Advanced Micro Devices: Time To Take The Plunge?

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About: Advanced Micro Devices, Inc. (AMD)
by: Achilles Research
Summary

AMD's share price has corrected heavily in the last two months.

AMD should continue to see strong revenue growth and high gross margins, thanks to its well-received Ryzen desktop and mobile processors.

Shares are no longer overbought or oversold.

AMD's shares sell for a much more reasonable P/S-multiple after the correction and have a much better risk/reward.

The correction of chip maker Advanced Micro Devices (AMD) opens up an entry opportunity for investors that believe that the company will continue to see strong revenue growth on the back of its critically-acclaimed Ryzen desktop and mobile processors. Advanced Micro Devices' shares have fallen ~38 percent from their September high and have a much more appealing risk/reward-combination on the sell-off. Shares are more reasonably valued on the drop and are ripe for a rebound.

According to the Relative Strength Index, or RSI, Advanced Micro Devices' shares are in technically neutral territory, meaning they are no longer overbought or oversold. Despite the correction in the stock market and especially in the tech sector in the last two months, Advanced Micro Devices are still up ~107 percent year to date.

Source: StockCharts

I think 3 reasons stand out why investors with an above-average risk tolerance might want to consider shares of AMD on the drop:

1. Investor Sentiment Has Turned Negative Because Of The Trade War

Investors' risk appetite has decreased in light of the tariff stand-off between the United States and China. Throw rising interest rates and surging bond yields into the mix and you have a recipe for bearish investor sentiment. The sell-off, which started in October, has had a particularly negative effect on tech stocks, including AMD, which have performed extremely well in the first nine months of the year. I see the current drop as nothing more as a healthy correction and buying opportunity from a sentiment point of view.

2. AMD Is In An Excellent Position To Grow

Advanced Micro Devices hit a home-run with the release of its Ryzen desktop and mobile processors for high-performance computing. Not only do the Ryzen processor chips drive AMD's revenue growth, but the chip maker also won 2018 Trusted Review Awards for its AMD Ryzen 7 2700X and AMD Ryzen 5 2600X processors.

Advanced Micro Devices' Computing and Graphics segment posted $938 million in revenues in the last quarter, reflecting an increase of 12 percent compared to last year, thanks to the ramp of Ryzen desktop & mobile processors. The division also shipped its most units since Q4-2014, while Ryzen processor sales grew to more than 70 percent of total client revenues.

Strong processor sales with respect to Ryzen and EPYC (AMD's datacenter processor) were also the key drivers of AMD's expanded gross margin in the third quarter. The chip maker reported a 40 percent adjusted gross margin, reflecting a 4 percentage-point improvement year over year. It was the highest gross margin in two years.

Source: Advanced Micro Devices Investor Presentation

All major key metrics in the third quarter 2018 reflected strong financial performance.

Source: Advanced Micro Devices

Advanced Micro Devices' total revenues increased 4 percent year over year to $1,653 million in the third quarter, and there are no signs of slowing revenue growth. In fact, AMD's management has guided for up to 8 percent year-over-year revenue growth in Q4-2018 while the gross margin is expected to expand even further to 41 percent. Total 2018 revenues are expected to jump more than 20 percent.

Source: Advanced Micro Devices

3. Valuation Is Reasonable

Despite the surge in Advanced Micro Devices' valuation this year, the chip maker is not overvalued. Compared to rival company, Nvidia Corporation (NASDAQ:NVDA), Advanced Micro Devices' forward P/S ratio is less than half Nvidia's sales multiple.

Chart AMD PS Ratio (Forward 1y) data by YCharts

Another indicator that the sell-off may have gone a bit too far relates to the increasing gap between AMD's share price and the consensus fair value/price target. While AMD's share price folded during the October sell-off, the consensus price target did not change. The consensus price target, according to MarketBeat, currently sits at $24.35, indicating ~14 percent upside potential.

Source: MarketBeat

Risk Factors Investors Need To Consider

AMD is well-positioned to ride the Ryzen wave and capture further revenue growth as the outlook remains positive. Risk factors, as far as I am concerned, largely relate to the market itself. The tariff stand-off between the U.S. and China is not resolved yet. The United States and China agreed to a 90-day truce earlier this month, which gives both countries time to work out a trade deal and remove uncertainty. Should they fail to reach an agreement, volatility will most likely creep back into the stock market, potentially extending the correction of technology stocks, including Advanced Micro Devices.

Your Takeaway

The correction is a good opportunity, in my view, to gobble up a few shares of Advanced Micro Devices. The company's fundamentals remain very strong (gross margins are still expanding, and revenues are projected to rise). The revenue growth outlook on the back of the Ryzen desktop and mobile processor roll-out remains appealing, which leaves room for valuation growth. Advanced Micro Devices' shares have a much lower P/S-ratio compared to Nvidia Corp., and, hence, an attractive risk/reward-combination. Speculative Buy for capital appreciation.

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