The AI Boom Runs Into an Unexpected Headwind

0:01Travis Hoium:The AI build out has a unexpected handwin. Motley Fool Hidden Gems Investing starts now. Welcome to Motley Fool Hidden Gems Investing. I'm Travis Hoium joined today by Lou Whiteman and Rachel Warren. And guys, we are in commencement season. The start of the midterm process has begun and that could be a problem for the multi-trillion dollar AI build out we've seen in Texas and Virginia were two of these states that a lot of these data centers are going have started to have some pushback against data centers. Moratorium was passed in Texas. I think that was kind of the most notable thing. But some of the commencement speeches are also getting booed as the speakers are talking about AI.

0:43Travis Hoium:So it seems like we're, Lou, we're really in an interesting environment where this is driving the market. This is why this is a big topic for us, I think. AI is fundamentally driving the market and almost every company that is doing really well right now, whether you're looking at energy or semiconductor stocks or materials, it's all AI tailwinds. And yet at the same time on the ground, there's a lot of pushback in the actual AI build out. So what is going on here? Is this just a natural backlash to kind of the new thing in town?

1:18Lou Whiteman:First off, and yes, I'm an old, and I need to acknowledge that, but I am here for the young booing the old and established. I have hope for the future when that happens. So please, kids, it's your big day. Boo the heck out of Eric Schmidt if you want. I am here for that. So, but to your top, to your question, I do not think this can derail or end the AI build out, but it can make it more cumbersome and slow things down. I almost think some of the companies wouldn't mind that, but it's just my pet theory, so I'm okay. But look, here's the thing. It just, this is going to be part of life now. This isn't going away.

1:55Lou Whiteman:And so I think, if anything, I think the backlash is going to accelerate, as you say, into the midterm political season. I think this is just a cost of doing business. And if the magic beans are what they say they are, it'll all work out fine. I keep coming back to what Microsoft CEO of Sato Nadella said back in January. AI must prove its worth. And AI, to this point, has not done that, especially on the consumer, I would say. Maybe sort of with Claude on the enterprise side, but this is about the consumer. The best way to make these headwinds disappear is to do that, to say, look, it's not all energy burn.

2:31Lou Whiteman:It's not all job loss. This is how we are making life better. They should get there fast. I don't think it's going to happen, though. And I do think that this is a headwind that they're stuck with for a while.

2:41Travis Hoium:Yeah, Rachel, it's wild that a technology that the leaders are saying are going to take everyone's jobs is having pushback, particularly in the communities where a lot of jobs were lost during the manufacturing move where everything moved to China. I mean, it's natural. I live in the Midwest. I live in Minnesota. It's natural, I think, to see, oh, this new data center is going in. And sure, there's going to be a handful of jobs that are going to come with it, just like an oil pipeline. But this is not going to fundamentally reshape your town or bring, you know, industry in. So are we just seeing this over again?

3:17Travis Hoium:Why do we need this data center here? It's not doing anything for us. So it almost seems like they're shooting themselves in the foot with the messaging. Yeah, and I don't think it's a surprise that there's a fundamental disconnect between maybe the excitement we see in the public markets around AI and how actual consumers are feeling about this. So there's really practical implications to that as well. I mean, you go to Northern Virginia, right? That is the world's largest data center market. There was an independent report that came out that said that skyrocketing AI demand had triggered a 76 percent spike in wholesale electricity prices.

3:49So this is really being felt by consumers. Of course, we're seeing that in the rural Texas counties, right, where they've enacted these historic moratoriums you were talking about. But it's also important to understand that there are other bottlenecks, too, right? Building high voltage transmission lines, it takes an average of five to seven years. Public grid operators cannot just scale overnight. I think it's also important to talk about the role of private credit here. So to bypass a lot of the traditional bank regulations and keep this infrastructure race alive, private credit has stepped in as the financial backbone of the AI boom.

4:22And you've got a situation where global data center expansion is projected to demand up to$5 trillion in CapEx. So you've got these alternative asset managers deploying billions in private credit loans to fund everything from the raw land acquisition to high end chips. So there's a bit of a mismatch here, right? I mean, private credit debt is structured around rapid construction, immediate leasing revenues. So if you see, say, grid power limits or moratoriums dragging out some of those timelines, there is a scenario where some of those debt service payments could come to bear without the operational revenues to cover them.

4:59The one final note I'll make is the big tech companies, the hyperscalers, they see the dangers of that failing single point of failure. They've kind of taken their own bring your own power strategy, if you will, from Microsoft to Amazon to Alphabet. And I think right now that's why these are the winners of the AI arms race.

5:17Travis Hoium:Yeah, Lou, it seems like we're in this weird space where things change so fast that we don't really have the infrastructure right now. Now, one of the ideas that Ben Thompson actually threw out, I'll give him kudos for this. We've been talking about UBI for a long time. What if the data center just came with a, hey, you know what? We'll pay everybody in town a check of a couple thousand dollars. A little bit like, you know, the oil industry does in Alaska. You know, there's taxes that that goes directly back to people. I don't think oil necessarily has such a bad connotation in Alaska because you get a nice check from it.

