some $2bn on its investment. Not surprisingly, MicroStrategy’s stock price also outperformed in 2023, up more than 330 per cent for the year. Its market value of around $8.8bn means that investors are valuing its software business at around $800mn. (That is still hefty given MicroStrategy made a small pre-tax profit of around £13mn on revenues of $371mn in the nine months to September 30, after taking into account share-based pay but excluding impairments on its digital holdings.)

So MicroStrategy is essentially a play on bitcoin and has been for years. In other words, there’s been no need to wait for the SEC to approve a bitcoin ETF, it seems to me. Saylor himself told CNBC: “We’re kind of like your nonexistent spot ETF.”

The problem with bitcoin isn’t that there hasn’t been a way to speculate on it. The problem with bitcoin is that it’s all about speculation. We don’t need new ways to speculate on the cryptocurrency. What we need, if bitcoin is going to be the saviour its advocates want us to think it is, is a use for bitcoin.

When it can be used to buy and sell the things we want, as seamlessly as fiat currency, that’ll be the game changer. The real excitement for bitcoin won’t come from the SEC authorising new ways to speculate on it, but rather when there’s more to it than just speculation.

For 6% yields, consider shares of a comatose wireless carrier and a bloated bank.

You see, this is why I didn’t do well as a stockbroker. But a little acceptance of the two companies’ flaws might be in order here.

The U.S. stock market is increasingly driven by artificial-intelligence world beaters. Its seven biggest tech companies are now worth more than the combined stock markets of Japan, Canada, and the United Kingdom, points out private-equity investor Apollo Global Management. For index fund buyers, valuations look puffy, with the S&P 500 index back up to 20 times earnings.

But there are still plenty of cheapies. Only 27% of stocks in the S&P 500 outperformed the index last year—the narrowest leadership in data going back to 1987. I count more than 150 index members trading below 15 times forward earnings projections.

A few of these companies are deeply challenged, but most are just unexciting. For example, Conagra Brands makes a frozen economic miracle called Marie Callender’s Chicken Pot Pie. Walmart sells the 10-ounce, 610-calorie one for $2.98. This past week, Conagra cut its sales guidance, saying that stretched shoppers are doing more scratch cooking. Shares lost 2%. I suppose they’re inexpensive at 11 times earnings, with a 4.9% dividend. But the sub-$3 dinner market sounds like a tough place to find returns.

Two stocks that are even further out on the value end of the S&P 500 attracted analyst upgrades this past week.

Let’s start with Verizon Communications, which KeyBanc Capital Markets took to Overweight from Sector Weight. A report outlining the bank’s reasoning contained the saddest of bullish points: “Adjusted Ebitda” growth is projected to top 2% this year, versus zero in 2023, which would be the second-fastest rate since 2018. In other words, a financial measure engineered for flattery might show barely perceptible improvement, which would qualify as better news than usual.

There are some brighter points, it turns out. One is that the wireless industry looks poised for benign competition in 2024. Subscriber counts are broadly growing. Churn, or the rate of customer defections, is stable. Device promotions don’t look overly generous. Revenue per user is rising. And funding needs for network investments are falling.

Easing competition could be particularly helpful for Verizon, which has been a market share donor for years. Its share of postpaid accounts, or ones with recurring monthly billing, fell from over 41% in 2019 to an estimated 36% last year. KeyBanc predicts steady improvement in net customer additions from here.

Broadband momentum is another plus. KeyBanc sees telecom players in broadband generally gaining market share from cable. Verizon in particular is estimated to have added more than a million connections in 2023, net of losses, counting 5G and Fios. AT&T is estimated to have lost broadband connections overall. Both trends appear poised to continue this year.

All of this should be good for Verizon’s free cash flow, which Wall Street sees approaching $19 billion this year, or 11.5% of the company’s market value. That makes its dividend yield of 6.7%—a high enough figure to raise suspicion—appear sustainable. It also makes debt reduction in 2024 look likely, and stock buybacks in 2025 not out of the question.

Shares, at a recent $39 and change, trade at 8.5 times forward earnings projections. The five-year average is just over 10 times. KeyBanc sees potential for a near-term rise to $45 a share. Add in the dividend and that would work out to a total return of more than 20%.

Let’s move on to Truist Financial. It’s both huge and not quite familiar to investors, for good reason. The company was formed by a 2019 merger between SunTrust and BB&T, making it the No. 6 bank by deposits. And it gave itself a new and totally made-up name. Atlanta Braves fans, at least, are basking in the branding—they see games now at Truist Park, formerly SunTrust Park.

