🚂 Choo Choo

Happy Sunday to everyone on The Street.

Today’s intro is short and sweet. It’s dedicated to those who fought, served, and died in the US armed forces. That’s what this weekend is really all about. So, while we hope you’re spending some much-needed time with family and friends, if and when you see an American Flag today or tomorrow, take a quick moment to say thank you. In your own head is fine.

There are countless people who put their lives on hold, delayed their dreams, and said yes to something greater than themselves so that we can live the lives we do. I, for one, am eternally grateful and while it’s seemingly become almost trendy to knock the US, it’s still by far and away the best place to call home. The people who gave their lives to make it that way deserve at least a moment of silent recognition from all of us, and certainly much more.

— Brooks

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Review

US stocks finished higher Friday amid growing optimism regarding a debt ceiling resolution. On Saturday, President Biden and Speaker Kevin McCarthy's teams struck an agreement on government spending that will raise the debt ceiling and avert a looming default. The deal must now pass through both the House and Senate. Here's a further breakdown of what's included in the agreement.

On the earnings front, Big Lots reported a far larger-than-expected loss of $206.1 million or $3.40 per share, compared to the estimated $1.95 loss. The company's revenue of $1.12 billion also fell short of the Street’s forecasts. The discount retailer is forecasting sales to drop again in the subsequent quarter.

On the economic front, Core PCE rose 0.4% month-over-month, compared to the 0.3% estimate. On an annualized basis, the Fed’s favored inflation metric accelerated to 4.7%, still well above the 2% target rate and slightly above expectations of 4.6%.

In company-specific news, Ford will be partnering with Tesla as part of its electric vehicle charging initiatives. Under the agreement, Ford owners will have access to more than 12,000 Tesla Superchargers. Ford’s next-generation EVs will also include a Tesla charging plug, allowing them to use Tesla chargers without an adapter.

Meanwhile, JPMorgan Chase is developing an AI program called IndexGPT that uses cloud computing software to analyze and select securities tailored to customer needs.

The program is based on the same generative training models as OpenAI's ChatGPT technology but will be repurposed to offer investment advice.

In total for the week, the Dow Jones Industrial Average fell 333 points or 1.00%, while the S&P 500 added 0.32%. The Nasdaq Composite surged 2.51%.

Preview

On Tuesday, the week will kick off with the release of the March home price index. In February, this reading rose only 0.4%, the smallest increase in more than a decade.

On Wednesday, investors will get updates on the number of mortgage applications from the previous week. For the week ended May 19, mortgage applications declined 4.6%. There will also be an update on the average mortgage rate, which currently sits at 6.69%. The JOLTS job openings report will also be released. In March, the number of open job opportunities dropped to 9.6 million, the lowest since April 2021.

On Thursday, the ISM Manufacturing PMI will be released. In April, this metric of economic activity rose to 47.1 from a low of 46.3 in March, showing economic activity in the manufacturing sector continuing to shrink for the sixth month in a row.

On Friday, investors will get insight into the state of the US job market from the updated unemployment rate. In April, unemployment matched its 50-year low of 3.4%. Additionally, investors will receive an update on the average hourly wage in the US which was $33.36 in April.

Earnings Spotlight

On Tuesday, Hewlett Packard (HPE) and U-Haul (UHAL) will welcome investors back from the long weekend with an update from their respective businesses. Investors may look to HP to address criticism of its HP+ subscription service. A trade association alleges HP+ printers prevent the use of third-party ink, in violation of EPEAT criteria.

On Wednesday, software giants Salesforce (CRM) and C3.ai (AI) will report earnings. Investors will surely have sky-high expectations for the AI-centric C3.ai. Last week, following blockbuster earnings, fellow tech titan NVIDIA’s (NVDA) CEO stated there has been a “fundamental shift” toward accelerated computing.

Thursday will be the busiest day of the week, with reports expected from discount retailers Dollar General (DG) and Five Below (FIVE). Athletic retailer Lululemon (LULU) and productivity platform Asana (ASAN) will also report.