5:50Travis Hoium:Maybe that's the future of these data centers.

5:52Lou Whiteman:Well, they're selling oil at a profit. Which makes that easier. You know, I think it'd be good if they get profit. We already have a huge cost stack for data centers. So I don't know how AI can do that. But I mean, there's another version of that is bring your own power, which I think is the answer here. And maybe that benefits.

6:08Travis Hoium:But even that's being blocked in some states. It is. That was the thing was even they said, you know, we don't even want you even if you're bringing your own power.

6:16Lou Whiteman:Right. Right. Well, because there's water, there's a lot of things going on. There was a story near me in Atlanta about it turns out that the whole county's water bills, it hadn't been disclosed to the county. But, yeah, everybody's water bills had gone up because of a data center there. There's a lot of issues. I do think bringing around power or some sort of contributing to the grid or financing that is probably more realistic than a dividend check, at least for now. But, again, this is a cost to doing business. As an investor, I think the most interesting part to me isn't the backlash making this go away.

6:48Lou Whiteman:But we are already talking about the huge barriers or the huge hurdles that these companies need to overcome for what could be a commoditized service. If you add on just kind of some of these, whether or not they're headwinds or actual added costs because of this, it makes the ROI that much harder. And I think that should scare investors or investors should be at least be aware of that. I don't think there's any way AI gives Alphabet the return on invested capital that Alphabet has enjoyed through its history, at least not in the near to immediate term. Look, if we're layering on more costs or more issues, it just becomes that much harder to get excited about the hyperscalers for me.

7:35Travis Hoium:Yeah, it's going to be interesting. We're also seeing this coming from consumers. And at the end of the day, yes, enterprises have adopted artificial intelligence. But if consumers just don't want to, in part because of this backlash or this is a sign that they don't want to adopt AI, could be a challenge on the demand side in the future as well. When we come back, we're going to get to what's coming up for retail investors. You're listening to Motley Fool, Hidden Gems Investing.

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8:26Travis Hoium:Welcome back to Motley Fool, Hidden Gems Investing. This is the end of the traditional earning season, but that means it's the beginning of the retail earning season. Most of these companies are on about a one month lag so that they can have the full holiday shopping season in the same quarter. So a number of retailers are reporting this week. We've been talking on this show about the K-shaped economy, about how more wealthy spenders have continued to spend while maybe those spending habits have changed a little bit as you go down the income stack. But this is going to be kind of our earliest indicator of not only what spending was like in the first quarter, But we're going to hear about how things like higher gasoline prices are impacting spending in the second quarter.

9:08Travis Hoium:So, Rachel, as we go into these earnings reports, what are you looking for? Yeah, I mean, you want to look at those traditional earnings metrics for these retailers, right? Same store sales, of course, is a really important one. Traffic versus ticket size can be really helpful. And looking as well at those inventory to sales ratios at major retailers. But we are seeing very much the K-shaped economy play out, as you noted. I mean, the lowest income cohorts we've been seeing from reports are spending about four times as much on fuel as a measure of their income compared to those top spending cohorts.

9:39There was a report from the New York Fed that showed that lower income households responded to the recent two month fuel spike by cutting physical gas consumption. But their nominal gas bills still rose. And of course, the cost of fuel is also having a hit back for big retailers, too, and their transportation costs as well, which is something important to note. But the flip side of that is going back to the K-shaped economy, households that are earning over$125 ,000 have barely reduced their physical fuel usage at all. So there is that greater insulation from some of the energy shocks that we've been talking about.

10:11Now, talking about a few of the big retailers, right, you've got Walmart reporting, you've got TGX companies, parent company of TJ Maxx and many others, Target. You know, Walmart kind of tends to capture both lower income households that really need to stick to more of the essentials, but they also tend to have shoppers who are earning over$100 ,000 and above that might be trading down on costs to try to save money. TJX companies tends to cater more towards the upper leg of the K, right? They actually have a lot of wealthier shoppers that maybe want the premium lifestyle brands and are looking for deeper discounts.

10:43I think it's no secret Target's been dealing with a rough few years. They rely a lot on discretionary purchases. So they have been struggling for a long time. I think for me, even if you don't own these businesses, right, they do tell us a lot about what the consumer is doing. And that information trickles down to a lot of stocks that we do own.

11:01Travis Hoium:Lou, when you see earnings reports like this, do the numbers matter or is it what management says that matters more?

11:08Lou Whiteman:A little bit of both. I think for the most part, the quarterly numbers don't matter. Rachel mentioned traffic versus ticket. And I think that's the most interesting thing for me right now, because I don't own these stocks. I don't have any desire to own any of these stocks. But I think, as Rachel said, as a macro watcher and as someone who does own stocks and other levels, this is you got to focus on retail. Traffic versus ticket. The idea here is assuming there is revenue growth and hopefully there is some revenue growth. Is that coming from inflation or is that coming from more purchases, more people out shopping?

