As the digital economy continues to expand, data centres have become essential to supporting cloud computing, artificial intelligence (AI), and data storage. Canadian investors eager to capitalize on this booming sector should explore smart investment strategies to minimize risk and maximize returns. While investing in data centre-specific companies is tempting, there are other investment opportunities worth considering to create a well-balanced portfolio.
The risk of direct data centre investments
Data centres, which require massive amounts of electricity to run, are seeing explosive demand. As a result, many investors are considering direct investments in data centre real estate investment trusts (REITs), such as Digital Realty Trust (NYSE:DLR). However, jumping into data centre stocks without considering their valuations could expose investors to significant downside risk.
Take Digital Realty Trust, for instance. The company is a leading data centre REIT, expected to see solid growth in the coming years. However, its current multiple is around 31, far above its historical multiple of approximately 20. This premium suggests that the market is pricing in an optimistic future, which may not always play out as expected.
Investors who buy now are essentially betting on continued growth at a lofty valuation, with limited room for upside. Moreover, Digital Realty’s current yield is only 2.5%, which may not be attractive enough for long-term investors, especially considering the potential downside risk of the elevated price.
Alternative investments: Utilities and renewable energy
Instead of focusing solely on data centre REITs, Canadian investors could explore related sectors that should benefit from the data centre boom. A particularly promising area is utilities that supply electricity to these energy-intensive facilities. One prime example is Brookfield Renewable Partners L.P. (TSX:BEP.UN), a global leader in renewable energy. As data centres grow, so too does the demand for power, particularly from sustainable sources.
Brookfield Renewable Partners is uniquely positioned to benefit from several tailwinds, including the push for net-zero emissions, government legislation supporting renewable energy, and the surge in electricity demand driven by digitalization and AI.
The company provides an attractive 5.9% yield through a stable cash distribution, with an annual payout of US$1.42 per unit. Furthermore, Brookfield has a solid track record, a 15-year cash distribution growth rate of 5.3%. Analysts predict that the stock has about 27% upside potential, making it a solid choice for long-term growth while earning a consistent income stream.
Diversification with other infrastructure investments
For investors seeking more stability in an investment that has data centre exposure, Brookfield Infrastructure Partners L.P. (TSX:BIP.UN) offers a diversified investment opportunity. Other than data centres in its portfolio, the company also owns assets in regulated utilities, railroads, toll roads, energy infrastructure, and more. This diversified approach provides a blend of steady returns and growth potential, which may appeal to more conservative investors.
Like Brookfield Renewable Partners, Brookfield Infrastructure Partners pays a growing cash distribution, with an impressive 15-year growth rate of 10.3%. Trading at $48.76 per unit at writing, the stock is considered undervalued by about 11%, offering near-term upside of around 12%.
The Foolish investor takeaway
The data centre sector offers exciting growth opportunities, but it’s crucial to approach investments with caution. High valuations, such as those seen in direct data centre REITs like Digital Realty, could expose investors to increased downside risk. By diversifying into related sectors, such as utilities and infrastructure, investors can capitalize on the rise of data centres while maintaining a well-balanced portfolio. Brookfield Renewable Partners and Brookfield Infrastructure Partners are excellent alternatives that allow Canadian investors to benefit from the digital economy’s growth while reducing exposure to the risks of direct data centre investments.