Rail Stocks On The Right Track? Citigroup Thinks So

3 Stocks Set To Get Back on Track

The potential for railroad strikes and a recession isn’t worrying analysts at Citigroup which upgraded a bunch of rail stocks last week. They think double-digit upside is in the cards for a few, including CSX (CSX), Norfolk Southern (NSC), and Union Pacific (UNP). How much? Citigroup analyst Christian Wetherbee says CSX has the potential to climb by 14.5%, Norfolk Southern by 18%, and Union Pacific by 19%.

Wetherbee said the rail industry is nearing a bottom which presents an opportunity for investors. “With US rails more focused on volume growth, we think the group is more closely tied to changes in the truck market than previous cycles, thus our call to pull them forward into the early cycle trade. Ultimately, we see upside to valuation and stock prices as the 2024 recovery story builds,” Wetherbee wrote in a recent research report covered by CNBC.

Norfolk Southern Stands Out

Among the railroad stocks to get an upgrade, Norfolk Southern stands out. Wells Fargo also raised its rating on the stock to overweight and upped its price target to $250. Shares of Norfolk have been under pressure so far in 2023, with the stock down more than 14%.

Wells Fargo analyst Allison Poliniak-Cusic acknowledged Norfolk Southern faced challenges in the past, including a high-cost structure, a choppy outlook, and the reputational hit of its disastrous Ohio derailment in February. But the analyst also said things are now improving, as Norfolk Southern shares look cheap compared to its peers in the industry.

“We see a period of elevated growth from 2025-2029 that justifies a multiple premium for the Eastern Rails, of which we view NS to have the most leverage for expansion given its lagging multiple, high relative intermodal exposure and lagging OR,” Poliniak-Cusic wrote in the research report.

Rail Stock Risks

The two Wall Street firms may be bullish about the railroad sector, but there are risks investors should consider. For starters, the sector can be volatile if the economy is weakening or when certain markets are under pressure.

Take timber for example. If there is a shortage or demand for new construction is waning, it could negatively impact a railroad company that specializes in transporting timber. Political turmoil can also impact railroad stocks. Rules and regulations could limit the production of certain commodities or hurt oil and gas companies. If the rail company caters to those industries, they too take a hit.

Rail stocks have had a rough go of it in 2023, but that hasn’t stopped some Wall Street watchers from seeing opportunity among the rocky road. Sure, rail stocks can be volatile, and yes, there are many influences out of their control. But with the stocks down so far this year, it could be an opportunity for bargain-hunting investors. At least, that’s what Citigroup and Wells Fargo think.

Imitation is the Sincerest Form of Flattery

Markel Wants Berkshire-Type Love

Mimicking the Oracle of Investing and his company Berkshire Hathaway (BRK.A) can be tough, but you can’t knock a company for trying. After all, Warren Buffet’s track record remains legendary. In the past three years, his conglomerate earned investors returns to the tune of 24.5% a year. That’s almost twice the S&P 500’s 12.4% in the same time period.

The Virginia insurance company Markel (MKL) has long taken a page from Berkshire — so much so, the company recently hosted an investor event a day after Berkshire’s annual meeting in Omaha, Nebraska. It didn’t matter that the company is located hundreds of miles away. Markel appeared keen on enticing the type of investors loyal to Berkshire.

It could be an uphill battle. The company isn’t making investors quite as much money as Berkshire — Markel has returned 16.1% over the past three years. But bulls think it has a shot.

“Underwriting results remain solid, investment income is surging, and Ventures continues to deliver very strong results (both top & bottom line),” RBC analyst Mark Dwelle wrote in a recent note. “We remain at Outperform and see valuation as attractive versus peers.”

Mini-Conglomerate

Markel’s main business is providing specialty insurance, but in the late 1990s it also branched into reinsurance, providing insurance for insurers. It also owns a whole host of other businesses under its Markel Ventures arm. These include: Cottrell, the automobile transport equipment maker; Brahmin, which makes high-end handbags; and Costa Farms, a plants retailer.

