AMD’s Advance Sits On Weak Fundamentals, But With Room To Grow
Back in the 1990s, processor speeds doubled nearly every year. As we hit the most recent decade, the increases in processor performance slowed the rate of real development to a crawl. What’s most interesting during this time period is the rise and fall of companies in the technology sector. Intel, being the behemoth that it is, weathered the storm fairly well, with some struggles until the last few years. NVIDIA was nearly left for dead until machine learning gave the graphics card maker a new life. Yet, still in the back sits Advanced Micro Devices.
Despite a general pickup in the overall technology sector, AMD has lagged its competitors substantially over the years. While revenues picked up nicely from 2015 through recent, the EPS failed to break into positive territory until 2017. True, the company has improved its net margins. However, it lags woefully behind its competitors and has only recently turned cash flow from operations positive in the last couple years. The company sits in a growing market but has a long way to go before they can justify their current or higher share prices.
Margin Mayhem
Bulls who cover AMD point to the sizable growth in the gross margin, which is nothing to sneeze at. From 2015 to present the gross margin has jumped a sizable 7%+. The Operating Margin and Net Margin ratios have all turned around as well. Yet, compare that to Intel & NVIDIA. Relatively speaking, they aren’t even close. NVIDIA boasts a Net margin of that’s grown from just under 16% to 33%, while Intel has increased from just over 15% last year to a TTM of nearly 28%. The operating margins of both are nearly double that of AMD.
All that being said, the earnings still show a significant disparity. Intel sits at a P/E of 12.2, which is pretty solid for a company that’s been growing both it’s revenues and margins and a sizable clip while plowing a lot of money back into the business for research. NVIDIA is priced a bit higher with a P/E of 44.61. If we took the most recent quarter earnings for AMD and did a run rate, the P/E would still be over 40. However, the caveat remains: If the company manages itself into the same fundamentals as Intel and NVIDIA, while capturing market share, then their current share price becomes more fairly valued.
And Yet Growth May Be The Key
AMD grew its revenues pretty quickly over the past several years. In 2017, they popped up to nearly 25% revenue growth. Right now their price sits at 2.93x sales. Compare that to INTC who sits at 3.34x and NVDA at 14.28, and if the increase in market share continues, as well as improvements in margins, AMD could be undervalued at its current levels.
So now consider the following scenario: AMD achieves a comparable P/S ratio as Intel, with similar net margins to a few years ago, say 15%. What would that look like? Taking the current items into consideration, the share price would climb from ~$19.30 today to ~$22.00. The earnings per share for 2017 would have jumped up near $0.80+, giving a P/E of 27.5x. The point is that if AMD manages to find a way to simply mimic the other companies at the lower end, they can justify their current and possibly higher value.
Quantum Leap
If you turned on any science or news station in the past year, you’ve probably heard about the advances made in quantum computing. Without getting too wonky, quantum computing appears to be the future of increasing processor capabilities. While traditional computing is comprised of 1s and 0s, quantum computing can do 1s and 0s as well as superposition where it can be a 1 or a 0 at the same time. Additionally, the technology looks to be using entanglement, which could lead to further advances in reading and transmitting data.
The importance of quantum computing cannot be overstated. The first company that would develop a truly marketable and commercial quantum computer would essentially put all others out of business. AMD, even though it spends nearly 25% of revenues on R&D, hasn’t made the foray into quantum computing in any significant way. Intel, on the other hand, is a leader in the research and development of the new technology. But, the big difference is that Intel does this at or below the percentage of revenue that AMD does. Effectively, Intel is doing more with its research and development more efficiently, on the same current products as AMD, but also on future technologies.
Leveraged Growth
In an effort to boost their top-line growth, AMD embarked on strategic partnerships with Sony, Microsoft, and HP over the years. However, in 2016, these companies made up 59% of the company’s total revenue (Zach’s Equity Research). Here’s the problem. While Microsoft has been growing solidly, Sony’s revenues, although increasing, aren’t nearly as good, and Hewlett Packard actually has declining revenues. While other factors play into these topline numbers, the point of having too few revenue streams leaves AMD exceptionally vulnerable.
However, the bigger concern lies in the debt the company maintains. The good news is that they don’t have much due for quite some time, leaving them locked into lower interest rates in an environment where borrowing costs are increasing. The bad news is AMD has funded a lot of their recent business with debt. While the growth realized recently is an outstanding development, they aren’t out of the woods yet. The company plans to reduce its debt structure in the near future with increased cash flow. Yet, given their high leverage and concentration of products and customers, the company has little room for error.
Final Thoughts
Although AMD sits in a risky spot, the company continues delivering solid growth numbers. With the stock priced near $20, they have little room for error, and the price itself doesn’t offer a lot of value. All signs point to continued growth and expansion in their core product markets. Because of the ambiguity to many things investors just don’t know, the stock would appear reasonably valued if not over-valued, when discounting for risk.
