Advanced Micro Devices: Trend Flip

Summary

• AMD reported strong Q1 results that the market viewed as mixed.
• The chip company remains on track for substantial sequential revenue growth in 2H of 2020.
• AMD should take meaningful market share from Intel this year.
• The stock remains cheap based on out year EPS projections of over $3.50 per share.
• This idea was discussed in more depth with members of my private investing community, DIY Value Investing. Get started today »

Following strong guidance for the rest of 2020, Advanced Micro Devices (NASDAQ:AMD) has slumped back to $50. The chip company was one of the few companies to provide guidance for the year leaving AMD on target for substantial growth for 2020. My investment thesis remains highly bullish on the stock as the company confirms a strong data center and console tailwind for the rest of the year.

Image Source: AMD website

Follow The Trend

For several years, AMD investors have followed the positive trends in the business to higher stock prices. The Q1 results and especially the guidance for all of 2020 confirmed the trend remains intact.

While the revenue trend over the last few years has been spotty, the gross margin trend has been the friend to shareholders. For Q1, revenues were up 40% to $1.79 billion, but down 16% sequentially from $2.13 billion in Q4. Even with the lower sequential revenues, gross margins hit an eight year record at 46%.

Source: AMD Q1'20 presentation

Gross margins grew an impressive 5 percentage points from last Q1. Investors should expect gross margins on non-console revenues to continue rising above 50% for the year as all of the new 7nm products have margins above 50%.

Despite the positives, the numbers could be far better. AMD saw weakness in China and other parts of the world due to retailer closures. The chip company had originally guided towards Q1 revenues of $1.80 billion, plus or minus $50 million, while actual revenues were only $1.79 billion. Naturally, the market wants to see the chip company beat the mid-point target.

In addition, the data center sales remain relatively small with the segment only generating $348 million in sales while Intel (INTC) has racked up over $7 billion in quarterly sales for a couple of quarters now. The main thesis of AMD taking major server market share from the chip giant hasn't even played out yet.

Relative Guidance

While the market is constantly looking at the relative numbers between AMD and Intel, the market generally missed that AMD guided to 25% revenue growth for the year while Intel pulled guidance. Sure, AMD guided down from the previous 28% to 30% growth, but the company still gave the caveat of growth still possibly hitting the magical 30% number.

Source: AMD Q1'20 presentation

The part really confusing investors here is Intel continuing to report surprise date center sales in a boost to revenue expectations. SemiAccurate already highlighted how a one-time deal pushed Intel server revenues higher for now. Also, the chip giant has highlighted a PC sales headwind in the 2H along with lost modem chip sales as Apple (AAPL) shifts to 5G chips from Qualcomm (QCOM) as reasons the chip giant is set to struggle for the rest of 2020 and into 2021.

On the flip side, AMD is driving forward with more data center sales as the EPYC 2 chip slowly takes market share. In addition, the chip company is taking other share in the PC space with notebooks hitting record sales in Q1 and semi-custom product sales are expected to soar with new consoles in the Fall.

On the Q1 earnings call, CEO Lisa Su discussed the expected ramp in console sales this year:

As expected, semi-custom product revenue was negligible in the quarter, as Sony and Microsoft, both reduced inventory in advance of next-generation console launches. We expect semi-custom revenue to increase in the second quarter and be heavily weighted towards the second-half of the year, as we ramp production to support the holiday launches of the new PlayStation 5 and Xbox Series X consoles.

The tailwinds at AMD and the headwinds at Intel are most visible via the below charts of quarterly revenues. Based on guidance, analysts expect AMD to grow Q4 revenues by 38% over the Q1 levels while Intel is expected to see quarterly sales dip by 11% in Q4.

These projected revenue trends for the next three quarters are dramatically in favor of AMD. Who knows, maybe Intel will surprise again, but the trends appear very undeniable in favor of AMD.

AMD will come out of 2020 in a far different position than the doubters think. Even analysts have sales topping $10.1 billion in 2021 now with an EPS in excess of $1.50. The chip stock appears expensive at 33x these EPS estimates, but AMD has substantial upside potential.

Once the company hits long-term gross margin targets in excess of 50%, even with the lower semi-customer margins, AMD will generate substantial EPS growth. The financial breakdown when AMD reaches an average of 25% market share on a $74 billion TAM is $18.75 billion in annual revenues with an EPS of $3.71 as follows:

• Revenue = $18.75 billion
• Gross Margins @ 50% = $9.38 billion
• OpEx @ 22% = $4.13 billion
• Operating Income = $5.25 billion
• Taxes @ 15% = $0.79 billion
• EPS = $4.46 billion/1.2 billion shares = $3.71

Takeaway

The key investor takeaway is that investors initially got lost in the mixed data with the Q1 results from AMD and Intel. Intel does a great job of beating very weak guidance while AMD always struggles to hit very strong guidance. The real numbers for the rest of 2020 have AMD separating from a lagging Intel. Despite the coronavirus global shutdown, the long-term story remains intact for AMD gaining significant market share and boosting both revenues and EPS to levels where the current $50 stock price is cheap.

Analyst’s 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.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.