Can Anyone Overtake Nvidia in the AI Race?

Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton.

Artificial intelligence is exploding. Many investors are narrowly focusing on a handful of names. But what if they broaden their view to other places that are offering opportunities, too? This week’s Investing Insights will look at the tech stocks driving the bull run and other areas that could benefit from artificial intelligence. I spoke with Morningstar Inc. Markets Reporter Sarah Hansen about the leader of the AI race and Morningstar’s AI outlook. Check it out.

The so-called “Fab Five” is powering the bull market. This group has moved on from the “Magnificent Seven” as demand for artificial intelligence explodes, but can anyone dethrone the leader? Morningstar Inc. Markets Reporter Sarah Hansen has written about this.

Welcome back to the podcast, Sarah.

Sarah Hansen: Thanks so much.

Should the AI Market Rally Broaden Its View?

Hampton: So, some market observers say the rally needs to broaden out beyond a few names for investors’ sake. Any sign of that happening yet?

Hansen: So, after this past earnings season, analysts say they saw lots of potential for stock market returns to broaden out, the way you’re describing. That’s theoretically good news for investors, but returns so far are telling another story. I ran some numbers for you today, and Nvidia is still the top contributor to the returns of the entire stock market this year. Nvidia alone is responsible for about a third of the market’s 12% returns so far, which is huge.

Who Is Driving the Fab Five’s Success?

Hampton: And we’ve talked on the podcast about Apple’s and Tesla’s slide this year. Their Magnificent Seven pals have now become the Fab Five. Who are they, and what’s driving their success?

Hansen: This group of five stocks you mentioned is the Mag 7 minus Apple and Tesla. So, that’s Nvidia, Microsoft, Amazon, Meta, and Alphabet. These are massive companies with a lot of cash to invest. They haven’t been hit as hard by high interest rates as many of the other companies that are publicly traded. They’re posting strong earnings, and investors are really excited about how much they’re investing in artificial intelligence. And related to your previous question, that group of five stocks is responsible for more than half of the returns of the entire market this year.

Will Nvidia Remain the Leader in the Artificial Intelligence Race?

Hampton: And with Nvidia leading the pack, can any of the other Fab Five members dethrone the chipmaker?

Hansen: So, the rise of Nvidia this year has been pretty amazing. It’s almost impossible right now to imagine another stock catching up. Our analysts rate Nvidia as a wide-moat stock, meaning it has a very durable competitive advantage. But it does have competitors, and it will be vulnerable if other companies like Microsoft and Google eventually become less reliant on its chips. That’s less likely in the near term, but maybe in the medium to long term. And the stock’s prospects will depend on how long it does stay at the front of the pack.

Tech Companies Struggling to Keep Up With the Fab Five

Hampton: And other tech names competing in the AI race haven’t seen the same success. Who is struggling as of mid-June when we’re recording this?

Hansen: So, you’re right. Other tech stalwarts haven’t seen the same success as Nvidia or as these other five companies. Intel has been one of the biggest detractors from the market’s returns so far this year amid lots of competition in its space, so has Adobe. Investors have also been pretty anxiously waiting for any kind of artificial intelligence announcement from Apple, which had been really lagging behind its competitors in that area. An announcement finally came from Apple this week at its Annual Developers Conference when it unveiled kind of a suite of new AI features. We will see. Time will tell if those features and if that announcement can reignite excitement for Apple and give the stock a boost.

AI Outlook

Hampton: And what’s Morningstar’s AI outlook?

Hansen: So, even though it might not feel like it right now, artificial intelligence technology is still in its really early stages. And our analysts don’t see any signs of AI development or demand slowing down. They’ve said that when times are good, companies will feel confident in investing in AI because it’s this super important technology for the future. And when times are more challenging, companies will turn to AI to cut costs, increase efficiency, and become more lean. So, there’s a place for AI regardless.

And then relatedly, our strategists have also encouraged investors to look beyond the companies that are most directly involved in AI and look to secondary firms that can still benefit from the technology without being on the first tier of AI companies.

