AI Infrastructure Build-Out Benefits Quality Names

0:00to discuss three standout industries in the current environment. Let's welcome in our next guest. Joining us, Jed Eller, Brook Portfolio Manager at Argent Capital Management. Jed, great to have you on. Where are you seeing opportunity right now in the market? Hey, Marley, great to be with you today. I think one area where there's opportunity are the cloud computing giants, Microsoft, Amazon, and Google, I think are all pretty compelling stocks. Those valuations have drifted down over the last year. Investors, you know, it seems like we rotate between thinking these companies are AI winners one month and then you look six months later, investor sentiment has turned quite a bit. But all the wild these companies are demonstrating accelerating revenue growth. Their valuations are becoming more appealing. As I said, in the margin compression that investors feared related to AI a couple of years ago has not come to pass. margins are actually going up at Amazon and at Google. And so as we look at these names, I mean, they're developing their own chips. How important is custom silicon to the long term economics of AI for Microsoft, Amazon, and Google?

1:07Exceptional important. These companies are handling lots and lots of workloads within their data centers for customers. Some of those workloads are, you know, very, very demanding and they require the top performing and video chips. Others are more road or standard and perform very well being used through their custom chips, which are a little bit more specialized and a little bit less kind of general purpose oriented and capable. So a mix of both is very, very important for all three companies. And the other benefit of the custom chips is, you know, they're designed in-house. And so they carry a higher higher margin profile. And that's one of the key reasons why you see Amazon and Google's margins performing so well. Microsoft's chip program is earlier in its deployment and its maturation process. And we will expect margin improvement to come from that over the next couple of years as they get a more widely deployed. And, Chad, one of the interesting points in your thesis is that these companies benefit whether the winning models are open source

2:10or closed source. There's been a lot of discussion around this, especially within video's acquisition of hugging phase. Explain that to me. Yeah, the open AI and Anthropic, obviously, two private companies that have the leading closed source models. Investors are very excited about those companies. One of the risk factors is that, you know, open source models, which are far cheaper and easier to customize, kind of encroach on or catch up to the capabilities of closed models. We've seen a little bit of that over the last six months. The most capable open AI and Anthropic models in the market, you know, the open source models have been kind of closing ground, you would say. But the cloud computing giants, Google, Amazon, Microsoft, they generate revenues via usage and consumption on their cloud computing platforms. And they charge less per task to use it and open source model versus closed. But there are lots of additional services like security and database, et cetera, that go along with the use

3:13of open source models. So the profitability of the two is really pretty similar for these big data center operators. So they're very happy to shift customers to the cheaper, more customized open source products. All right, another area you like is aerospace. And I want to walk through this one because it's struggled recently. I mean, I'm just looking at the ITA ETF right now, down more than 10% over the last month and year to date, it's only up 3%. So how are you looking at aerospace here? And what's the market getting wrong? Yeah, the market is very focused on number one, the war in Iraq and the Iraq, I meant to say Iran, sorry, the impact of oil prices from the war with Iran. And then also the increase in Boeing's production rate, both of those are risk factors for aerospace after market businesses like Transdime, GE, HIKO, and others. We think those stocks are increasingly attractive. Their valuations have become more appealing as this year is going on, and those stocks have underperformed. They're not underperforming because earn exhibits are going

4:17down. They're not underperforming because, you know, they're financial results are weak or because their revenues are declining. The opposite is true in all of those cases. Investors are just fearful that higher oil prices are going to lead airlines to cut their flight schedules, which means less demand for aftermarket services that likes these companies provide. And then the other one, Boeing increasing their production rate, more new airplanes means less wear and tear on the old ones, perhaps. I think what investors are missing though is that all of the airplanes are being used today. And the new airplanes that Boeing is delivering, that higher production rate, is going to go and in service of new routes and new new flight tracks for the various airline companies around the world. So I think that demand for aftermarket services is durable. I think these companies are going to keep growing and growing at an above GDP rate. And they also have pricing power because the aerospace industry, you know, has significant regulations on a part-by-part basis. And it's

5:18pretty difficult for airlines to toggle from one to another. So I think the outlook for these businesses is appealing. I think the valuation has gotten even more attractive. And several of these companies are really allocating capital in a shareholder-friendly manner. GE completed or announced a decent-sized acquisition today of a key supplier. TransDime has been acquiring over the last couple of years, including in the last few months and the same is true for HICO as well. And TransDime is in that that aftermarket business group that you were just highlighting, they're what specifically do you like about them, either in their fundamental or technical setup? Yeah. First of all, the business is growing double digits organically. Second, their margin has been increasing lately. So profits growing even faster than revenue. Third, valuation has come down. The stock is underperforming materially in the last year. And the stock today trades at an attractive valuation. And the company's capital allocation process is very shareholder-friendly. If they're unable to find appealing acquisition candidates, they either pay special dividends to shareholders or they buy back the stock. They've actually been

6:21buying back the stock recently, which I think is an important indicator for shareholders. In the past, when TransDime has bought back their stock, it's been because it's attractively valued and the stock has done very well over the following year or two. We're in one of those periods right now where the company's buying back the stock and I think it's a compelling buy for investors today. And, Jed, the other area I know you like is AI infrastructure. I was just talking to George Tillis about Orion Energy Systems, a small lighting company that's benefiting from the build out right now. So, who do you like here in data centers in the infrastructure play? Yeah, we think that investing with the most high quality established companies is a good way to go at this point in the AI infrastructure build out. We're in year three or four of what we think is going to be a long cycle, but there will be ups and downs and digestion periods within this build out. And so, companies like Nvidia, Broadcom, Eden on the electrical equipment side is appealing.

7:21I think applied materials is another semi-cap equipment company that we like too. So, there are a bunch of really outstanding data center CapEx beneficiaries. A lot of those stocks have underperformed over the last couple months after the all-time rally that we experienced in the second quarter. And I think that we're kind of seeing a bottoming out in that process now. I think the introduction of OpenAI's Astra Model last week has kind of shifted the market's focus. We're kind of back. It feels like we're entering that environment again that we experienced in the second quarter where data center CapEx beneficiaries stocks were doing well and software stocks and other kind of like SaaS, Pocollips, Fier, Disruption companies. A lot of the intermediary brokerage companies and commercial real estate and insurance, Thompson Reuters, those types of companies that really suffered in the second quarter are again weakening. And I suspect we'll probably see that continue here for a while as we build up to Anthropics IPO in a month or two. And, Jed, you said you liked the quality names here. So, who falls in that category?

8:25Yeah, for us, that's Nvidia Broadcom. Applied materials, Eden, Amazon, Google, Microsoft, Meta, a whole bunch of companies. A whole bunch of big names there that I've had mixed performance today, at least as I'm looking across the Big Burt. We've got some red on the screen, but perhaps as you think the trade may be turning higher here, Jed always appreciate you joining the show. Great to talk to you. Jed, Eller, Brook, Folio Manager over at Argent Capital Management.