Does AMD Stock Have More Legs After The Epic Gains?

Date24 Sep 2018

Advanced Micro Devices Inc (AMD) stock is the best performing S&P 500 stock this year. Can it still soar higher?

Does AMD Stock Has More Legs After The Epic Gains

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Over the last few months, shares of semiconductor company AMD (NASDAQ:AMD) have taken everyone by surprise, gaining more than 200% in the year to date. Majority of the analysts have been playing catch up with AMD stock’s phenomenal rise. Aas a string of price target hikes and rating upgrades have come over the last week or so. A few months back we had written a post on AMD suggesting that there was too much optimism around the AMD stock and thus it warranted a cautious investment approach. The situation is no different after the recent rally with many critics suggesting an almost 100% fall citing the stock’s historical performance.

Having said that, the fundamental picture of the chip-maker has vastly improved over the last few quarters and its arch-rival Intel (NASDAQ:INTC) woes have been a great tailwind for the Sunnyvale based semiconductor company. With many analysts waking up and giving bullish price target hikes, the question now is whether AMD stock has still more legs after the astronomical gains in the last few months? Let’s take a closer look. AMD stock chart

AMD stock by uniquefinance.org

The GPU headwind.

Thanks to Intel’s production woes, AMD’s CPU business has garnered a lot of positive press lately but the company’s GPU business has taken a back seat with not much attention among the investing community. There are already concerns about the GPU business owing to demand from cryptos weakening. Turnings to Q3 2018, the management has guided the revenue to be $1.7 billion, +/- $50 million, which is just 7% higher YoY.

Further, they stated that higher sales in CPU and data center products are likely to be offset by lower sales of GPU products in the blockchain market. In the second quarter 2018, AMD’s Computing and Graphics segment revenue was $1.1 billion, up 64% year-over-year, but approximately 60% of client revenue was driven by Ryzen products, which was not the case last year.

Even though the chipmaker is seeing strong traction for GPUs in the data center segment, there is likely to be a GPU drag going forward and the only question is by how much. Going by the latest trends and management estimates, the GPU revenue may come down heavily from the Q1 2018 in the remaining quarters of 2018.
AMD revenue chart

AMD revenue by uniquefinance.org

For AMD to maintain its growth trajectory, the growth has to come with the GPU business still shrinking over 2018. With current estimates only suggesting a little over 9% revenue growth in 2019, the softer GPU business doesn’t sound good for investors. To compensate for any weakness on the GPU side, the company has to hit near double-digit market share in the datacenter segment, which is one of the fastest growing business for AMD, much earlier than expected.

In the recently concluded Deutsche Bank Technology Conference, CFO Devinder Kumar hinted that would be probably a 4-6 quarter journey from the middle single digits. The company’s year-end goal is to achieve 5% share in datacenter. So, investors need to wait until the company’s latest earnings call to get a better picture of the GPU drag going ahead.

US-China Trade war might pile further pressure on the GPU business.

A latest ExtremeTech post reports that the ongoing US-China trade war may soon have an impact on semiconductor parts and PC components in the near future. The post shares the list of items which are soon to be hit with a 10% tariff post-September 24. It is further mentioned that the tariff rates will increase to 25%, in case the trade war isn’t resolved by January 1, 2019. The author highlights how the components going into GPU manufacturing could draw tariffs for the specific components that are manufactured in China.

Even though many component manufacturers are trying to move their production centers to Vietnam, Thailand, or India to reduce tariff exposure, the shifting of fab as a CPU or memory manufacturing units is very complex to shift immediately. Even the Taiwan based components are indirectly affected as some of their units are manufactured in mainland China. So, in summary, sooner or later the component prices are going to increase with GPUs being among the ones to be affected, that’s bad news for the likes of AMD and NVIDIA (NASDAQ:NVDA). The rising component prices could be a further drag on the GPU business.

Exciting CPU and Datacenter trends but valuation concerns persist.

AMD’s CPU and Datacenter segments have been the key drivers behind the strong revenue growth and improvement in fundamentals in the first half of 2018. A number of analysts also have recently upped their price targets for AMD highlighting the strength in CPU and datacenter growth, with Jefferies being the latest. Analyst Mark Lipacis suggests that Dr. Lisa Su led company could triple its CPU market share from 10% today based on a research report from FUBON. Similarly, on the datacenter side, many analysts predict the company will easily achieve its year-end target 0f 5% datacenter market share.

However, the valuation concerns make many investors wary of the AMD stock. AMD stock trades at almost 4.7 times its sales which is not only a 5-year high but also an all-time high. With revenue growth projections of only 9.3% and 12% in 2019 and 2020, it would be very difficult for the company to sustain the rich valuation. Even if AMD were to surpass analyst estimations going ahead due to strong CPU and data center growth, it is highly unlikely AMD stock will be able to deliver astronomical returns as in the last few months.

AMD PS 5 years

Summary.

Apart from the valuation risk, investors need to be cautious about the balance sheet risk. AMD ended Q2 2018 with a free cash flow of negative $88 million. However, the management has guided the company to become cash flow positive in Q3 and for the year. Investors should keep a close tab on this front as the company has an obligation to repay $156 million of its debt in FY 2018. Further, the company has some senior notes due in 2019.

If the free cash flow situation doesn’t improve much in the coming days then it can take a toll on the company’s cash position. As of Q2, AMD had a total principal debt of $1.7 billion, including a secured revolving line of credit. To sustain the high valuation the company’s latest bet’s should come true. The sentiment around AMD stock also has changed recently with a number of analyst upgrades. The latest short interest to be released this week will give us a better idea of the bearish bet around AMD.

Despite the strong operational and financial outlook, investors must be cautious while investing in AMD stock at this levels. The outlook for AMD looks bright operationally albeit for a few hiccups, and investors can expect some strong performance going ahead but the recent sort of astronomical gains might be too much to expect in the near future.