Hampton: Thank you, Sarah, for explaining what’s going on in this bull run.

Hansen: Absolutely. Thanks for having me.

Hampton: Now, we’re going to rewind and bring back a couple of interviews from earlier this year that focused on artificial intelligence.

The restaurant industry is catching up with others in embracing what the technology has to offer. I spoke with Morningstar Research Services’ senior equity analyst Sean Dunlop in January about how AI can help restaurants innovate.

Can AI Speed Up Tech Evolution?

Hampton: Let’s talk about AI, or artificial intelligence. What’s the role there with that? I mean, how can AI speed up the tech evolution?

Dunlop: It has a number of interesting use cases in the restaurant space. First of all, as a cost center, there are a number of places where they can plug it into software modules and work on things like predictive scheduling or work on things like inventory management. That can really take a lot of costs out of the profit and loss statement. Secondarily, it can really serve to grow sales. So, you think about personalization in an app medium. I’m sure you’ve gotten push notifications for pizza, right, when you’re just thinking about ordering a pizza or for a burger right after the kids’ swim meet. And that’s AI. These restaurant chains have gotten extraordinarily good at segmenting consumers into cohorts. They’ve gotten extraordinarily good at serving up offers right when you want them. And they’ve gotten even better about figuring out, in terms of personalization, what you typically order with what. So, for instance, would you like to add fries to that, or would you like to upgrade to a large soft drink? So, as a sales center, AI definitely will have implications as well.

And then, in terms of line extensions, we’re starting to see companies realize when they’ve got something that could be a real hit. So, for Starbucks, for instance, 70% to 75% of beverage sales today, which is astounding, come from cold beverages, which I imagine the average listener would not have thought. I certainly wouldn’t have if I didn’t cover the company. And a big part of that is they saw the success with the cold foam cold brews, with the nitro cold brews, with the Starbucks Refreshers beverages, and they decided to say, all right, let’s lean into this and really grow that IP. I think, to summarize, it can take costs out of the equation. AI can help restaurants grow sales. And then, it can also serve really to drive menu development.

Hampton: About the cold drinks, I am very surprised. It’s going to take me some time to get used to that.

Dunlop: It’s wild, yeah. It’s not a hot coffee business.

How Digital Adoption Can Grow Bottom Lines

Hampton: You’ve written that restaurants can grow their bottom lines without raising prices on customers if they shift toward digital adoption. Explain how.

Dunlop: This became particularly pressing in 2021 and 2022, and we saw those massive wage increases. We saw a big uptick in commodity costs. Restaurants really tried to pass that through with pricing. So, there were phases where we saw 15%, 16% annual pricing in the restaurant industry. And really, it’s only been recently that consumers have started to balk at that. They’ve gotten a little bit of sticker shock. It costs more or less $4.50 more to get a quick service meal today than it does to get a similar meal in the grocery channel or in the convenience store channel. And so, we’re starting to see traffic declines industrywide. So, our recommendation is that operators take a much different tact moving forward. They lean a little bit less heavily on pricing and a little bit more heavily on using some of these restaurant technologies to really take costs out of the equation.

The three big ones that we identify are inventory management—33% to 40% of restaurant food is actually wasted. So, even just a 15% reduction can unlock 2 points of margin. We’ll get at labor scheduling. So, payroll scheduling and tip management typically takes about eight hours of general manager time per week. That can come down to two with some of these modules. That unlocks another 40 to 50 basis points of restaurant margin. And then, digital ordering is really, really effective for this as well because you think any order that comes through digital channel, through your Starbucks or Chipotle app, is not getting taken by somebody at a point-of-sale, at a register or in the drive-thrus. That really allows employees to focus on the customer experience and to focus on making food.

Restaurant Industry Forecast for 2024

Hampton: What is your forecast for the industry in 2024 and beyond?

