Since I first argued that Intel (INTC) was a safe and strong investment here, the stock has gone up by 9.6%, beating the Dow Jones by nearly 250 basis points. What mainly surprised me, however, was how strongly Advanced Micro (AMD) outperformed the broader indexes at a return of 18.3%. I find that given continued end market uncertainty and a shift towards lower cost solutions, both firms face a good deal of risk. Based on multiples analysis and DCF modeling, we can see why Advanced Micro is rated a "hold".
From a multiples perspective, Advanced Micro is the cheaper of the two. It trades at a respective 4.2x and 9.9x past and forward earnings, but has significant volatility at a beta of 2.2. With Texas Instruments (TXN) and Intel offering dividend yields of 2.2% and 3.3%, respectively, as well as 50% lower betas, Advanced micro is a tough sell.
At the third quarter earnings call, Advanced Micro's CEO, Rory Read, nevertheless mentioned some progress amidst a challenging environment:
AMD's third quarter revenue was $1.69 billion, up 7% from the prior quarter and up 4% year-over-year. And AMD's non-GAAP operating income grew by 28% quarter-to-quarter and was flat year-over-year…
Third quarter demand for our new AMD platforms was strong, particularly in the mobile processor space, where we saw revenue grow 35% sequentially and 20% year-over-year, clearly outpacing the market in a significant way. Additionally, in the server space, we saw a solid 27% gain in revenues sequentially with solid customer demand for our next-generation Opteron offerings.
However, we also had our challenges. We saw both 32 and 45 nanometer supply challenges in the third quarter. No doubt, we must improve our execution and we are taking action to improve our ability to consistently deliver our products on time, day in and day out".
While the company has resolved a meaningful amount of Llano supply chain issues recently, market share in NBs is likely to remain flat. ODM builds are also trending as much as 12% lower, sequentially. Failed execution in IvyBridge, coupled with greater customer interest in low-cost solutions, further add to the risks.
Consensus estimates for Advanced Micro's EPS forecast that it will decline by 2.1% to $0.48 in 2011 and then grow by 25% and 35% in the following two years. Assuming a multiple of 13x and a conservative 2012 EPS of $0.55, the upside of the stock is 22.9%. If, however, the multiple only doubles to 8.4x and 2012 EPS turns out to be -15% below consensus, the stock would fall by 26.5%. Overall, I find the general market assessment is at fair value and, thus, risk/reward is not the best at the present moment.
Intel, on the other hand, offers an attractive amount of safety. The technology company had excellent third quarter performance, with quarterly EPS at its highest ever. Solid momentum in netback PC was demonstrated with double-digit sequential growth, while Enterprise PC demand in China, India, Turkey, and Indonesia are all up. As the company has strong footholds in emerging markets, it is well positioned to drive free cash flow in the event of a recovery. Add the rise of Ultrabook and Windows 8, and you have the potential for solid volumes.
While the firm has done well in a challenging economy, the road ahead in its core PC market is plagued with obstacles. PC OEMs are substituting away from x86 and towards ARM PC platforms. These low-cost solutions can run key applications, so the pressure is certainly on.
Consensus estimates for Intel's EPS forecast that it will grow by 15.6% to $2.37 in 2011 and then by 0.4% and 8.4% more in the following two years. Of the latest 46 revisions to EPS, all have gone down for a net change of -3.2%. Assuming am multiple of 13x and a bearish 2012 EPS of $2.19, the rough intrinsic value of the stock is $28.47, implying 10.6% upside. Modeling a CAGR of 7.97% for EPS over the next three years and discounting backwards at a WACC of 9% implies yet a greater discount with fair value at $33. Intel may be rated a "hold", but it provides a strong defensive play.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
