UBS Group AG: Data center construction to accelerate again in 2027, Carter's Incorporated Caterpillar (CAT.US), Cummins Inc. (CMI.US), and Quanta Services (PWR.US) to ride the "AI infrastructure tailwind"

UBS Group AG expects that despite persistent supply chain constraints, data center developers are still expanding capacity, and AI infrastructure demand will accelerate in 2027, creating opportunities for industrial equipment manufacturers and engineering companies. UBS Group AG analyst Steven Fisher said in an October 16 research report that industry experts attending the Data Center World Expo in Singapore said orders are accelerating, multi-year capacity bookings are continuously increasing, and there is confidence that AI infrastructure investment will continue beyond 2027. These findings indicate that even as the broader economy faces inflationary pressure, data center spending remains an important growth engine for industrial companies. Power generation and construction companies are expected to benefit UBS Group AG identified Caterpillar (CAT.US), Cummins Inc. (CMI.US), and Quanta Services (PWR.US) as beneficiaries of continued data center construction. Caterpillar and Cummins Inc. are expected to capture demand for power generation equipment, while Quanta Services will benefit from grid investment. Caterpillar told the UBS Group AG team that demand for power generation equipment remains exceptionally strong and that the company is expanding capacity. The report also highlighted growing interest in "behind-the-meter power generation," a model that allows data centers to generate power on-site rather than relying entirely on the public grid. UBS Group AG expects that by 2028 or 2029, most projects will still primarily be grid-connected, equipped with traditional diesel backup systems. The final combination of on-site generation, energy storage, and grid connection will determine how much revenue equipment manufacturers can capture. Supply shortages remain a constraint Industry experts listed equipment availability and manufacturing capacity as major obstacles to data center expansion. Suppliers of cooling systems, power equipment, and power generation technology are racing to shorten delivery times and increase output. Customers increasingly favor prefabricated and modular systems to speed up construction and reduce labor requirements. The industry is also transitioning to 800-volt DC power distribution, expected to be deployed between 2027 and 2029. UBS Group AG said the technology should reduce copper demand, heat generation, and the complexity of power distribution systems. Construction share continues to rise UBS Group AG estimates that data centers directly account for about $63 billion, or about 5%, of the $1.3 trillion U.S. non-residential construction market. However, when indirect spending on manufacturing facilities, power infrastructure, and related projects is included, the bank estimates that data centers drive 20% to 30% of overall non-residential construction activity and most of its growth. The strength of this spending contrasts with concerns about the broader industrial economy. UBS Group AG noted that inflation and rising interest rates related to the Iran conflict have complicated expectations for an industrial recovery. The bank expects higher input costs to become more evident in fourth-quarter results, especially for companies with greater exposure to fuel and materials. Caterpillar power business margins in focus Caterpillar's (CAT.US) Power and Energy segment second-quarter profit beat expectations, with incremental margins reaching 39%. UBS Group AG said consensus expects incremental margins to remain high in the third and fourth quarters but to decline from second-quarter levels. Caterpillar has warned that the exceptionally favorable incremental profitability in the second quarter may not persist. Investors are also questioning whether industrial stocks can continue to outperform if AI-related order growth slows. Fisher believes that even if the absolute level of backlog remains high, a substantial slowdown or flattening in Caterpillar's sequential backlog growth could make further outperformance more difficult. AI investment risks UBS Group AG acknowledged that the AI infrastructure boom could eventually slow as technological advances reduce computing costs and smaller AI models gain broader adoption. Such developments could suppress AI companies' profitability and reduce demand for new data centers. However, the bank still expects technology adoption to create more opportunities for industrial suppliers, while warning investors to watch the sustainability of infrastructure spending. The report also raised questions about the financial stability of newer cloud computing providers after a selloff in CoreWeave (CRWV.US) bonds. UBS Group AG said that compared with established hyperscale cloud operators, industrial suppliers typically disclose insufficient information to determine their exposure to these customers. This distinction could become increasingly important as investors assess the durability of equipment backlogs and future orders.