Investors in Advanced Micro Devices (NASDAQ:AMD) are paying attention to a downgrade from analysts at Oppenheimer, sending shares nearly 3% lower at the start of the trading week.
I can see why Oppenheimer is cautious with Intel aggressively trying to boost market share in the low end of the PC market, implying that AMD could lose further market share in an already declining PC market. Oppenheimer furthermore sees margin pressure on sales to console makers, while the graphical business is currently the firm's most promising asset.
Myself, I don't see compelling arguments to either be long or short with a comfortable margin of safety at current levels, prompting me to stay on the sidelines.
Oppenheimer Turns Cautious
Analysts at Oppenheimer lowered their rating on AMD from "Perform" to "Underperform", with no specific price target being assigned.
Analysts note that PC/graphics sales will most likely continue to fall faster than PC units, with Intel leveraging its cost advantage aggressively to capture low-end market share. At the same time, AMD faces strong competition from Nvidia (NASDAQ:NVDA) in the competitive graphics area.
Combined with lower margins for Sony's PlayStation 4 and the Xbox One as owned by Microsoft (NASDAQ:MSFT), this might hurt corporate gross earnings to a great extend.
Halfway through October, AMD released its third quarter results. The company ended the quarter with $1.18 billion in cash, equivalents as well as short- and long-term marketable securities. Total debt stands at $2.05 billion, for a net debt position of $870 million.
Revenues for the first nine months of the year came in at $3.71 billion, down 13.0% on the year before. The company made huge improvements to the bottom line as net losses narrowed from $710 million to $172 million.
At this pace, annual revenues are seen around $5.2 billion as the company will pay a modest GAAP loss for the year.
Trading around $3.60 per share, the market values AMD at $2.60 billion. This values the company at 0.5 times annual revenues.
AMD does not pay a dividend at the moment, which is not a surprise given the poor operating performance at this time.
Some Historical Perspective
Shares of AMD are trading with year to date gains of about 50%. Despite these gains, shares are off more than 20% from highs in the summer when shares traded around $4.50 per share.
The long-term returns have been outright terrible. Shares rose from $10 in 2004 to highs of $40 in 2006. Shares actually fell to lows of $2 by the end of 2012, and have nearly doubled again in the meantime.
Between 2009 and the fiscal year of 2013, AMD is expected to report a modest cumulative revenue fall of about 5% to $5.2 billion. Revenues did peak around $6.5 billion in 2010 and 2011, but fell in 2012. After being solidly profitable in recent years, the company was forced to report a nearly $1.2 billion loss in 2012, yet the firm has made a lot of improvements in 2013, returning to profitability at the moment.
Basically AMD operates two major businesses at the moment. The computing solutions group reported third quarter revenues of $790 million, down nearly 15% on the year before. The continued decline in the personal computer market are impacting AMD here. While the market might stabilize in 2014 at best, intensified competition from Intel (NASDAQ:INTC) will most likely mean that the calendar year of 2014 will remain very difficult. Despite the difficult market circumstances, AMD managed to squeeze out operating earnings of $22 million for the quarter. The continued shift towards tablets is hurting the PC market and AMD along with it.
The bright spot is the graphical and visual solutions business which almost doubled revenues on an annual basis to $769 million, driven by the strong demand for games. Operating earnings improved significantly as well to $79 million over the past quarter. Note that the business is typically very seasonal with the third quarter being traditionally strong.
I must say that the prospects for the PC market remain dismal. AMD's operations will undoubtedly suffer from Intel's focus on reducing costs in the coming year, knowing that Intel has more room to financially maneuver given its superior gross margins compared to AMD. On top of that Intel obviously has much greater financial and organizational resources.
The promising thing is that the graphical and visual solutions business is on track to generate revenues of around $1.8-$2.0 billion in a conservative estimate. Operating earnings could come in between $150 and $175 million. Even if AMD were to wind down its computing solutions in a cost-friendly manner, the current equity valuation values the graphical and visual business solutions at 1.4 times annual revenues and 16 times operating earnings. While AMD has found a very nice niche, this is not immune to future competition, obviously. Analysts at Oppenheimer already foresee margin pressure for the business in the very short term.
Back in October following the third quarter earnings release, I last took a look at AMD's prospects. In the wake of the results, shares sold off and fell to lows towards $3 per share. I concluded that computing faced severe headwinds with no end in sight. The continued growth being reported by the graphical and visual business is impressive, both in terms of top-line revenue growth and earnings. This allowed the entire firm to be profitable again on a GAAP basis.
Under command of CEO Read, AMD is focused on sales of bundled graphics and chips, supplying to all the big game console manufacturers in the world. As such, AMD has now achieved a nice and profitable niche market presence. While AMD has a lot of challenges ahead, the graphics business and leverage reduction in recent years are two very positive points.
Even while a share price of around $3.60 seems optically low, it still represents a valuation of $2.6 billion for the equity. Given the risks ahead into 2014, notably on a further computing deteriorating, I don't like the shares that much. If computing will be wounded down in the long term, this will obviously come at a cost, while the graphical business cannot support the entire valuation of the firm just yet, especially not with competition emerging. On the other hand, the current capitalization is so limited, that names like AMD might always become involved with merger and acquisition activity.
With no compelling case towards the upside or downside with enough margin of safety at current levels, I remain cautious and stay on the sidelines.