Investor Spotlight: Investing in Australian AI stocks

In this week Investor Spotlight, we shed light on the exponential growth of the AI market and turn the spotlight on AI investment opportunities in Australia, taking a closer look at major players on the ASX.

Growth Projections for the AI market

To provide some context around the size of the Artificial Intelligence (AI) market, Morgan Stanley estimates the total addressable market (TAM) will grow from the current US$90bn to US$275bn by 2027. This includes semiconductors, hardware, and networking.

Moreover, AI semiconductor growth is forecast to triple over the next three years to US$43bn to US$125bn. The expected IT spend on AI is estimated to reach US$3 trillion by 2029. Not surprisingly, there is a lot of interest and hype around any company that uses the word AI.

Understanding the core components of AI

The first thing to acknowledge is that the AI onion is not new. What Microsoft CEO Satya Nadella refers to as autopilot AI is essentially the humble search engine. The latest iteration is generative AI. This is software that goes beyond matching searches. It interprets and creates language and images.

The open-source software ChatGPT was launched in November 2022 and has partnered with Microsoft to embed generative AI into all of Microsoft 365 software packages, known as Co-Pilot. Meanwhile, Alphabet's AI service offering is called Bard, named after Shakespeare.

Hardware and infrastructure essential to AI

At the core of AI is terabytes of novel data which needs to be processed quickly on highly intelligent architecture, notably Nvidia’s gaming GPUs (graphics processing units). These GPUs are warehoused in massive supercomputers in the cloud, or hyperscalers and data centres, otherwise known as digital infrastructure. Microsoft (Azure), Alphabet (Google Cloud), and Amazon (AWS) are notable examples.

Further back in the supply chain, there are foundries which manufacture the GPUs, the world’s largest is Taiwan Semiconductor (TSMC); and the company which makes the machines for the foundries is Dutch ASML. One ASML machine costs US$200m. NVIDIA H100 are the current GPU being used by developers for the AI language models and are priced at around US$36,000 per unit.

ChatGPT requires hundreds of Nvidia’s GPUs to perform the generative AI software functions.

Applications of AI in various industries

AI is already being used by many companies from Disney's (DIS:NYSE) latest Avatar movie to L’Oreal (OR-FR:Euronext Paris) which allows you to try on different makeup on a digital avatar or Symbiotic (SYM:Nasdaq) which automates Walmart’s warehouses.

Generative AI can be in a language or visual format and is designed to enhance and simplify the work experience. Companies and organisations that can successfully use AI applications have the potential to produce substantial productivity gains (higher margins) as well as competitive advantage.

As AI develops, the plan is to move beyond the current machine learning to the inference or predictive phase which can be employed for end point or edge AI, such as self-driving vehicles.

There is also tremendous scope for applications in the healthcare sector via telehealth and reading of imaging and diagnostic samples. Companies like ResMed (RMD) and Cochlear (COH) are employing remote patient monitoring as part of their service offering.

Investing in AI in the Australian market

Domestically, the AI plays are concentrated in the hardware segment (digital infrastructure) of the market, specifically cloud communication services, data centres and ancillary telecommunication offerings - Next DC, Macquarie Technology and Megaport.

Equinix (EQI:Nasdaq) recently noted “Given AI compute will operate in public cloud, private cloud and in between, Equinix believes its entire suite of assets will benefit (xScale hyperscale facilities; and Co-location facilities)”.

_{Source: Goldman Sachs (Australia Technology: EQIX Analyst Day: Positive read-across for AI led growth in Australia).}

Three stocks to watch

• NextDC

NEXTDC Ltd (NXT) is the largest on the ASX with a $6.5bn market capitalisation. The company builds and operates data centres across Sydney, Melbourne, Brisbane, Perth and New Zealand and is expanding to Malaysia.

The current broker consensus has an average price target of $$13.77, offering about 6.5% upside. Macquarie has a standout price target of $15.80 and Goldman Sachs at $14.96 with a Buy rating. Macquarie notes there are some potential risks to FY24 earnings, but nevertheless has an Outperform rating.

NextDC daily chart

• Macquarie

Macquarie Technology (MAQ), no relation to Macquarie Group, has a $1.57bn market cap. The company recently raised $160m via an institutional placement at $58.50 to expand their data centres.

Goldman Sachs has a conviction buy on the stock with a target price of $77.20 and “believe MAQ is on track to building a generational vertically-integrated cloud franchise.”

Macquarie daily chart

• Megaport

Then there is Megaport (MP1) which recently provided an earnings update, which saw the share price rally over 30%.

The company is expected to be cash flow positive in the 4Q23 and has a market cap of $1.53bn with an estimated 8.1% upside to the consensus target price of $8.10, although Ord Minnett has a $13 target and Accumulate rating on the stock, followed by UBS with a Buy and a $12.50 target.

Megaport daily chart