- AMD surprised short-sellers by reporting a strong quarter.
- Market still underestimating positive momentum for company moving into current quarter and year.
- Analysts should revise 2014 and 2015 earnings upwards.
In February, investors bid up shares of Advanced Micro Devices (NYSE:AMD) ahead of results, only to get disappointed. Management gave a conservative, cryptic forecast that did not give the market any confidence that the company's transition program was on schedule. Thanks to a better Q1 report, AMD is now poised not only to revisit the $4.50 level reached at the start of the year, but to continue to trend upwards. There are five reason this support this view:
1) Profitable quarter likely
AMD is in a good position to report a profitable second quarter (GAAP-adjusted). AMD already reported three consecutive quarters of non-GAAP profitability. In the just reported Q1 report, non-GAAP earnings improved $0.15 per share from last year. The company lost $20 million, or $0.03 per share (using GAAP).
Q1 is traditionally the weakest quarter, so it is not surprising that many investors anticipated the company to disappoint. Momentum is on AMD's side now, and will extend into the current second quarter. Console sales will help AMD achieve profitability. Sony (NYSE:SNE) already said it sold 7 million PS4s, while Microsoft (NASDAQ:MSFT) is quiet on the matter. Even with PS4 outpacing Xbox One sales for now, Xbox One still shows promise. Microsoft's console is not as widely available geographically. Microsoft's bundling of Titanfall and a one year membership of Xbox Live will help sales.
AMD also highlighted on its conference call that it will have up to two new semi-custom design wins this year.
2) 9 billion market outside PC
Reports of a drop in PC shipments were supposed to hurt AMD, but the chipmaker is becoming immune to the general malaise in that sector. In fact, it is gaining share in the professional graphics market. This is due to the success of long-awaited Apple's (NASDAQ:AAPL) Mac Pro refresh. Apple and AMD will both benefit from demand for systems that are capable of handling video graphics resolutions of 4K. Despite surprises in this segment, AMD wants 50 percent of revenue to come outside of the PC market. It sees embedded SoCs (System on a Chip) and processors as having a $9 billion TAM (Total Addressable Market). It is now reasonable to expect AMD's price multiples to expand, because the product cycle is longer in this market. Revenue is more consistent and predictable. Now that inconsistent results are in AMD's past, its low share price will also be history.
3) New server hardware
AMD has a good chance of finding strong demand for its first 64-bit ARM server. The solution will have broad appeal for data centers, since AMD will launch both the x86 and ARM platforms later this year.
4) PC a wildcard
Intel (NASDAQ:INTC) reported quarterly results that were not nearly as bad as many had feared. One reason PC demand might improve is because Microsoft is ending support for Windows XP. Even though some customers are paying millions for XP support, the majority of corporations will upgrade to Windows 7 or 8. AMD is not expecting to grow market share here, but its high end A8 and A10 APUs will keep the company in play. As a growth strategy, AMD is focusing on low-cost PCs in the emerging market.
Analysts on average expect AMD to earn $0.13 per share this year, and $0.15 next year. The strong positive momentum in AMD's Q1 suggests these estimates are at least 15-25 percent too low. This implies AMD could earn $0.19 per share next year. At earnings 25 percent higher than the average consensus, the forward P/E is just 21.7. At a more optimistic forward P/E of 30, AMD should trade at $5.70 by the end of this year.
Computing Solutions was a weak spot for AMD in Q1. Revenue was $663 million, down 8% sequentially. Debt also rose slightly to $2.14 billion, though AMD purchased and issued debt to push out the most significant debt maturity to December 2017. This will lower the cash flow pressure on AMD for the next few years as the company executes its transition plan.
Open interest for options on AMD calls expiring January 17, 2015 and with a strike price of $5 and $7 is high. AMD surprised the market with good results, but that was just a start. New product announcements, profitability in future quarters (using GAAP), and renewed bullishness suggest AMD will close the year at just below $6.