Rudi’s View: GenAi, The Super-Megatrend, Part 2

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Part Two in a broad assessment of the new industrial revolution that is now upon us, GenAi.

Part One: https://fnarena.com/index.php/2024/06/19/rudis-view-genai-the-super-megatrend-part-1/

By Rudi Filapek-Vandyck, Editor

Next phase: more beneficiaries

Apart from Nvidia, which has managed to position itself at the heart of the GenAi revolution (think about it), the second largest beneficiary at this point in time has to be Microsoft, itself one of the earliest investors in the technology. Contrary to most companies, Microsoft has a vast network of sticky customers who purchase and renew subscriptions to its suite of software programs around the globe.

Microsoft has thus already been able to start monetising GenAi through its regular channels. Things move fast in 2024 and competing manufacturers of PCs, laptops and mobile devices have equally launched their own GenAi products, including Acer, HP, Lenovo, and Apple.

Apple and Google (Alphabet) have their own global networks and are equally eager to monetise their own Ai investments. With GenAi promising a much improved user experience versus Google search, the latter behemoth will be going through a fundamental transformation.

How quickly will we all jump on the bandwagon and start upgrading and renewing our current hardwares?

That question is not easy to answer at a time when many a household budget is under pressure, and the same squeeze applies to small and medium-sized businesses in many developed and developing economies.

But analysts in Australia have been reporting Wesfarmers ((WES)) is optimistic about the boost GenAi products are poised to deliver for Officeworks. Dicker Data ((DDR)) too expressed an oversized dose of optimism in its most recent share market update.

Macquarie analysts already calculated if GenAi shortens the average renewal cycle for computers by one year (to five from an average six), the benefit for the industry will be significant. On the broker’s calculations, shortening the replacement cycle by one year, and assuming prices go up by 15%, would result in a 34% increase for the PC market locally in 2025.

It remains to be seen if and when exactly such benefits materialise, but if we, as a society, are going to migrate towards GenAi, those who sell the products will benefit.

In Australia, the obvious beneficiaries will be JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)), for sales to consumers, and Officeworks, Dicker Data and Data#3 ((DTL)) for sales to small and larger businesses.

The big unknown: corporate execution

GenAi is promising the next modern day industrial revolution, but ultimately its success will come down to execution. The jury is still out on whether that promise will be delivered, when exactly and what its shape and practical outcome might be exactly.

The arrival of the Internet, and later the smart mobile, has had a tremendous impact on corporations and society, but no-one could anticipate the many new businesses that have been established on the back of these technological breakthroughs, or predict which businesses would succeed or fail.

For each sector specifically there are many moving pieces in play, which makes forecasting extremely difficult at this early stage. In some sectors, benefits might be achieved eventually but subsequently competed away for a no net advantage to the business, irrespective of the effort and investments made.

Note how the latest initiative by the Albanese government intends to force local banks into more transparency for financial products, at the same time as it will be easier for customers to switch to a competitor.

All of this also points to another strong motivation for businesses to join the trend: the competition cannot be allowed to obtain a GenAi advantage.

History shows not every business will be equally successful. Not every business, not even every sector will be able to adopt and adapt easily. There will be Winners and Losers. Some businesses will fail miserably.

For your typical ‘value’ investor who likes to snap up beaten down, cheaply priced assets this opens up a whole new set of risks, as companies that won’t be able to make these investments, or cannot use this new technology to their financial benefit, will be priced at a valuation discount by a share market that only reasons in black and white.

Owning these assets in the investment portfolio might only pay off when the market’s assessment is wrong, as happened in the year past with shares in CSL ((CSL)) and ResMed ((RMD)) on speculation their businesses would be heavily impacted by the GLP-1 obesity breakthrough by Eli Lilly and Novo Nordisk.

In all other cases, those who fail in tomorrow’s GenAi contest are most likely to repeat the trajectory seen for News Corp, Nine Entertainment, et cetera since 2000.

Another type of risk has become evident through recent market communications from the likes of Westpac ((WBC)) and the ASX ((ASX)), warning investors the pace of necessary investments will be of much greater magnitude in the forthcoming years. Such acknowledgment not only weighs on growth prospects generally, there can be consequences for a company’s ability to pay dividends.

The ASX, which admittedly has a series of concerns that need to be dealt with, is expected to pay out a lower dividend for the third consecutive year in FY24. The broader question is whether the general corporate culture in Australia, preferencing dividends for shareholders above making investments in IT or growth, is simply not suitable for your typical old economy stalwarts to deal with the requirements in a new Ai-inspired technological era.

A time bomb ticking for boards asleep at the wheel?

During times of technological advancements, buying ‘cheap’ can lead to a whole different investment outcome than has been the case in the past.

Having said so, the market is certainly not always right and thus there’s always an opportunity for the contrarian investor who knows better. With shares in search and data services provider Appen ((APX)) trading below 50c, a level last witnessed eight years ago, the obvious GenAi contrarian idea on the ASX seems to already present itself.

According to some, including management at the company, Appen will be a net beneficiary of GenAi. The market certainly shows no appetite for revisiting Appen’s future potential prior to tangible evidence of that thesis emerging.

