As AMD Stock Dips, Is It A Buy, Sell, Or Hold?

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Semiconductor Maker Advanced Micro Systems Reports Quarterly Earnings

Justin Sullivan/Getty Images News

Introduction

Advanced Micro Devices Inc (NASDAQ:AMD) is an industry-leading high-performance and adaptive computing semiconductor giant that also happens to be a rapidly-growing, free cash flow machine. Despite its elite financial performance, AMD’s valuation has been cut by ~55% in the last eight months. In today’s note, we will analyze AMD’s business performance, outlook, and long-term projections to see if this drawdown is a good entry point for long-term investors. To do so, I will be using a mix of fundamental, quantitative, and technical data analysis. Furthermore, I will share my fair value estimate and 2026 price target for AMD. Since we have a lot to cover, let’s kick off our discussion without further ado.

AMD Stock Key Metrics

AMD is etched into history due to its remarkable return from the brink of bankruptcy, and its business momentum is very much intact. As AMD wins market share against Intel (INTC) (especially in the data center), its financial profile is improving significantly. The combination of robust revenue growth and expanding margins are powering massive free cash flow generation.

AMD Fundamentals

YCharts

Here are the highlights from AMD’s Q1 results:

AMD Q1 2022 Earnings

AMD Q1 2022 Earnings Presentation

In Q1, AMD’s revenue came in at $5.9B (boosted by the Xilinx acquisition), with gross margin rising to 53% (up 660 bps y/y, up 240 bps q/q). Operating expenses as a percentage of revenue continue to trend lower, with operating margins climbing higher (up to 31% now). In a nutshell, AMD’s business fundamentals are getting better and better.

AMD Q1 2022 Earnings Presentation

AMD Q1 2022 Earnings Presentation

Looking at AMD’s business segments, each and every segment is growing at mid to high double-digit growth rates. I think it is fair to say that AMD’s business is firing on all cylinders (particularly in the data center).

AMD Q1 2022 Earnings Presentation

AMD Q1 2022 Earnings Presentation

Unlike in the past, AMD is now a cash-rich company with a robust balance sheet. As of Q1 2022, AMD had net cash of ~$4.7B (cash of $6.5B, debt of $1.8B). During Q1, AMD repurchased ~$1.9B of its shares, which leaves ~$8.3B remaining on its buyback authorization.

AMD Q1 2022 Earnings Presentation

AMD Q1 2022 Earnings Presentation

With Q2 already in the books (with the report date just three weeks away), AMD is nailed on to register yet another record quarter. During AMD’s analyst day in June, management re-affirmed their guidance and laid out the path for their next phase of growth against a $300B total addressable market opportunity. For Q2, AMD is expecting revenues of ~$6.5B (at the midpoint of guidance) with further improvement in gross margin (1pp).

AMD Q1 2022 Earnings Presentation

AMD Q1 2022 Earnings Presentation

AMD will be breaking out results in a new format from Q2, and I guess it is fair to assume that its data center business segment will be its largest segment (considering a portion of Xilinx’s business will be included within the data center segment). I am looking forward to AMD’s Q2 numbers, but that’s for forward guidance and not the actual results.

Starting with second quarter 2022 results, AMD is updating its financial reporting segments to align with its strategic end markets:

  • Data Center: Including server CPUs, data center GPUs, and the portions of Xilinx revenue related to the data center business
  • Embedded: Including the Xilinx embedded business plus the AMD embedded business
  • Client: Including the traditional desktop and notebook PC business
  • Gaming: Including the discrete graphics gaming business and the semi-custom game console business.

Source: AMD news article on SA

Fundamentally, AMD looks pristine. However, we know that its stock has fallen 55% in just a few months. So, what’s going on here?

Why Is AMD Stock Dipping?

Over the last twelve months, AMD’s stock is down ~22%, which is slightly better than iShares semiconductor ETF (SOXX) and slightly worse off than Invesco QQQ ETF (QQQ). AMD is significantly underperforming S&P 500 (SPX); however, the rout in (higher-beta) tech stocks has been much worse than broader markets, and so this is pretty natural. In my view, AMD’s price action is simply mirroring the market. I say this because AMD’s fundamentals are very strong right now, and they are expected to get stronger throughout 2022 and beyond.

AMD 1-yr performance vs benchmarks

YCharts

From its all-time highs of ~$164, AMD’s stock has declined precipitously. In hindsight, the Fed’s pivot to hawkishness (quantitative tightening) in November marked the top for AMD and triggered this downdraft.

Here’s my thought process around AMD’s price action:

Soaring inflation rates forced the Fed to tighten monetary policy, but the Fed’s switch from QE to QT was too late. We are now facing the prospects of rising interest rates and balance sheet moderation at the Fed (liquidity removal) coinciding with negative economic growth and persistently high inflation rates. As interest rates soar, assets are getting re-priced according to the new financial realities.

