AMD Is Probably Punished Too Much By Investors

Jun.29.12 | About: Advanced Micro (AMD)

AMD (NYSE:AMD) has lost 35% of its market value between March and now. The company's share price is down from low $8s to mid $5s. The more interesting thing is that there has been no news that drove this plunge in the last few months. The company didn't announce anything negative, analysts maintained a price target around $10 for the company, and the company's newest products received a lot of positive reaction. It is clear that AMD got punished too much by the investors and it is only a matter of time before the investors realize the company's value again.

After earning 67 cents per share in 2011, the company started the first quarter of 2012 with a profit of 12 cents per share. While the company's revenue declined by 2%, its revenue beat the estimates of 9 cents per share. Additionally, the company increased its guidance for the rest of the year; however investors still continued to sell this stock non-stop. This year, the company is expected to earn 70 cents per share and the next year, it is expected to earn 73 cents per share. These numbers would yield a forward P/E ratio of 7.7 for this year and 7.4 for the next year for the company. Assigning a fair P/E ratio of 10 to AMD would provide an upside of nearly 50% by 2014.

Of course, investors are overly worried about the impact of slowing global economy on AMD. Many investors seem to believe that there will be very little demand for AMD products in the next few years because sales of computers will decline significantly. However, we don't see the same sell-off in Intel (NASDAQ:INTC) who has as much exposure to slowdown of the global economy as AMD, if not more. The investors might have just priced-in more global slowdown than necessary in AMD's share price.

Because AMD doesn't get involved in the actual manufacturing of its products, the company is able to keep its margins high. As long as the company meets the guidance numbers of its own management, it will do fine for the foreseeable future. The company's biggest threat is its debt; however it has been successful in paying off its debt in the recent years. In 2007, the company's outstanding long term debt was $5.03 billion, which got reduced to $4.70 billion in 2008, $4.25 billion in 2009, $2.18 billion in 2010 and $1.57 billion in 2011. Soon enough, AMD's debt repayments will stop being a burden for the company.

In the short run, PC demand may be weakening, particularly in the emerging markets; however, long term investors should use short term weaknesses as opportunities to buy their favorite shares rather than times to sell. In the long term, most of the troubles are behind the company and it should result in nice returns to investors.

AMD doesn't have dividends, however the writing covered calls can result in good returns for this company due to high volatility. Selling out of money calls expiring in January 2013 will result in premiums ranging from 9 cents to 69 cents, which should result in a yield between 1.5% and 12.04%.

One note of caution: I don't expect the company to have a rapid growth like Apple (NASDAQ:AAPL) does. I simply see the company being as grossly undervalued. Even if the company doesn't show much of a growth in the next few years, all it needs to do is to catch up on valuation in order to result in handsome returns. If, for example, a company is undervalued by 30%, this will result in a potential 30% upside in the company even in the absence of any growth for the company.

At the moment I rate AMD as a buy due to its valuation in the short term and opportunities in the long term.

Disclosure: I am long AMD.