So far, the merger has been a dud for shareholders, who are down 21% since the closing date, and that’s counting the hefty dividend yield, recently 5.6%. The S&P 500 over that same stretch has returned 57%. The stock is up 30%, though, since Barron’s recommended it in September. BofA Securities this past week upgraded Truist shares to Buy from Neutral, giving a few reasons for optimism.

More so than its peers, Truist’s net interest income stands to benefit from the Federal Reserve shifting from interest-rate hikes to cuts, as expected. Long term, a footprint in the U.S. Southeast bolsters growth prospects. Cost cuts should help. Management aims to bring cost growth down from 7% last year to a range of flat to negative 1% this year.

Savings will come from shrinking the workforce and branch networks and consolidating tech and administrative work. BofA says there is room for cost-cutting to continue beyond 2024. A recent shrinking of the board and some senior management replacements suggest that change is gathering pace.

There is also Truist’s 80% ownership in Truist Insurance Holdings, the sixth-largest U.S. insurance brokerage. Selling that stake would free up cash to refinance debt and boost earnings per share. BofA calls that business “differentiated” but “not strategically integral,” which I’m pretty sure nets out to a “ditch it.”

Shares, at about $37, sell for 10.8 times estimated 2024 earnings, versus over 13 times before the pandemic. BofA says they ought to be able to fetch $43 within a year, which would put the total return on this one, too, at over 20%.

Growth stocks and large-caps led the market in 2023. That suggests the best bargains now reside among value and small-cap names.

That’s the view of Jonathan Boyar, head of Boyar Value Group, a New York–based asset management and research firm that compiles an annual list of 40 undervalued stocks with potential catalysts for a turnaround. “There are a lot of good opportunities in small-caps today, but you have to be choosy,” Boyar says. “Almost half [of small-caps] are unprofitable, and debt maturities are coming due.”

Boyar Value has compiled the so-called Forgotten Forty for the past 30 years. The portfolio has gained an average of 9.9% annually over the past 15 years, versus 8.4% for the Russell 3000 Value index. But it has lagged behind the S&P 500’s 11.8% average annual gain in that same span.

Barron’s recently spoke with Boyar about five ideas from the 2024 edition of the Forgotten Forty.

Medtronic, a maker of medical devices, has been buffeted in the past few years by supply-chain disruptions and the underperformance of the company’s diabetes-management business. The latest hit to the stock came from investor excitement about a new class of weight-loss drugs; their uptake is expected to dent demand for various medical procedures and devices.

Boyar sees aging populations in developed countries and improving standards of medical care in emerging markets as long-term tailwinds to the sale of medical devices and equipment. Medtronic has a promising robotic-assisted surgery system, he notes, with a lot of growth potential.

Medtronic shares have fallen almost 40% from their mid-2021 high, and now trade around $84. Boyar applies a five-year average enterprise value-to-Ebitda (earnings before interest, taxes, depreciation, and amortization) multiple of 17 times to fiscal 2025 estimated Ebitda, to yield a price target of $121 a share—a prospective gain of 44%. That’s before a dividend yield of 3.3%. Medtronic has lifted its payout for 46 consecutive years.

Boyar also sees a favorable risk/reward for Comcast stock, up 16% in the past year. The company’s Xfinity cable business is highly profitable, and its NBCUniversal Media unit has the best balance sheet among traditional media companies.

Although broadband subscriber growth has slowed, Boyar says Comcast has been able to continue growing due to price increases. Network investments should yield more subscriber growth in the future. NBCUniversal has generated cash from the sale of Comcast’s Hulu stake to Walt Disney. Meanwhile, its theme parks are performing well, and losses are shrinking at the Peacock streaming service.

All that means plenty of free cash flow to direct toward Comcast’s dividend—current yield: 2.7%—and share buybacks. The company has returned more than 20% of its market value since the start of 2021. Boyar calculates an intrinsic value estimate for Comcast of $70 a share, up 63% from the stock’s recent $43.

Atlanta Braves Holdings is a holdover from the 2023 Forgotten Forty, but it is a different stock today. Until July 2023, it was a tracking stock representing ownership of Major League Baseball’s Atlanta Braves, whose parent was John Malone’s Liberty Media.

