AMD: Upgrade Ahead of Accelerating Growth (NASDAQ:AMD)

investment thesis

Advanced Micro Devices, Inc. (NASDAQ:AMD) remains one of the most attractive alternative investments in AI chips besides Nvidia (NVDA). But that’s exactly what hindered the bullish rating on the stock. That’s a high valuation that rivals Nvidia’s, despite only a fraction of its growth.

Recently, the stock price cooled down somewhat after exceeding $200. Valuations are still very unfavorable, but there may be some tailwinds on the horizon that could warrant a potential upgrade.

Overall, the thesis has been upgraded to neutral or bearish in the near term but bullish in the long term due to valuation concerns. Since the stock has historically held high valuations, an explicit downgrade/bearish recommendation is not considered under any circumstances.

background

In a previous report from last February, AMD’s Valuations seemed to be years ahead of actual performance. This is contrary to Nvidia, the real leader in AI. Nvidia’s stock valuation hasn’t been all that expensive given its strong growth (which has allowed it to quickly grow into its valuation). For AMD, this strong growth was lacking (or at best on a minimal basis) in the first place.

First quarter results

AMD has been showing mixed results since the first quarter of 2023. The 2% revenue growth in the first quarter, with revenue of $5.5 billion, marks overall revenue flat since the first quarter of 2021, when it hit $5.9 billion following the Xilinx acquisition. AMD has yet to actually exceed the $6.5 billion it posted after the quarter. Nonetheless, in 2021, the stock actually continued its upward trend through the end of the year and remains at similar levels today. This means investors have remained fairly optimistic about further growth during this period. Even though this did not occur, there was a significant decline at the end of 2022.

Looking more closely at the results, data center revenue grew 80% year over year to $2.3 billion, driven by the Ryzen and Instinct product lines. Despite seasonal Epyc declines, Instinct growth led to a 2% QoQ increase. Our clients continued their recovery from the recession, down approximately 50% from the lowest levels and up 85% year-on-year.

The two segments that produced poor results overall were Gaming ($900 million in sales), down 48%, and Embedded ($0.8 billion in sales), down 46% year-on-year and 20% quarter-over-quarter.

Regarding profitability, non-GAAP EPS was $0.62, with gross margin of 52% and operating margin of 21%. However, GAAP gross margin was 47% and GAAP operating margin was 1% for EPS of $0.07.

eyesight

AMD expects revenue of $5.7 billion in the second quarter, a slightly stronger 6% year-over-year growth. So, like Intel (INTC), it appears that most of the growth is expected in the second half of the year.

business updates

After issuing an initial forecast of $2 billion in AI revenue in 2024, this revenue has since grown to $3.5 billion. This strong increase has led to speculation about what the actual outcome will be, suggesting a variety of possibilities. To that end, AMD appears to have debunked some of the more bullish ones with its Q1 update, showing a single-digit multi-billion dollar trend, just $0.5 billion higher than $4 billion.

AMD recently announced that it would move to an annual cycle, following a similar announcement from Nvidia.

Upside potential and valuation

According to the Seeking Alpha page, a stock with a forward P/E of 45x and a large gap (20 points) between GAAP and non-GAAP earnings is expensive. Nonetheless, a look at some of the potential upside suggests a tentative upgrade may be necessary.

First, as mentioned, AMD continues to show weakness in its two main businesses: gaming and embedded. If market conditions improve, a total upside of $1.5 billion per quarter or $6 billion per year could be possible. Moreover, even customers have continued to see declines in revenue from close to $2 billion per quarter before the recession.

Second, the Instinct ramp is still in its infancy stages, despite hitting $1 billion in cumulative revenue in record time. Over time, this business will likely double (or more) the currently projected $4 billion in 2024.

Overall, optimism suggests revenues could rise to around $36 billion. Instinct is $8 billion to $10 billion, Epyc is $6 billion to $8 billion, Ryzen (client) is $6 billion to $9 billion, Gaming is $6 billion to $8 billion, and Embedded is $5 billion to $6 billion. These estimates range from $31 billion to $41 billion. Looking at Nvidia, it appears that most of the potential upside lies in its Instinct product line.