Identifying future beneficiaries

Having said all of the above, GenAi very much favours digital and online businesses, and this makes some businesses better positioned to adopt and integrate the new technology than others. GenAi also thrives on databases filled with data, so businesses with proprietary data have an instant advantage.

Logistics services provider WiseTech Global looks ideally placed to incorporate the new technology in its network, and achieve tangible benefits both for its customers and its bottom line.

A recent report by Morgan Stanley states GenAi might allow the company to reach into key adjacent markets such as customs, compliance, warehousing, and land-side logistics, effectively adding additional revenue streams.

GenAi also offers the option of better and enhanced product offerings, and the ability to integrate new acquisitions faster. WiseTech already is seen as the superior operator in its field (just ask the analyst at Morningstar). Through GenAi the company might be able to truly differentiate itself from the competition.

To illustrate the importance of GenAi when integrated successfully, look no further than Morgan Stanley’s modeling. The broker’s price target for WiseTech Global shares currently sits at $95. GenAi success would instantly shift this target to $125.

Other ASX-listed companies that might equally be at the forefront of tomorrow’s GenAi revolution in Australia include Pro Medicus ((PME)), Life360 ((360)), Sonic Healthcare ((SHL)), Transurban ((TCL)), Temple & Webster ((TPW)), Xero ((XRO)), SiteMinder ((SDR)) and, in theory, virtually every ‘quality’ online business.

In a preliminary attempt to set out the parameters for identifying future GenAi Winners, analysts at Morgan Stanley put forward a three-pronged approach, directing investors to look for companies with:

1. A track record of innovation
2. Deep engineering capability
3. Proprietary data advantage

Combining all three conditions, Morgan Stanley nominated Breville Group ((BRG)).

GenAi holds the promise of a decade-long global transformation

The emergence of GenAi already has had a big impact on financial markets. When the Federal Reserve and other central banks embarked on the steepest tightening cycle in history back in 2022, the general fear was this would drag global equities into a nasty, long-lasting bear market a la GFC.

GenAi is certainly not the only reason, but its emergence as the next technological breakthrough is one of the key factors as to why such a scenario has not materialised (at least not at the top end of global equity markets).

Similarly, if economies around the world prove stronger-than-feared throughout 2024 (i.e. no recession) then GenAi is yet again at the very least co-responsible, as it probably also is for higher-for-longer inflation readings.

This raises all kinds of questions about the way forward for central bank policies and bond yields. What if the next decade consists of higher inflation and higher bond yields in comparison with the decade past? Won’t companies on higher PE multiples face significant de-rating just like what happened in 2022?

I think not, unless we’re talking doom and gloom with significantly higher inflation and bond yields. While nothing is per definition impossible, it’s hard to see how such a scenario can be anyone’s base case outlook.

Investors can draw their own conclusion from the fact share prices in GenAi beneficiaries are making new all-time highs this year with bond yields significantly higher, albeit, admittedly, on the general expectation central banks will soon all be cutting rates (with a few exceptions) as inflation and bond yields will continue to trend lower.

The one key lesson history teaches investors is that ‘growth’ pretty much heals and conquers everything, over time.

GenAi holds the promise of a decade-long global transformation, with significant rewards for companies operating in the right place, with the right tools, and the right products and services.

History also shows all of the above will most likely accumulate into the next financial bubble, just like what happened prior to the 1930s and throughout the late 1990s. But should this outcome be on investors’ mind already?

One hundred years ago, equities would only be in the second year of a fresh bull market that would ultimately stretch out for another seven years. What we are experiencing in 2024 is arguably still the embryonic phase of a process that will take many more years to unfold and develop.

The time to worry about bubbles forming and bursting will come, but now seems way too early for that. This won’t stop many from calling out “bubbles”, “irrational exuberance” and “the next crash forthcoming”. If, however, the end of the Ai-driven uptrend arrives in 5, 7, or 10 years from today, can these voices still claim to have been “correct”?

Viewed from a positive angle, GenAi is the modern day Super-Trend that is injecting fresh stimulus into existing Megatrends that had already been beneficial to companies such as Goodman Group, NextDC, REA Group, WiseTech Global, and others, also including the already favourable outlook for commodities due to the global decarbonisation and electrification, and the transformation of the global energy sector.

There will be many Winners and beneficiaries, through a variety of sectors and applications, and there will also be many laggards and Losers.

Let’s make sure we will enjoy the journey ahead.

****

More reading:

–https://fnarena.com/index.php/2024/06/14/a-bite-of-the-refreshed-apple/

–https://fnarena.com/index.php/2024/05/27/amazing-nvidia-has-fans-critics-in-awe/

–https://fnarena.com/index.php/2024/05/08/rudis-view-opportunity-in-data-centres/

–https://fnarena.com/index.php/2024/05/02/generative-ai-investing-in-the-21st-century-megatrend-part-one/

–https://fnarena.com/index.php/2024/05/09/part-two-generative-ai-investing-in-the-21st-century-megatrend/

–https://fnarena.com/index.php/2024/05/14/part-three-generative-ai-investing-in-the-21st-century-megatrend/

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

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P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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