AMD: Sell-Off Is Warranted As AMD Disappoints So Early In The Recovery Cycle

Jul.18.14 | About: Advanced Micro (AMD)

Summary

AMD had a soft quarter, as it failed to benefit from the recovery in PCs unlike Intel.

This was accompanied by a very soft third quarter outlook as growth is stalling.

This is as management is underdelivering again, which means this sell-off creates no obvious buying opportunity.

AMD (NYSE:AMD) disappointed investors yet again by reporting soft second quarter results accompanied by a very disappointing outlook for the third quarter.

With growth stagnating on an annual basis, and AMD not benefiting from the rebound in PC sales, investors sold off their shares massively in after-hours trading. In my eyes the 20% sell-off is warranted after recent momentum and the poor news.

Second Quarter Headlines

AMD posted second quarter sales of $1.44 billion. Revenues showed solid growth, increasing 24% compared to last year while revenues were up by 3% compared to the first quarter.

Despite the increase in sales, AMD posted a net loss of $36 million, or $0.05 per share. This compares to a $74 million loss last year and a $20 million GAAP loss in the first quarter of this year.

Non-GAAP earnings came in at $17 million or $0.02 per share which compared to a nine cent loss reported last year. Earnings on this metric missed consensus estimates by a penny.

Developments During The Quarter

Despite hopeful signs from Hewlett-Packard (NYSE:HPQ) and Intel (NASDAQ:INTC) regarding the PC market, revenues at AMD's computing solutions business were very challenged.

Reported revenues of $669 million were down by more than 20% compared to last year even as sales were up a percent from the first quarter. Operating income of $9 million compares to a modest $2 million profit last year and a six million loss in the first quarter.

The graphics and visualization group continues to drive results. Revenues of $772 million were up by 141% compared to last year, but rose by just 5% on a quarterly basis. Operating income was $82 million which was down from the $91 million reported in the first quarter of this year. The sequential decline in earnings is partially the result of pressured average selling prices.

Operating earnings evaporated on the back of high interest expenses and costs related to the readjustment of its debt position.

Valuation

AMD ended the quarter with $948 million in cash and equivalents while having $2.21 billion debt outstanding. This results in a net debt position of around $1.26 billion.

The company has been active in re-profiling its debt (maturity) structure. It issued $500 million worth of notes due in 2024 carrying a 7% rate. At the same time shorter term duration notes carrying an 8.125% rate which are set to mature in 2017 have been repurchased. All of this resulted in a $49 million GAAP loss during the quarter, but will lower future interest expenses and increase the duration of outstanding debt.

Factoring in the huge after-hours reaction following disappointment from investors, shares trade around $3.80 per share. This values equity in AMD at about $3.0 billion. On a trailing basis the company posted sales of $5.9 billion on which it has posted a slim profit of $80 million on a GAAP basis.

This values equity in the business at roughly 0.5 times sales and about 37-38 times GAAP earnings. Of course GAAP earnings are severely impacted by the debt restructuring efforts, as well as interest payments which are relatively high at about $180 million over the past year.

A Lost Decade, But What About The Future

AMD has seen a very difficult past decade, not only competing with giants like Intel but operating in a declining PC market as well. Between 2004 and this moment, the company has posted relatively stable revenues of $5.0 to $6.5 billion. Following multi-billion dollar losses during the crisis, AMD has seen a rebound in 2009-2011 when it posted earnings of $370 to $490 million per year.

This was followed by a new big loss in 2012 of $1.2 billion as AMD was restructuring again, followed by a modest rebound last year. For investors it has been a very unprofitable ride, with shares falling from $40 in 2006 to lows of $2 during the 2009 crisis. Shares rebounded and peaked at $10 in 2010 but have fallen back again to levels just below $4 at this moment. What should be realized is that the total share count has doubled as well over the past decade while investors have not received any dividends over this time period.

For the current quarter, AMD sees revenues up 2% on a sequential basis, while it attaches a 3% uncertainty range to this outlook. This would imply that sales are seen between $1.43 and $1.51 billion. Note that AMD posted sales of $1.46 billion last year, which essentially means that sales are unchanged on an annual basis. This is very disappointing with analysts projecting sales to reach as high as $1.57 billion in the third quarter.

Recent Investor Update

Back in April, AMD held an upbeat investor presentation, detailing its strategic outlook for the coming years. The company stressed the fact that by next year it is likely to generate 50% of sales from growth markets, up from just 10% in 2012. Growth markets are defined as the professional graphics, dense servers, embedded and ultra low power clients business.

The company notes that the restructuring took place around the turn of the year from 2012 into 2013. This was followed by the acceleration and execution phase in 2013 and 2014, while the future should focus on the transformation. I can hardly call the nearly flat year-on-year revenue guidance for the third quarter an "acceleration".

While the company is very successful in the graphic business, AMD only sees a $1.3 billion addressable market for these solutions. Much bigger are the dense server, embedded and ultra low power client opportunities, yet real gains still have to be demonstrated in these areas. Again, the presentation looks really nice, yet investors like to see real tangible improvements and not just promises.

Final Takeaway

Investors are clearly not happy with the results based on the second quarter earnings miss and the soft outlook for the third quarter. This is especially after Intel reported very strong numbers earlier this week.

While Intel's PC business might be more tied to the business segment of the market which is replacing older PCs, it looks that AMD's performance in the areas was very soft. Softness in AMD's PC business was priced in to some extent, and investors have become hopeful about its graphics and visual solutions business. Yet growth trends and margins in this promising segment have been disappointing over the past quarter.

Combined with the strong momentum shares were vulnerable to a violent sell-off if earnings missed, which it did. Shares of the company have risen by nearly a quarter over the past quarter, with momentum accelerating earlier this week.

AMD does have a promising future if it can execute, yet investors are not happy with a disappointment so early in the recovery cycle after having been disappointed many times in the past. The company's finances have improved however in recent times, and the company is able to report modest profits after accounting for debt restructuring charges.

The company can easily grow into the current valuation if earnings are improved, yet investors appear to discount management's future predictions given the past disappointments. As such investors are discounting future promises to a great extent, which is very understandable.

I remain on the sidelines not being convinced that the sell-off creates enough appeal given the risks out there.

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