Morgan Stanley's base, bull and bear cases for 4 ASX companies with AI potential

One acronym has driven almost all of the S&P 500's gains, and the NASDAQ's outperformance this year. AI, or artificial intelligence, has been brewing as an investing mega trend for a long time.

Then, chip maker NVIDIA's earnings dropped. A healthy beat on revenues as well as lofty earnings guidance, earmarked at a 50% premium to what the street was expecting, allowed shares to soar. Its market capitalisation even topped US$1 trillion briefly.

And while Australia has very few AI-leveraged stocks of its own, Morgan Stanley has found four more companies in the ASX's emerging technology sector which could become the beneficiary (or the front of the firing line) as the AI story continues to evolve.

Opportunity or existential threat?

To quote the Old El Paso ad, porque no las dos? While the base case of Morgan Stanley's technology analysts is that AI more upside, they issue a very important caveat.

"Our base case is positive ... as AI [can be used] to better service users + new products + new revenues, with upside to long-term earnings/value. But on the flip side, we also see AI-linked risks and chance of major negative disruption, which no-one is talking about," analysts led by Andrew McLeod wrote in a client note recently.

With this in mind, Morgan Stanley has picked out four (in its words, "excellent") digital businesses that may be able to reap the benefits of AI. Note, none of these companies are expected to retain cost savings from its implementation. Rather, everything will be reinvested into those AI-specific projects.

The four businesses are:

• Carsales (ASX: CAR)

• Seek (ASX: SEK)

• REA Group (ASX: REA)

• Domain (ASX: DHG)

The base case

All four companies incrementally improve on its respective AI capabilities, which improves functionality, boosts productivity, and could even lead to entirely new revenue streams.

The added functionality and improved consumer experience underpins further growth in time-on-site for each of them, which in-turn underwrites ongoing price increases for their existing, core products and services (e.g., CAR's dealer and private prices, REA and DHG annual listings price increases and SEK's listings price.)

Most importantly, if all of these assumptions were to come to fruition, there could be as much as a 5 to 10% valuation upside.

"We don’t think consensus has fully thought through the upside opportunities, in terms of efficiencies and future price increases and new product potential. It is still early days, but we envisage an additional +5% to +10% to FY26E earnings and valuation for these stocks, over and above consensus expectations," analysts wrote.

The bull case

The biggest change between the base case and the bull case is really the rate of change. If companies implement AI faster and customers respond to it quicker, 3-year CAGRs could increase by 300 to 400 basis points for all four companies.

And while it won't lead to bigger EBITDA margins (because there are no cost savings), it could still lead to share price boosts of between 10 and 30%.

The bear case

The other reason these four businesses will likely need to jump on the AI bandwagon is that despite having strong pricing power and generating big profits, they are all vulnerable to the emergence of substitute products.

In our view, this leaves them somewhat vulnerable to the emergence of substitute products, which is something we are already paranoid about and monitor closely.

Morgan Stanley found three forms of potential competition:

• Existing competitors starting to use AI

• Completely new entrants which prioritise or have AI as a fundamental component of its business.

• New competition from AI platforms itself (eg Google launches its own version of REA)

Ratings and price targets

• REA Group - EQUAL WEIGHT (Price target: $130/share)

• Domain - EQUAL WEIGHT (Price target: $3.50/share)

• Seek - OVERWEIGHT (Price target: $29.50/share)

• Carsales - OVERWEIGHT (Price target: $26.50/share)