Markel also has an equity portfolio worth nearly $8 billion. At the end of March, the two largest holdings were, unsurprisingly, Berkshire’s Class A and B shares. Combined, Markel’s stake is worth close to $1 billion. Amazon (AMZN), Alphabet (GOOGL), and Home Depot (HD) are also large holdings.

Growth in the Cards?

Some Wall Street watchers are confident Markel can earn investors greater returns. They point to strong underwriting results for the first quarter.

Analysts also praise Markel’s investment income, which is increasing. Then there’s strong top- and bottom-line growth from Markel Ventures. In announcing quarterly results above Wall Street estimates, CEO Thomas Gayner cited all its units for the performance.

"The first quarter of 2023 saw all three engines — insurance, investments, and Markel Ventures — meaningfully contribute to our strong operating results," said Gayner. "Markel Ventures achieved impressive organic revenue and profitability growth. In insurance, we continue to grow while maintaining our decades-long approach to disciplined underwriting. Our investment income continues to benefit from higher interest rates, and we experienced favorable returns in our equity portfolio.”

Turns out it's not unrequited love either. As of early 2022, Berkshire has a $600 million stake in Markel.

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An Unsuspecting Way to Play AI: Uber

Wall Street Thinks AI Will Be a Boon to the Bottom Line

Artificial intelligence is helping all sorts of companies' bottom lines. One that may be poised to benefit from this advanced technology is ridesharing company Uber (UBER). Sure, Uber and its rivals already incorporate AI in their businesses to match drivers and riders, but that’s just the beginning. Some Wall Street analysts think further adoption will reduce wait times, help Uber better manage fleets, and improve pricing.

It's an assessment Uber seems to agree with. During the company’s earnings conference call earlier this month, CEO Dara Khosrowshahi touted Uber’s “significant data advantage” thanks to AI, which enables it to predict arrival times for rides and food deliveries at a highly accurate rate.

The CEO also believes there’s more to come. “We are just starting to understand the capabilities of AI and we are a long way from understanding its potential,” Khosrowshahi told CNBC following the company’s quarterly earnings report.

Margins To Get a Boost?

Uber pointed to increased productivity on the developer side as a big benefit of using more AI, bringing down costs as more chatbots are employed. After that, the company intends to use AI to “surprise and delight” customers. With the help of AI, Uber plans to learn more about its customers, aiming to wield the knowledge to make them more loyal to its ridesharing and food delivery services.

On the ride side of Uber’s business, Morgan Stanley said every 1% increase in rider frequency and 20-basis-point increase in rides taken would result in 1% additional revenue and 3% incremental EBITDA. As for the delivery business, a 1% increase in rider frequency and a 5-basis-point increase in rides taken would lead to 0.4% additional revenue and 1% incremental company EBITDA.

“They were really on the forefront [of AI],” Sarat Sethi, a portfolio manager at Douglas C. Lane & Associates, told CNBC. “Now we’ve seen the results over the last few quarters, where the efficiencies are really coming through. And Uber is just understanding more and more of the customer and the more and more data they get.”

Watch Out for Amazon

Beyond boosting productivity and lowering costs, AI could help Uber move some of its fleet toward autonomy, which would further reduce its overhead and increase margins. It can also be used to better anticipate customer behavior.

“For the rideshare businesses, this could take the form of better allocation of supply to meet rider demand as algorithms are better able to predict where influx of demand will next occur and point drivers in that direction,” Morgan Stanley wrote in its research report. As for delivery, AI can offer better suggestions or provide automatic orders.

There is one risk that Uber and the others have to worry about: Amazon (AMZN) and the other cloud giants. After all, they have huge balance sheets, free cash flow, and the processing power to dominate if they decide to enter the ridesharing or food delivery businesses. “Their biggest death star is Amazon,” Mortonson said. “Their extension on delivery into food or … other services … they just have to turn the switch.”

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