Is the Hut 8 Rally Sustainable?

Hut 8 (NASDAQ: HUT) is riding the artificial intelligence (AI) wave. The company that began as a Bitcoin (CRYPTO: BTC) miner and evolved into a neocloud provider has more than doubled its share price year to date as more investors recognize that gigawatts are the new currency of the AI boom.

The advanced chips needed to support artificial intelligence are best deployed in massive clusters housed in specialized data centers. Those data centers, in turn, require prodigious amounts of electricity to operate. Hut 8 is set up to deliver that infrastructure, and the market has been rewarding it for that -- but does its rally have more room to run?

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Hut 8 has a vast gigawatt pipeline

In its first-quarter earnings presentation, Hut 8 touted more than 9 gigawatts of energy capacity. However, a closer look shows that 5.3 of those gigawatts haven't been secured yet. It actually has almost 4 gigawatts of secured power.

Data center operators have been scrambling to get as much electrical capacity under contract as possible as they build out their infrastructure for potential customers. Players across the industry have been making heavy use of financing to get those projects underway, and Hut 8 is no exception.

The company raised $4.25 billion for its Beacon Point data center project through a sale of investment-grade senior notes and sold an additional $3.5 billion in investment-grade senior notes for its River Bend data center project. Hut 8 will have to raise more capital for other projects, all of which may put pressure on its margins for a while.

The hope is that these AI data centers will eventually pay for themselves and produce substantial profits. Hut 8 has a multiyear journey ahead of it before it will fully realize the value of its backlog: So far, just 710 megawatts of its energy capacity have been monetized.

It's securing hyperscaler customers

The amount of contracted electricity supply a data center company has in its portfolio is important, and the terms some hyperscalers have agreed to demonstrate just why those gigawatts are moneymakers.

Hut 8 has secured two massive contracts with hyperscalers, the more recent of which was finalized in May. Each of these deals has three embedded five-year renewal options under the same financial and term structure that can more than double their total values, but the current terms are enticing enough.

Hut 8's first hyperscaler deal was for 245 megawatts of capacity at its River Bend site. It has a 15-year term, and it's valued at $7 billion, with expected average annualized net operating income of $454 million. That comes to an average value of $1.85 million in net operating income per megawatt.

If it brings its secured pipeline of 3.1 GW online and monetizes the full 3.8 GW of infrastructure that it would then control at that rate, it could bring in $6.97 billion per year. However, the second deal was slightly better. The Beacon Point site secured a hyperscaler tenant for 352 megawatts over a 15-year, $9.8 billion term. Hut 8 expects that contract to result in $655 million in average annualized net operating income, which comes to $1.86 million per megawatt.

Hut 8 will definitely have to raise more money to build the projects in its pipeline. However, the value of each megawatt of computing capacity it can bring online could increase over time and potentially result in higher margins for future projects.

The company's top line more than tripled year over year in Q1, but its revenues still mostly come from its crypto mining segment. Once its hyperscaler tenant contracts start producing operating income, the company's sales and margins should improve substantially. Investors are willing to buy its shares now while waiting for those contracts to play out, and that can keep the rally going.

Marc Guberti has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.