After a spinoff, the Atlanta Braves is now a stand-alone, public company. That paves the way to an eventual sale of the team. Sports franchises are trophy assets that trade on prestige and scarcity value, not business fundamentals or team performance—with valuations seemingly climbing ever higher.

Boyar values the Braves at nearly $3 billion, a 15% premium to Forbes’ valuation of the franchise. He assigns another $356 million in value to real estate holdings around Truist Park, the Braves’ home.

Adjusting for cash and debt, Boyar gets an equity value of $3.4 billion for the Braves, or about $55 per share, compared with the stock’s recent $42. It just might take a sale of the team to get there.

IAC’s portfolio looks set for a strong year in 2024, Boyar says, with improvement in the fundamentals and the option of monetizing holdings. The Barry Diller–founded holding company owns shares of publicly traded Angi and MGM Resorts International, plus stakes in Dotdash Meredith, Care.com, and Turo.

Boyar expects revenue and earnings at Angi and Dotdash Meredith to improve in 2024. A Turo initial public offering would be another positive catalyst. IAC owns about 30% of the car-sharing platform, which it carries on its balance sheet at a total-company valuation of about $1.3 billion. More recent purchases of Turo equity have been at a valuation closer to $3 billion. An IPO could help close the gap.

Shares are too cheap given the sum-of-the-parts value of IAC’s holdings, Boyar says. Its stakes in MGM and Angi are worth $2.8 billion and $1 billion, respectively, at recent prices, and it has $619 million in net cash. Added together, those figures exceed by more than $150 million IAC’s recent market value, before considering the value of any of its other holdings, which Boyar puts at around $1.5 billion. The sum-of-the-parts math gets to $69 per IAC share, 33% more than the stock’s recent $52.

Interactive Brokers Group is a unique player in the online brokerage industry. It is smaller but faster-growing and more international than peers. Compare IBKR’s 2.5 million accounts—growing by more than 20% a year—with Fidelity’s 43 million or Charles Schwab’s 35 million.

Unlike major U.S. online brokerages, which have moved to zero-commission trading, 95% of IBKR clients pay fees. That is largely a function of the international user base: Payment for order flow, which supports the zero-commission trading business model, is already or soon will be banned in Canada, the U.K., Australia, and Europe.

The result is a highly profitable business: IBKR generated $2.1 billion in pretax earnings on $3.1 billion of revenue in 2022. IBKR also has a “fortress” balance sheet, Boyar says, with more than $9.4 billion in excess capital. He values the stock at 20 times 2025 expected earnings—versus a 10-year average multiple of 26 times—or $124, representing 43% upside.

The 2023 Forgotten Forty had some notable winners, including Uber Technologies, highlighted in Barron’s and up 123% in the past 12 months, and Booking Holdings, up 62%. If investors embrace more value-oriented and small-cap stocks this year, as Boyar expects, the latest list of names will be forgotten no more.

Chile’s Lithium Deal Is Good News for EVs

Chile’s government sneaked in a last-minute New Year’s gift for the coming generation of electric-vehicle owners around the world: a public-private partnership to extend the life of the world’s cheapest lithium basin by 30 years.

That would be the Atacama salt flats in the high Andean desert, where local miner Sociedad Química y Minera and U.S.-based Albemarle produce a quarter of the global supply of the essential mineral for EV batteries. SQM’s concession was set to expire in 2030. That will now move to 2060, as the firm enters a 50-50 joint venture with state copper giant Codelco.

The deal marks a pragmatic tilt for Gabriel Boric, the 37-year-old ex-student activist who became Chile’s president in 2022, vowing extensive progressive reforms. He’s making common cause with SQM’s dominant shareholder, Julio Ponce Lerou, a son-in-law of late dictator Augusto Pinochet who was fined in a stock manipulation scandal 10 years ago. “For the government, Ponce has been considered a sort of devil,” says Juan Carlos Guajardo, founder of the Plusmining consultancy in Santiago.

Chile will need a lot more compromise to fulfill its lithium destiny. The nation of 20 million sits on the world’s largest proven reserves. But exploration has been constrained by a Pinochet-era law designating lithium a strategic metal, for its presumed importance to nuclear energy. Moves to scrap that statute have been stymied by divisions between statists and free marketers in Congress, says Francisco Acuna, a Santiago-based consultant with raw-materials specialist CRU. “There’s a political paralysis around lithium,” he says.

Australia has taken advantage to power past Chile in production of the now-strategic metal. Neighboring Argentina should surpass it by 2028, shrinking Chile’s global market share to 15%, CRU projects.