Dunlop: In a sentence, I’d say in 2024 I’d expect low-single-digit nominal growth. And I think the biggest players can probably take a little bit more share than that. They’re the ones that are going to be able to continue to invest in the cycle and build new units, even in an environment where capital is tight and where restaurant margins are below historical median levels.

Now, that said, I think 2024 is going to be quite challenging for the industry. We’ve seen declining traffic for the last 18 months. In the restaurant industry more broadly, we’ve seen consumers trading down the menus. So, we would call that “mix” has declined, and that might be maybe I don’t order french fries, or maybe I order small fries instead of large fries, maybe I don’t get a combo meal. And that is pretty consistent with downturn behavior, what we usually see with consumers. We would expect, given the widening gap between the grocery and convenience store channel cost, and between restaurants, we’ll probably see a little bit more traffic shift that way in 2024. So, on balance, I would think of pricing as being sort of 2% to 4%. Mix is probably being negative, traffic is being negative, so we’re looking at low-single-digit growth.

Beyond that, I think a lot of the structural pieces are still in place. So, restaurants are—it’s been well publicized that they’re moving closer to consumers. You’ve probably seen them popping up in suburban markets. You have a lot more drive-thru concepts. They’re really much more convenient. Delivery times are faster. Access is easier through mobile order channels, through omnichannel access. And consumers are now spending about 55% of their total food budget at restaurants, up more or less 10 points since the early 2010s. So, we see no structural reason for that to change over the next few years and still think that the industry can grow faster than GDP.

Hampton: Here’s an update from Sean. He says Starbucks, McDonald’s, and Yum Brands are some of the companies investing heavily in restaurant technology.

Now, let’s go back to a conversation I had with Travis Miller in May. The energy and utilities strategist for Morningstar Research Services explained why investors interested in AI shouldn’t overlook utilities. Here’s our discussion.

Utilities Stocks: When Will the Market Give the Sector Some Respect?

Hampton: Why do you think the market has not given the utilities sector its respect?

Miller: This is really cool to be here and talking about the utilities sector because we’ve got a generational change going on here in the sector. This is not something we’ve seen in 20 and 30 years, and let’s give it its due, toward artificial intelligence. These data centers that are coming up here take a lot of electricity. You’ve read the headlines, and the numbers are even greater than what we see in the headlines right now. Utilities are going to benefit, and it’s been a fun time here as we look forward.

Where Do Utilities Fit Into AI Growth?

Hampton: Many investors are paying a lot of attention to companies and sectors at the center or near AI. Where do utilities fit in this growth? You mentioned that it’s powering it. What else you got?

Miller: We’re just in the early stages here. We’ve heard a couple of announcements. I’ll just give you a couple of details here. Wisconsin is turning into a big data center hub. You wouldn’t think about the Midwest, but the Midwest is really a focus point here for a lot of these data center developers. So, to give you one number, Wisconsin Energy in Southeast Wisconsin, Microsoft just announced one project that’s under construction and the potential for three more. That could increase Wisconsin electric demand by 10%. Give you a sense there, Wisconsin electricity demand’s grown 6% in the last 20 years. So, within five years we could more than double the growth in electricity demand just in Wisconsin.

Another example, in Georgia, Southern Company, the largest utility in Georgia, just took their demand estimate up by almost 50% during the last two years. Microsoft has six data centers there in the Atlanta suburbs, either in construction or planned.

One more data point, these are coming in every day: In Mississippi, AWS [Amazon Web Services] announced a $10 billion project there for data centers. The largest industrial project in Mississippi state history. All of that’s going to need electricity.

Hampton: And now Travis has an update. He says Microsoft has announced another data center project in Northwest Indiana since we recorded that interview.

That wraps up our AI episode. We’ll be back with a new conversation at this table next week. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends, and analyst insights. Thanks to Senior Video Producer Jake VanKersen and Associate Multimedia Editor Jessica Bebel. And thank you for watching Investing Insights. I’m Ivanna Hampton, a lead multimedia editor at Morningstar. Take care.

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