The AMD Turnaround Story Remains Intact

| About: Advanced Micro (AMD)


The AMD turnaround story is still intact, even though the company still has balance sheet issues.

The reason why AMD is such a followed stock is because of the potential profits as a turnaround situation.

And if management continues on the current path, profits to be had will be plenty.

Highlights from the company's Q1 2014 results were:

  • Revenue of $1.40 billion, decreased 12 percent sequentially and increased 28 percent year-over-year
  • Gross margin of 35 percent
  • Operating income of $49 million and non-GAAP(1) operating income of $66 million
  • Net loss of $20 million, loss per share of $0.03 and non-GAAP(1) net income of $12 million, earnings per share of $0.02

AMD's (NYSE:AMD) results were better than expected, for the market was looking for a non-GAAP EPS of $0.00 and revenue of about $1.34 billion. As a result the shares traded higher by about 6% in after-hours trading on Thursday.

The Graphics and Visual Solutions segment was the clear winner for the company and produced a 118% year-over-year revenue increase for AMD, even though on a sequential basis revenue was down by about 15%. Operating income for the segment came in at $91 million as compared to only $16 million the same time last year.

Revenue at the Computing Solutions segment decreased 8% sequentially and 12% year-over-year. Furthermore, the operating loss was $3 million as compared to $7 million last year. So overall even here we see an improvement. The company said the average selling price for microprocessors was flat sequentially and only decreased slightly year-over-year.

I am not going to get into the technology side of the equation. Overall I think AMD is on the right path and the turnaround story remains intact. My main concern is the company's balance sheet, that I think is the main deterrent that's keeping the stock down.

Current assets for the quarter stood at $2.69 billion with current liabilities at $1.38 billion. So the current ratio is about 2. That is an improvement from the current ratio of 1.78 of the previous quarter.

Long-term debt however continues to be persistently high. The company's long-term liabilities have not come down at all for the entire year, standing at around $2 billion. Overall, AMD has a total of about $4.2 billion in liabilities. For a company that will do about $5.6-$6 billion in sales this year, that is a very big debt load.

However, this is also partly the reason for the stock's attraction. See AMD's market cap is currently about $2.7 billion. If you didn't notice, it is trading at around 1/2 times sales. Intel (NASDAQ:INTC) on the other hand is currently trading at 2.5 sales. That's about a fivefold difference. Obviously, AMD trades this low for a reason, but if somehow AMD can make its balance sheet look more like Intel's, AMD shareholders will hit the jackpot.

The company paid a total of $47 million in interest payments for the quarter (which was actually up sequentially by $3 million). If it didn't have this debt load and all those interest payments, the stock would be at much higher levels.

There are several ways for the company to reduce debt, and make the balance sheet look better:

1) The best way is if the company performs well and increases revenue and profits over time

2) The company finds some way to reduce its debt load very fast (perhaps selling assets, if it has any)

3) Or the company can sell shares in a secondary offering, but at much higher prices (so as to avoid excessive dilution).

None of the above are easy and my guess is that deleveraging the balance sheet will be a very slow process. Overall however the company's pipeline is very interesting and that should help in its turnaround and deleveraging effort.

Among other things, by late 2015 the recent agreement between Samsung and Global Foundries should ferment and we should start seeing the first line of products rolled out with 14 FINFET. That should (will) close the gap between the lead Intel currently enjoys against AMD.

Intel has a near monopoly in the server space. AMD has been trying to crack this market for a while now and management is very confident it will by the end of the year. The dense-server market is projected to be about 25% of the overall server market by 2019. The company will be the first to bring to market a 28-nanometer, 64-bit server chip later this year. It is still soon to tell what kind of revenue AMD will achieve, however, keep this in mind: Intel has almost a monopoly in the server space. When you have everything, you have a lot to lose. AMD on the other hand has nothing to lose, but everything to gain, if it gains traction in this market.

The bottom line

While AMD does not have the marketing muscle and resources Intel has, it is managing OK. The stock however trades at a very deep discount to Intel, mostly because of its debt load, which makes is a good candidate for extraordinary returns if management performs.

Revenue will continue to be supported by Console sales and the company's graphic segment for many more years to come. And while PC sales might continue to decline, the company has a good chance of taking a sizable chunk of the server market over the next two years, that will more than make up for evaporating PC sales.

AMD expects to report revenue growth, to be profitable, and to generate free cash flow for the entire year, while keeping interest expense neutral. If indeed these goals are met, then management is on the right track.

And while the company will continue to have balance sheet issues, if management can continue to execute as it has, then these balance sheet issues will become less important, and the stock will more than compensate current shareholders for the increased risk of ownership.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.