Plenty remains unresolved on the Atacama deal itself, which is still in memorandum-of-understanding, or MOU, stage. The current extraction method there—sucking lithium brine to the surface and then letting the liquid evaporate over a few months—could exhaust water resources over the next 35 years. Sustainable exploitation depends on so-far unproved improvements like reinjecting brine or “direct extraction” of metal from underground deposits. “There’s guidance in the MOU on ‘moving toward new technologies,’ but it’s very vague,” Acuna says.

Albemarle’s concession, in a different section of Atacama, stretches until 2043. So, it isn’t a primary concern for now. SQM and Codelco will pool resources at a greenfield deposit called Maricunga. Production there is years away, at best.

Argentina’s lithium prospects benefit from that country’s federal structure, which has given mining-friendly governors in two northern provinces a free hand to nurture investment. An obstacle, Acuna notes, is the national government’s tangle of currency controls, which can keep foreign investors from repatriating profit. Just-elected pro-business President Javier Milei may lack the political strength to untangle them. “It will take a bit more time to see if Milei can change course,” Acuna says.

Consultant Guajardo, for his part, is opening an office in Melbourne. “It looks like Australia will do the right thing in the current mining boom, while Latin American countries struggle,” he says.

Chile’s cost advantage may grow increasingly important as the lithium market matures, though. Prices plunged 80% last year to below $10,000 a ton. Guajardo sees them settling at $20,000 to $25,000 over the next decade. “Lithium is not a scarce mineral, and that’s starting to be evident on the supply side,” he says.

More good news for EV manufacturers and drivers.

Renewable energy will make life more complicated but could be a boon for the companies providing it.

The year is 2051 and newly married, first-time homeowner Olivia is driving to work. (Olivia was one of the most popular baby names in 2020, and she has just turned 31.)

She parks her electric vehicle at an office building at 6:45 a.m. and plugs in her EV, getting a free charge at work. About half of the vehicles sold in the U.S. are still gasoline-powered, but there are enough EVs that it makes sense to get there early. Just after lunch, Olivia gets an alert on her phone that her car isn’t charging. On this scorching July day, the electric company needs the energy to meet peak cooling demand. She understands—and also understands the opportunity it offers, as she taps a “sell” button on an app. Her car starts to discharge electricity to the building’s battery, which will power the lights and air conditioning during peak hours, lowering the building’s total cost of operating by not relying on the grid.

Olivia gets something, too. By the time she leaves work, her car has discharged about 40 miles worth of electricity, knocking $3 off her monthly bill. She could have sold more, but she wanted to make sure she had enough left to get home.

Olivia’s car isn’t the only thing responding to the heat wave. So does her two-bedroom bungalow in a nice suburban neighborhood, which uses a heat pump to cool down. In an alert on another app, she learns that the electric company had lowered her thermostat to 68 degrees in the morning, cooling her home ahead of expected peak demand. The utility then set the thermostat to 75 degrees in the afternoon, and reset it to 72 degrees about an hour before she got home.

Olivia isn’t surprised—she elected to allow the utility to change temperatures to get more favorable rates. Now she’s thinking about adding solar panels and battery storage to her home so she can sell power back to the grid when demand is highest. There would be an upfront cost, but her electricity bill would drop even further.

Sure, it’s complicated—and Olivia isn’t always a fan of the apps that keep pushing alerts to her phone. It’s worth it, though. Olivia spends less on electricity and gas than her parents did a generation ago. Welcome to the grid of the future.

Getting there won’t be easy. “The grid” refers to everything that goes into the production, storage, transmission, distribution, and consumption of electricity, and it’s set to go through big changes. Production of electricity will have to increase as power-hungry data centers proliferate along with EVs, and as home heating and cooling go electric. The sources of all that electricity will shift to more-renewable sources like solar and wind, which will also necessitate more energy storage assets—think batteries—as well as more-robust transmission lines. Behind the curtain will be more software and artificial-intelligence tools coordinating it all.

For homeowners, it means more complexity in exchange for a lower total energy bill. For utilities, it means growth. And for the companies that build grid infrastructure, make the electrical hardware, and write the software to control it all, it means big opportunities.

Not much has changed for the power grid over the past couple of decades. The U.S. consumed about 4.2 trillion kilowatt-hours of electricity in 2022, a record, but overall demand has been sluggish—just 0.4% growth annually since 2000. About 60% of that comes from burning coal and natural gas. Another 20% comes from nuclear power, with another 20% from renewable sources.