Excluding the new AI accelerator business that is entering, this forecast does not necessarily require much market share growth (except perhaps for games ceding additional stake to Nvidia) and could be achieved primarily through a modest total addressable market. . (“TAM”) increases. For example, in the client segment, the new AI PC trend could lead to a rise in ASP, while in the data center segment, Intel (INTC) predicts that the price per core will remain fairly stable as ASP rises due to increased core counts. I’m doing it.

Assuming an operating margin of 25% (on a non-GAAP basis), net income could be as high as $9 billion. That’s just over $5.50 EPS and a forward P/E of 29x. The 30% operating margin expansion previously achieved in the record-breaking Q2 2022 quarter will further reduce the multiple to 24x. The AI ​​accelerator business is obviously a very high-margin business, so perhaps (or quite likely) more operating leverage is possible.

These low-20s multiples align very closely with a bullish growth profile. Or, since the stock’s multiple is already much higher, you could allow for some reduction in the multiple, but still allow for upside for shareholders. Considering historically fairly high stock valuations, the latter seems more likely.

danger

The biggest risk is that the bull case, which assumes continued growth in the accelerator and a full recovery of other businesses, does not materialize.

For example, while PC revenue at the time increased due to the COVID-19 cycle, PC TAM has since returned to historical levels. Combined with Intel’s strengthening competitiveness, which implies major market share growth, most of the growth opportunities may have already been realized with 85% YoY growth in Q1. Nonetheless, some bulls may point out that AMD’s fairly low market share, which is actually hovering in the low 20s at best, still represents a long-term growth opportunity.

Similarly, in the data center space, Intel continues to strengthen its competitiveness with the goal of regaining market share through its latest 2024 product launches. Embedded currently has inventory digestion, which means some (QoQ) growth will pick up soon. On the other hand, digestion is partly caused by oversupply, so if peak sales numbers are based on market oversupply, a full recovery in sales may not happen anytime soon.

Finally, as mentioned, even after using bullish numbers for all companies, non-GAAP (never mind GAAP) P/E multiples remain higher than the S&P500 average. Even with AI revenue of around $8 billion or more, this business is still only a fraction of total revenue, so even if it continues to grow rapidly at that scale, the company’s overall growth rate is enough to warrant a valuation as high as it is today.

Overall, a multiple in the low 20s seems realistic for a company like AMD. So, given its current financial situation in the worst case, roughly half of its share price and market capitalization are at risk, so its valuation actually appears to reflect further growth over the next few years.

Previous coverage compared ASML (ASML) and evaluation. However, there are significant differences in the quality and positioning of the two companies, as ASML is the sole supplier of EUV lithography equipment, while AMD remains a smaller competitor for most of its business.

Because AMD is a fabless company, there isn’t much risk in terms of capital expenditures to stay in business. This compares to Intel, for example, which has been spending heavily on capital expenditures to build new fabs, which has recently put a significant strain on its FCF.

Investor Implications

Realistically, the stock should be uninvestable, with about half of its market capitalization and share price at risk, given its current financial situation. Still, since many of AMD’s businesses are well below the peak revenues it achieved even near the trough in the embedded and gaming segments, this creates an investment opportunity before a return to growth as these businesses recover. Additionally, since long-term sentiment toward the stock has been strong, it may be unlikely that the AI ​​hype will cool down significantly. However, these investment opportunities remain constrained by elevated valuations (which are unlikely to increase further, if not decrease substantially) even after the stock price has fallen over the past few months.

In an optimistic scenario of a full recovery, especially combined with continued AI growth, revenue could rise to more than $36 billion in 2024, up from the projected $24 billion. Combined with increased operating margins, this can result in: At the current stock price, the P/E multiple will be lowered to the low 20s.

Depending on your perspective, this is either an investment opportunity or a confirmation of previous reports that concluded that years of growth are already priced in, as AMD, unlike Nvidia, has or has not yet increased its accelerator revenues to significant levels.

Therefore, Advanced Micro Devices, Inc. The temporary buy upgrade for the stock is rather based on investors’ general optimistic outlook for the stock over time, which has resulted in an above-average valuation for several years, even during the recent recession. Therefore, if AMD returns to double-digit growth later this year and beyond, its valuation multiple may not decline significantly, which could lead to potential shareholder returns over time.