11:40Lou Whiteman:It's a crude but interesting way to kind of look at the health of the overall consumer, I think. But yeah, mostly, Travis, like you say, it's how they're thinking. It's guidance. It's what the future shows us. The hardest thing to do as an investor is to try to predict the future. It's hard for CEOs, too. I don't take it at the word. But if there is a theme where we think it is getting worse, that resonates with me more than whether or not they beat by a penny or missed by a penny or same store sales are up 0.1 % or down 0.1 % or something like that.

12:14Travis Hoium:Yeah, that will be interesting to see is what is the theme for the week? It seems like every earning season, especially with these retailers, there seems to be one word or a small phrase that comes out of each of these CEOs' mouths. So we'll see what that is. When we come back, we're going to stick in retail and talk about the drama going on at Lululemon. You're listening to Motley Fool, Hidden Gems, Investing.

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14:23Travis Hoium:Welcome back to Motley Fool Hidden Gems Investing. Lululemon's proxy fight with Chip Wilson is heating up. Lou, this is right up your alley. You love a good proxy fight. He wants a few seats on the board. I think three seats on the board, two that he wants to assign. And then they can choose from a group of people for the third seat. Also wants to meet with management once a quarter. I thought that was an interesting ask. I just want to go hang out with management and give my thoughts once a quarter. But Lululemon said no. That's too far. That's too far to go. when you look at this or any proxy fight in general, what should investors think?

15:01Lou Whiteman:So investors, look, it's very important that you pay attention to these things if you own the stock. I will say straight up, I don't own the stock. I don't have any desire to. This fascinates me, though, because I can't figure out which side to root for. A pox on all sides. On one hand, you have an entrenched board that has overseen massive value destruction. Just look at what the stock price has done over the last year. They are arguing that Chip Wilson is trying to destroy shareholder value without mentioning that Chip Wilson is the largest shareholder. So he is in the fact they are saying that he is acting against his own interest.

15:36Lou Whiteman:That sort of strains credibility. It also strains credibility to say that Chip Wilson is interrupting their turnaround plan since they haven't really said what this turnaround plan is. And the CEO they hired couldn't be bothered to take this promotion for six months. We're just in limbo waiting for her to get out of her non-compete. I feel like there was probably a way to negotiate something with Nike if you really, really wanted her that bad. But we have a board that has just overseen all this. They can't even get their CEO in place, and they're complaining that someone is messing with their mojo.

16:09Lou Whiteman:Well, look, this is the kind of mojo we want to mess with. All right. Over on the other side, you have a guy who had a great success, who is basically the plan is, I want to get the band back together, man. All right. I mean, which is, look, it's great if you can do it. I mean, look, we all remember why Chip Wilson isn't involved day to day. All right. Shout out to the people that don't look as good in his black pants, I guess. But I guess if I was an investor here, I'd be voting for Chip Wilson because I think the status quo is not great. But I have no confidence in we can just capture the genie again, put the genie back in the bottle and the magic will flow again.

16:50Lou Whiteman:I don't know if there is a comeback here. I mean, Lululemon was a really, really hot trend. They convinced people to pay huge amounts for what were probably overpriced athleisure wear. A lot of people have copied this now to the point where they sued Costco for basically having too good of an imitation product. Like, wow, Costco thanks you for that advertising. I don't know how you can just do a plan of like, well, let's go back to overcharging for what there's lots of competition for. My best advice is stay out of it. But if I was an investor, I think I'd be voting for change.

17:29Travis Hoium:Yeah, Rachel, the strange dynamic here is they do have a new CEO coming in. But Heidi O 'Neill is coming from Nike where things don't seem to be going particularly well at Nike. and I, you know, look through her history. It's not like the areas that she ran were doing great and the rest of the company was struggling. It reminds me a little bit of Target. We talked about their CEO change. You moved the COO who was operating the company into the CEO role. How do you expect things to change? It sort of seems the same. Every time I look at Lululemon stock, I want to think this is a good value, that their turnaround is in play.

18:07Travis Hoium:And then I see something like this and I just run for the hills. Yeah, this is a business I really like, But I think the management team has been troublesome, shall we say, for a while now. I mean, you also could see that at least the early signs of the market's response to the CEO change were not positive. I mean, the stock is already down, I think, more than 40 percent. The stock fell further after this news of O 'Neill's hiring from a struggling Nike. And there are a lot of issues with Lululemon right now. You know, their core market for a long time has been North America. That's obviously a really saturated space for them now.

18:40Now, it's not just competition from the lower cost rivals. There's also newer, shall we say, higher priced athleisure rivals like Aloe.

18:49Travis Hoium:Yeah, even in the yoga space. Yes. So there are a lot of premium priced competitors to Lululemon that are selling similar, you know, expensive athleisure wear that are doing really, really well. It is a very different market than a decade ago. Now, Lululemon has been expanding a lot internationally. I will say their growth trajectory in international markets like China, for example, has actually been really impressive. But it is not enough to combat the slowdown in growth we've been seeing. I will say, you know, if history and activist trends are any indication, some of the pressure we're seeing, maybe it's the wake up call that's needed.