The subdued demand growth has meant that the industry has been focused on the maintenance of existing assets, and not investing for the future. The transformers—those buzzing boxes that convert voltage into levels that can be used in homes and offices—are essentially identical to the ones used 20 years ago. The biggest change homeowners may have noticed is the automatic meters that have replaced the monthly visits by a utility employee.

All told, publicly traded electric utilities have spent some $134 billion a year on average maintaining their $2 trillion asset base, according to the Edison Electric Institute, with few dollars going to drive the modest growth.

Such complacency won’t cut it in the years ahead. Data centers are growing as more data move to the cloud. What’s more, AI computers are power hungry, needing five or six times more power compared with their less-sophisticated computing ancestors. Heat pumps, which are replacing conventional heating and air conditioning, shift demand from natural gas and heating oil to the grid. While the transition away from internal combustion engines to EVs hasn’t happened as quickly as some imagined, it’s still happening—and powering all of those cars will take a lot of electricity. Right now, EVs account for less than 1% of total electricity demand. That could be anywhere from 5% to 15% by 2050, depending on how fast EVs get adopted.

All told, electricity use could grow by 2% a year over the next decade, ending years of stagnation. “I just think we’re going to have massive amounts of electrification everywhere,” says Reaves Asset Management CEO Jay Rhame. “Every utility has a story where demand growth is the highest it has been in forever.”

Demand isn’t the only thing that’s changing—so is how electricity is produced. In the past, coal- or gas-fired power plants would be cranked up as needed to deliver electricity. For the most part, it has worked. But that’s about to change. New capacity is desperately needed—the Department of Energy sees capacity expanding by 2.6% annually over the next 20 years, about double the rate since 1990—making the grid 70% larger. Roughly 70% of that will be renewable, a source of energy that is more dependent on climate conditions than fossil fuels.

Production will also be increasingly decentralized. Utilities will still generate the bulk of the electricity, but it will also come from a Walmart store with a solar roof, a Tesla

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owner with a backup battery, or a homeowner with a standby generator made by Generac Holdings. They’re all potential producers that will be able to send electricity to the grid at times of peak demand.

All of that is still very much a work in progress. As unpopular as a local utility might be when prices spike, the U.S. grid is incredibly reliable. The average American spends about six or seven hours without power each year. Decentralization could lead to more price volatility, with electric-power prices rising faster than inflation at times, and customers will be forced to deal with a less reliable grid, with a neighborhood transformer going down when too many EVs plug in all at once—a problem that can be addressed with newer, more sophisticated equipment.

In the worst-case scenario, the result looks a lot like Texas in February 2021, when millions of residents lost power for as many as four days, due to severe cold. Both natural gas and wind assets failed, with a lack of gas production accounting for a significant portion of outages.

Some of the problems will be solved by creating better infrastructure, including the development of higher-capacity cables, which would add transmission capacity without increasing the number of transmission towers needed, and updated hardware designed to handle the ebbs and flows of demand. Texas, for its part, didn’t cast aside renewable energy after the blackout. Instead, it reassessed margins of safety and updated forecasting and interdependence methodologies.

The grid has “got to be slightly bigger, but a lot smarter,” says Thierry Godart, general manager of Eaton’s Energy Automation Solutions unit, which sells hardware and software ranging from smart electric meters to automation software and predictive analytics.

The industry already employs complicated acronyms, including Droms, Derms, and VPPs, for the kinds of software it needs to handle the grid of the future. Droms is short for “demand response optimization and management systems,” which can change the thermostats in houses to manage electricity demand when the grid is under strain. The more sophisticated systems include demand forecasts and logic to precool homes so there is no spike in demand following a weather event.

Derms, short for “distributed energy resource management systems,” can orchestrate the growing number of distributed generating assets including solar roofs, businesses with their own generators, and even battery storage owned by anyone. VPPs, or virtual power plants, will aggregate megawatts of electricity generation from things such as solar panels on top of a Walmart and sell them to a utility.

“It isn’t about putting in poles and wires,” says AutoGrid CEO Ruben Llanes. “Optimization and efficiency are very important.”

Over the next 30 years, some $9 trillion, or about $300 billion a year on average, should be spent adding generating, transmission, and distribution assets while upgrading in-home technology such as smart metering, connected thermostats, and smart, connected circuit breakers. Some of that will be spent by businesses looking to cut their utility bills, and some will be spent by homeowners adding solar panels to their roofs or adding batteries and backup generators to ensure they never go without power. Most of the spending will fall to the existing utilities and independent power companies.