Inflation, interest rates, fed and more

YCharts

The repricing in multiples has led AMD to trade at ~27x P/E (~16-18x forward P/E). In my opinion, the market is trying to price in a downturn in the semiconductor industry (potential recession). Micron’s (MU) recently released quarterly numbers were robust (beat on top and bottom line); however, the sales guidance fell short by ~24%. Here’s what Micron’s CEO, Sanjay Mehrotra, said –

Recently, the industry demand environment has weakened, and we are taking action to moderate our supply growth in fiscal 2023.

Micron’s weak guidance has led to increased fear among investors of semiconductor stocks, with the calls for a cyclical downturn growing louder. The idea of a secularly growing semiconductor industry has evaporated. To my credit, I have always believed that semis are cyclical; however, I know that the pendulum could swing too far to the downside, and that’s where the point of maximum financial opportunity arises. Hence, I am looking for reasons to be optimistic (bullish) and not bearish after a 55% decline.

As we saw earlier, AMD has fantastic business momentum, it is well-capitalized, and it is FCF generative. I think AMD is strong enough to face a downturn, and a big part of my thinking is based on the strength AMD is showing in the data center (which is now a massive piece of AMD’s business [>50% in Q2 2022]). AMD’s revenues are well-diversified, and that should allow the company to fare better now than during previous cyclical downturns.

AMD is diversified

AMD Analyst Day 2022

After completing its transformational acquisition of Xilinx, AMD’s management believes that the company is ready to address a much larger TAM with its best-ever product portfolio. By acquiring Xilinx, AMD significantly boosted its data center presence, and this acquisition could be Dr. Lisa Su’s best move yet as AMD’s CEO (at least she thought so back in 2020).

AMD product portfolio

AMD Corporate Presentation

With its Ryzen, Radeon, and EPYC processors, AMD is winning market share across the CPU, GPU, and server (data center) markets. Over the last few years, AMD’s products have been far superior to those of Intel’s, and with a strong product roadmap, AMD looks good value for a greater chunk of the expanding semiconductor industry.

As the industry continues to grapple with supply shortages, AMD has focused its resources on higher-value chips. Naturally, AMD’s gross margins have expanded significantly over the last few quarters.

Source: Here’s What I am Doing With Another Blowout Earnings

With Intel reporting further delays on key products, AMD’s technology lead is getting wider, and further market share shift is only a matter of time. This dynamic is clearly visible in AMD’s financial statements and forward guidance (from AMD and Intel).

From a layman’s perspective, I think there will be more semiconductor chips in the future than today. Hence, AMD’s end markets are only going to get larger, and AMD has a lot of market share to win from its rivals. Thus, I can see AMD growing at a healthy clip for many more years to come. And that’s all I need to know [growth may dip in a recession, but it will come back for sure (more semiconductors in the future, not less].

AMD TAM

AMD Analyst Day 2022

AMD Long-term guidance

AMD Analyst Day 2022

As AMD executes against a massive $300B TAM, its management is projecting a long-term growth rate of ~20% CAGR (from a base of $20B in 2021, inclusive of Xilinx). With AMD growing at 60% in 2022, this guidance is an absolute joke and has to be severely sandbagged. In addition to healthy revenue growth, AMD’s margins are projected to expand too (direct indication of its product leadership). With operating margins in the mid-30s, AMD’s FCF margin could easily reach 25-30% over the long run. This margin expansion will be gradual, and that’s how I am modeling it in my valuation. Now that I have mentioned valuation, I think it is a good time to take a look at AMD’s fair value.

Is AMD Undervalued Now?

To find the fair value and expected return of AMD, we will use a simple discounted cash flow model with the following assumptions:

2022E revenue $26B
Forward 5-Yr Revenue Growth Rate (%) 20%
Terminal Growth Rate (%) 5%
Optimized FCF Margin (%) 21-25%
Discount Rate / Required IRR (%) 15%
Exit Multiple [P/FCF] 15-25x

Results:

AMD Fair Value And Price Target

TQI Valuation Model (Author)

As you can see in the image, AMD’s fair value is ~$172B ($105 per share). With the stock trading at ~$73, it is currently trading at a discount of 44% to its fair value. Hence, it is a buy. But what sort of returns could one expect from this investment?

Today AMD trades at a P/FCF multiple of ~28x with revenue growth of 60%. Over the long-term, AMD’s management expects this growth rate to be ~20% CAGR, which I believe is too low; however, using such a sandbagged guide in the model provides us a significant margin of safety. But I digress. The more important question is – “Where would AMD trade at the end of 2026?”.

To find a reasonable range, I looked at different semiconductor giants (in different lifecycle stages). Intel has been struggling for revenue growth for years, and it still trades at 10-15x P/FCF. Qualcomm (trading at ~20x P/FCF), on the other hand, has a similar growth and margin profile to what I expect of AMD (in 2026). Nvidia still trades at a hefty premium, which is probably deserved due to its higher-margin profile.

AMD relative valuation

YCharts

Conservatively, I expect AMD to trade at ~20-25x P/FCF [4-5% FCF yield] in 2026, and this would be the reality [unless we were to undergo a complete economic reset (interest rates of 6-8%), where AMD’s FCF yield would need to rise to 8-10% and the valuation multiple would need to contract to ~10-12x P/FCF]. Assuming an exit P/FCF of ~20x, AMD could deliver 19.8% CAGR returns from here.

