What Will It Take For Bernstein To Reassess AMD?

| About: Advanced Micro (AMD)
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AMD announced a stronger than expected set of quarterly numbers, and even boosted the Q3 outlook.

Research firm Bernstein had recently downgraded the stock to Underperform.

Do you think Bernstein will upgrade the stock?

AMD (NASDAQ: AMD) has posted a staggering Q2, and boosted the outlook for Q3, beating all the naysayers at once. You can read about the results here. To sum them up, the results are strong enough to force any bear to reconsider his stance on the stock.

After the company's Q1 earnings, the stock rallied roughly 50 percent in a day. At the time of writing this piece, the stock is trading 10.92 percent higher at $5.79. Those who dared to short the stock before the earnings will likely cover today. (First of all, they shouldn't have taken their short positions home given the massive move in the first quarter earnings.)

Roughly two weeks ago, research firm Bernstein had downgraded AMD from Market Perform to Underperform, with a price target of $3 per share. Bernstein analyst Stacy A. Rasgon had at that time said that "the stock has run too far, too fast," and warned investors that the shares could crack.

He also said that the company's Q2 results will likely come in below analysts' expectations; as we know now, the company beat the analysts' projections by a huge margin.

So, the question now is: Will Bernstein Upgrade AMD? Or at least, will we see an upward revision in price target?

To gain some perspective regarding this, it is best to refer to the earnings call where Rasgon asked three questions from the management. The questions were definitely more critical than what others had asked.

AMD has guided a low single digit revenue growth for 2016 year-on-year. Rasgon asked the management if 3% revenue growth was to be assumed for the entire year, it would imply Q4 would be down 16% - 17% sequentially, given that the Q4 will have an extra week?

Here is AMD's President & CEO Lisa T. Su's answer:

Overall, the businesses are performing well. So we do expect both computing and graphics and EESC to both grow for the year. I think the semi-custom business is the large driver of the fourth quarter, in terms of just how we see the overall business playing out, but the computing and graphics business is playing out as you might expect. So, the second half should be seasonally higher. Certainly with Polaris and as we launch broader availability across the product line, as well as the seventh generation APUs as they go into back-to-school and holiday. So that's the way we should think about it.

This indicates that with semi-custom sales expected to peak out in Q3, the company's other business segments might not perform well enough.

The next question he asked was related to the notebook shipments in Q2. While asserting the low base effect, he questioned whether three successive quarters of sequential increases was due to the actual demand or was it a sell in into the channel?

The reason why I mention this here is because this was one of the reasons given by Rasgon when he downgraded the stock. Rasgon had then said, 'Q1 PC upside was likely due to Bristol Ridge channel fill, not necessary sustainable demand (a pattern we have seen before.)'

Su cleared his query stressing that it's the consumption that is stabilizing the business and not the sell-in.

Bernstein analyst then asked his third question on the sharp decline in wafer purchases given the increase in notebooks as well as with the upcoming launch of Polaris. To this, Devinder Kumar, CFO said,

I think basically the purchases of the wafers are in line with product demand and mix of business and as I said in the prepared remarks, year-to-date we've purchased about $260 million of wafers and we are getting into the back half of the year, which as you can see, with our revenue guidance in Q3, is pretty strong.

With the third answer, the management has conveniently rested it for the Q3 results.

So, do you think Berstein will reconsider its stance on AMD? I think there is a fair chance that the research firm will not budge from its stance given that the downgrade came just a couple of weeks ago. Additionally, since Q4 will be weak relative to Q3, it will give them some room to reassess their study of the business. I suppose they would choose to wait for the full-year results before they even begin to re-rate the stock, but an upward price revision in the meantime cannot be ruled out. The average analyst price target is $4.09 (Yahoo estimate), and this might go up too any time.

By 2016's end, the bearish thesis would have been tested for two quarters and the firm will have a clearer picture before them as to whether AMD is really poised for growth or not. If AMD delivers above-par results for the next 2 quarters, the stock may see Berstein upgrade it back to Market Perform, which will boost the investor confidence. However, if the bearish thesis does play out and AMD is caught on the wrong foot, the downside risk is 48% with regards to the current price and Bernstein's price target.

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Disclosure: I/we 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.