Utilities won’t mind. The grid of the future will mean more electricity to generate, distribute, and manage—and faster growth than they have had in the recent past. The capital spending means sales and earnings growth as regulators allow utilities to earn a return on their outlays. NextEra Energy

NEE, with about 34 gigawatts of clean generating capacity, is already the largest producer of utility-scale renewable power in the U.S., with roughly 10% of total U.S. nonnuclear renewable capacity.

More important for investors, it has grown earnings at a rate of about 11% a year on average for the past three years. While Wall Street projects growth to slow to about 7% for the coming three years, that slower growth may already be reflected in the stock, which trades for 18 times estimated 2024 earnings, down from a three-year average of almost 26 times.

Edison International should benefit from being based in California, an early adopter of renewable energy. California means wildfire risks, something that has kept a lid on valuations for utilities based in the state, but more than 20% of all the cars sold in the state during the first three quarters of 2023 were all-electric, which should drive demand for electricity. Edison International’s earnings are expected to grow at an 8% clip over the next three years, up from 1% annually over the past three. Shares trade for about 14 times earnings, in line with historical levels.

American Electric Power, one of the largest utilities in the U.S., serves more than five million customers across 11 states, including Oklahoma, Texas, and Tennessee. Those states are among the fastest-growing, and power demand is increasing with the population. That provides AEP with a kicker, with the utility expected to grow at a 6% annual rate over the next three years, about the same as the past three. It trades at 15 times 2024 earnings, down from an average of 18 times.

Growth has already started to show up for the established suppliers of electrical components and software, including Hubbell, Eaton, and France’s Schneider Electric. Those opportunities are starting to be reflected in the stocks. Hubbell, a key supplier of transmission and distribution equipment to utilities, has grown earnings at an average annual rate of about 26% a year for the past three years, including fourth-quarter estimates for 2023, but is expected to grow by just 8% over the next three years.

That is probably a conservative view. Mizuho Securities analyst Brett Linzey, who has a Buy rating and $370 price target on the stock, expects the inventory adjustments that hurt volumes in 2023 to have normalized in the fourth quarter, which should help earnings beat consensus estimates. Other stocks benefiting from that dynamic include Schneider Electric, which has grown earnings at about 22% a year on average for the past three years but is expected to grow them at a 10% clip over the next three, and Eaton, which has grown earnings at 29% a year for the past three years but is expected to grow by just 9%.

The expectation that growth will return to normal is playing out at infrastructure companies that will build out the grid, too. Quanta Services has grown earnings at about 23% a year on average for the past three years, but analysts project growth of 16% for the coming three years. That solid growth is reflected in the stock, which trades for about 24 times estimated 2024 earnings. Likewise, Sterling Infrastructure provides building services for data centers, transportation, energy, and other customers. It has grown earnings at 40% a year on average for three years, but Wall Street sees that falling to about 12% a year. Sterling shares are up 120% over the past 12 months, but the stock trades at less than 17 times 2024 earnings per share.

Clough Capital Partners CEO Vincent Lorusso is a fan of Sterling. “They are just so well positioned in areas where [the U.S. is] going to continue to invest a lot of capital,” he says.

Wall Street sees earnings growth decelerating at Hubbell, Eaton, Schneider, Quanta, and Sterling. That doesn’t mean they have peaked, just that analysts are loath to assume good times last forever and tend to project normalized results into the future.

Don’t expect rooftop solar stocks like Sun Power and Sunnova Energy International to get the biggest boost from the grid of the future. There is roughly 40 to 50 gigawatts of small-scale solar generating capacity in the U.S., representing some 3% of total U.S. generating capacity, and the $2.7 billion in sales expected to be generated in 2024 is a tiny portion of the hundreds of billions spent growing and maintaining the grid. What’s more, neither stock is profitable, and neither generates free cash flow yet. They are also as dependent on interest rates and capital markets to fund their growth as they are on the grid.

First Solar, on the other hand, is a leader in utility-scale solar technology. It has a market capitalization of about $18 billion and is profitable. Sales and earnings are expected to grow at about 25% and 60% a year on average, respectively, over the coming three years. Shares trade for just 13 times estimated 2024 earnings because sales and earnings tend to be cyclical and tied to government policy.

The grid of the future could make it a winner.