In previous sections, we saw that AMD is a cash-rich company with a generous capital return program. Today, AMD is producing massive amounts of free cash flow, and it will continue to do so over the coming years. We also know that management plans to maintain shareholder-friendly capital allocation policies that can boost shareholder returns. As per AMD’s Analyst Day 2022 presentation, more than 40% of FCF will be returned to shareholders. I think this figure will be much higher, and if AMD’s share remains depressed, the management may choose to be very aggressive with buybacks.

Let’s visualize the effectiveness of an aggressive buyback program:

AMD Infinite Buyback Pump

TQI Valuation Model (Author)

Stock buybacks do not increase the value of a business, and this is evident in the table above. However, if an investor hangs onto AMD’s shares for the next 4.5 years, he/she could generate a CAGR return of 26.6% (instead of 19.8%). This is the power of financial engineering being done by AMD’s management.

Is AMD Stock A Buying Opportunity Now?

As you can see, AMD is growing faster than its peers [Q1 2022 y/y growth 71%, 55% (excluding the Xilinx acquisition)], and it is expected to maintain high growth rates in the near to medium term. However, AMD’s margin profile is slightly worse than Intel’s and looks pale compared to Nvidia (NVDA) and Qualcomm (QCOM).

AMD vs NVDA vs INTC vs QCOM

YCharts

Hence, AMD’s forward PE ratio of 16-18x makes sense, with Intel, Qualcomm, and Nvidia trading at ~11x, ~10x, and ~27x, respectively. In my view, Qualcomm is one of the best semiconductor stocks in the market today, but we will talk about it some other day. Let us now take a look at AMD’s quant factor ratings.

Barring the energy sector, I do not see many companies with positive quantitative factor data these days; however, AMD is an exception, making it such an interesting setup. According to SA’s Quant Rating system, AMD’s stock is losing momentum [‘A+’ to ‘C+’ grade], but its valuation is getting more attractive [‘D’ to ‘C+] with growth [‘A’] and profitability [‘A’] ratings holding firm amid positive earnings revisions [A-]. Against the backdrop of a potential recession, AMD is still performing exceptionally. I believe AMD’s quant factor grade of 4.37 is a bullish data point. Next, we shall look at technicals.

Quantitative Factor rating for AMD

Seeking Alpha Quant Rating

In a matter of months, AMD’s stock has tanked by 55%, going from overbought territory to near-oversold territory on the weekly chart. Right now, AMD is sitting at a strong support zone (marked by a black horizontal line on the chart below), which also happens to intersect with AMD’s long-term bullish trend line (market by the green line on the chart below) and the 200DMA.

AMD Technical Charts

WeBull

In recent weeks, the volume has been trending lower, which could be a sign of seller exhaustion. Considering the support zone and price-volume action, I think AMD is a good long-term buy here. The fundamental and quantitative data support a long position too. However, a break of this support at the ~$70 level could send the stock into a tailspin (down to the $40-$60 range marked by red dotted lines on the chart). I don’t think these levels will materialize, but the market could do crazy things when fear levels are elevated amid talk of an impending recession (heck, we might already be in one, I believe this to be the case). I guess the eventual bottom will depend on how deep the recession turns out to be; however, I don’t know where the bottom is, and I’m not going to try to find it.

Concluding Thoughts

After a vicious drawdown that saw its stock get cut by more than half, AMD is sitting at a strong support zone like ripe fruit for a long-term investor. With its product lead over Intel, AMD is likely to gain greater market share. Despite the rising expectation of a recession, AMD’s business fundamentals are likely to improve in the near to medium term as it takes a bigger share in the data center market.

Unlike in the past, AMD’s business is very well capitalized and far more diversified; hence, I think it should get through any downturn in the semiconductor industry without much fuss. According to my analysis, AMD’s fair value is $105 per share, i.e., it is deeply undervalued at this time. With an expected CAGR of 19.8% (26.6% with buybacks), AMD offers fantastic risk/reward for long-term investors. The quantitative factor ratings for AMD remain bullish, and while AMD’s stock is in a falling downward wedge pattern, it is sitting at a key support level, which I think AMD should hold. In case AMD’s stock fails to hold the $70 level, we may be in for another leg down to the $40-$60 range.

From a long-term investor’s perspective, AMD is a great buy right here. If you are worried about the possibility of another down leg (i.e., a deep recession), I would suggest the use of a 3-6 month DCA plan to accumulate a long position.

Key Takeaway: I rate AMD a strong buy at $73.

If you have any thoughts, questions, and/or concerns, please share them in the comments section below or DM me.

Housekeeping Note: I’ll soon be launching a Marketplace service on Seeking Alpha focused on generating long-term outperformance through financial engineering. While “The Quantamental Investor” won’t be live until early September, we are already building an exclusive (and free) community for retail investors at TQI Network. You can find more details in my profile bio. Stay tuned for more updates!



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