In my February article on Advanced Micro Devices (NASDAQ:AMD), "Don't Confuse Stable Foundation With Eternity," I pointed out that there is no infinite growth for AMD without more sensitive setbacks. COVID-19 has brought precisely this setback. Since I recommended investors to repurchase AMD in April, the stock has gained almost 30 percent. Investors are now facing a difficult phase. Between partial market opening after the lock-down measures and the possibility of an economic downturn that has just begun, questions about the fundamental valuation of AMD arise. Quo Vadis, so where do you stand on AMD? Time for some more profound thoughts.
AMD's share price performance (like the market as a whole) was quite volatile. Currently, we have again reached a point where AMD was before the COVID-19 volatility.
At that time, however, I had already warned investors that further growth was not necessarily guaranteed. One main reason for my rating was the fact that I did not like the high valuation of the company. Accordingly, I have often given AMD a neutral rating (plus because I am not invested myself).
Therefore, it would only be logical for me to issue another warning, and for investors to wait for a better time to enter the market.
The thing is that this form of market timing may work from time to time, but overall it is a bet with poor odds. Of course, prices may fall again and create better investment opportunities. However, the question is whether this is guaranteed or whether investors will miss out on further price increases and thus possible profits. There are also good reasons to believe that speculating on AMD is the wrong way to go and that holding it over the long term could give investors an equally excellent return.
The year 2019, in particular, could have been a groundbreaking year with remarkably growing sales.
(Source: 4Q 2019 results/table by author, taken from previous analyses)
EPS and cash flow are now also on a sustainable path. If you look at the graph below, you can see a relatively rising curve. The extremely volatile operating times with severe losses seem to be over for now.
(Source: AMD, EPS an operating cash flow)
This growth in revenue and EPS is also associated with the fact that AMD has overcome the phase of declining margins due to higher capital expenditures and is aiming for further increasing margins in the future.
(Source: AMD, Revenue and margins)
AMD has seamlessly followed this up with the first quarter of 2019. Year-over-year sales increased by more than 40 percent, and the gross margin rose to 46 percent (5 percentage points). The "Computing and Graphics Segment" was particularly convincing, with a growth of 73 percent. AMD also increased its market share in the important CPU market.
In desktop, overall demand for our latest Ryzen 3000 and prior generation Ryzen 2000 processor families were strong, both of which continue to top retailer bestseller lists and have more than 50% share of premium processor sales at many top global etailers.
Although the second segment, "Enterprise, Embedded, and Semi-Custom" lost 21 percent, the development of the EPYC CPU was promising. Here AMD scored especially in the HCP segment. Here I see great potential for AMD's GPU product, which are now more important in the HCP segment than CPU.
Most importantly, EPS has also improved enormously (GAAP from USD 0.01 to USD 0.14).
For the year 2020, AMD is planning sales growth of 25 percent and a one percentage point higher gross margin despite the uncertainty surrounding COVID-19. This operational development is a strong bullish signal for investors, which was not expected in this form a year ago.
Readers often ask me about the very high P/E ratio of AMD. And indeed, the P/E ratio is extremely high compared to its competitor Intel (INTC). This refers to both the current P/E ratio and the future P/E ratio.
Does the market act irrationally here and rates AMD far too highly?
Not necessarily. For example, AMD is growing at a much faster pace than Intel in terms of profits.
Take only the first quarter of 2020, when AMD's GAAP EPS increased fourteen times year over year and non-GAAP EPS tripled.
AMD is also fair or slightly undervalued compared to its own historical valuation based on the price/cash flow ratio and the P/E ratio. Here, however, the better growth prospects could even justify higher multiples.
(Source: Fair Value Calculation)
Another aspect that I think is too much neglected in the fundamental valuation is the excellent financial situation of AMD. With less than USD 600 million gross debt at the end of Q1 2020, AMD is net cash positive:
And also here a good comparison can be made to Intel, whose balance sheet is by far not as stable as with AMD:
Of course, this does not mean that Intel is a bad investment! Investors should just not look at individual multipliers such as the P/E ratio in isolation and draw over-hasty conclusions.
AMD has overcome COVID-19-related volatility The company has thus achieved a respectable outperformance compared to the broader market. This can be attributed to the good prospects on the one hand and the excellent operating performance and good management on the other.
However, there is also the question of how to proceed with the share price. It is clear that there is no unlimited growth. The P/E ratio is also quite high.
Conversely, I think that marketing timing at AMD is the wrong way to go. The company is strongly positioned and has an excellent balance sheet. The high P/E ratio is also put into perspective in historical comparison and taking into account the speed of growth. I, therefore, believe that future price gains are justified by the reasons outlined above.
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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.