Following the DeepSeek news that scared the market near the end of January (cheaper cost impairing CapEx assumptions), we highlighted that the AI trade isn’t dead, but could be changing.

Since then, enthusiasm around the data center basket has faded, which was then magnified by a note from TD Cowen indicating Microsoft was cancelling data center leases.

Microsoft responded to the viral note (it’s been a while since we saw broker research go viral!), indicating that any cancellation decisions are a matter of resource allocation and that overall demand remains strong:

Investor sentiment appears to have shifted though, with our data center basket down big YTD.

With investors likely wondering what comes next for the theme, we figured it would be prudent to reassess the environment for data center stocks.

Demand forecasts, CapEx budgets still strong

According to CBRE, total supply across primary markets surged by 34% Y/Y to 6.9 GW, outpacing the 26% growth recorded in 2023.

Despite this, many are still calling for a future supply crunch, driven by demand growth led by advanced AI workloads.

Big tech CapEx expectations for the year remain elevated at ~$340B, giving us some confidence that demand is still there, though we’ll be monitoring the coming earnings prints closely for signs of deterioration.

What benefits from elevated data center capacity demand? 

Well, a lot of things (see the graphic below), but to keep it short, here are the major beneficiaries:

1. Grid infrastructure (transmission lines, voltage transformers, etc.)

2. Power supply (data centers used 2% of global power in 2022 - by 2030, projections are 3-4%)

3. General server infrastructure (cords, racking, cooling, etc.)

4. Expensive chips! (the NVDA stuff you keep hearing about)

If Celestica’s outlook from Q4 is any indication, the demand backdrop for server infrastructure remains strong…

… and so does the outlook for power demand, which will require adequate investment in grid infrastructure to support a continued data center buildout.

Baseload power seems to be the winner here, as data centers require 100% uptime and reliability, favouring natural gas and nuclear technology, as we wrote about previously.

Has value come back to the theme?

The basket looks to have come back to earth over the last month, now trading narrowly above its long-term average.

There is some variance when looking at the individual constituents, with some names screening more expensively than others relative to historical valuation.

For the first time in a long time, the data center trade is starting to look interesting again. Consider this the foundation of more work to come, as we dive into the basket segments and constituents to get a deeper look at the investment setup from here.