By Chaim Siegel of Elazar Advisors, LLC
Summary
After going nowhere for 10 years, Advanced Micro Devices (NASDAQ:AMD) is about to break out to the upside of its decade long base. We believe this will be driven by the company's new CEO and her focus on the higher-end of the chip market.
AMD had been playing at the lower end and losing share to Intel Corporation (NASDAQ:INTC) in what is already a crowded space. AMD's new “higher end” products have a huge launch schedule this year that can be a catalyst for the stock to continue to move up.
After having spoken to the company, we've assembled the facts and will walk through our rationale showing how AMD can get to $23 a share in the next 12 months:
But It's Already Up From $2
Investors are starting to get excited about AMD coming back from the ashes. The issue for newer investors is that the stock has already gone from $2 to $13 in about a year. That's a huge move and has caused many people to kick themselves and assume, "I missed it.”
Only Just Starting To Break Out
If we zoom out though, going back 10 years, it's clear that AMD is only just starting to hit levels not seen since 2007 which makes this stock look much more appealing.
Any positive change in the business model that can drive earnings should be able to drive the stock higher.
Near Term Catalysts Can Keep The Stock's Momentum Up
AMD has an accelerated launch schedule this year for some key products. They are launching multiple CPU chips (Central Processing Unit) and GPU chips (Graphics Processing Unit). The chips are for desktops, servers, and gaming consoles and will compete with Intel and NVIDIA (NASDAQ:NVDA) in portions of the market where, until now, AMD has been losing share.
AMD’s newest chips compete more effectively on price and performance measures after a refocus by management which began several years ago. What is getting investors excited are the huge amounts of market share AMD has the potential to win back. And the launch schedule for this entire effort began just last Thursday with the introduction of Ryzen.
March 2nd
*Ryzen: A CPU to compete with Intel on the desktop. Intel owns roughly three-fourths of this market. If AMD's product can live up to recent price/performance attributes it claims for this CPU it finally has a shot at catching up to Intel here, with substantial market share to gain.
Second Quarter 2017
*Vega: GPU to compete with Nvidia in the gaming space at the high end of the market.
AMD had been competing in the mid-range of the market but did not have a product robust enough to compete at the high end of the gaming space. Nvidia owns upwards of 70%+ of the GPU gaming market. This is also is a huge market in which AMD can begin winning back some share.
*Ryzen will be launched to compete with Intel in the server market.
2nd Half 2017
*Ryzen will be launched to compete in the notebook market.
*Ryzen will integrate with an APU (Accelerated Processing Unit) which will allow the CPU to compete in graphics and gaming segments.
Brief Background
Under CEO Dr. Lisa Su, whose tenure began in 2014, AMD has morphed itself from a dull, low-end PC processor company to a higher end chip company. Dr. Su has redirected the company’s focus to up-market products for higher-end PCs, servers, gaming and AI chips.
The PC business has been dominated by Intel. After losing share for many years, we believe AMD's new products have the potential to effectively challenge the competition. With AMD currently at 10% the size there is a huge revenue opportunity here.
The gaming and AI segments helped propel Nvidia to become the top performing S&P 500 stock of 2016. These are fast growing markets which are up-for-grabs and AMD is positioning itself to win back share here too. Dr. Su's transformation of AMD has already been growing revenues the last few quarters. These material launches during 2017 should boost revenue growth yet further.
Let's Do The Math
We think the Street is wrong on the math. In our view they are probably being too conservative regarding AMD by waiting to see reported numbers before they raise estimates for 2017 and 2018.
What gets us excited is when we do the simple math, working through the numbers in the earnings model, below. For 2017 we get closer to $.30 versus the Street’s average of about $.05.
We acknowledge AMD was trading in the $2 range this time last year. Therefore, it’s fair to ask yourself, “How in the world can I buy this thing now.”
Let's try to come up with an answer regarding why now might just be the right time to get in.
First, it's no secret stocks trade on a multiple of earnings. You have to figure out where earnings can go and what multiple to put on the company. Then you can do the simple multiplication math and get a price target. You can do all of the micro-analysis and industry analysis you want, but the bottom-line comes down to what can they earn when and what will the market pay for it.
The Multiple
AMD has traded up in the 40x PE multiple range when they had some earnings. Lately, without earnings, it was tough to value them on a PE basis. Now that they will have earnings we have something to work with.
Because we think earnings are about to beat and grow quickly we think the stock will trade higher. We’ll walk you through how we get to our $23 price target. Investors have a history of what appears to be overpaying for strong performance. We know that seemingly expensive companies end up getting more and more expensive while cheap companies often just get cheaper.
If AMD is going to do what they expect to with this year's aggressive launch schedule, we think they are going to beat earnings estimates which will add to the stock's upward momentum.
Nvidia trades at about 40x. We give AMD a 30-40x PE multiple this year and maybe next year. Now let's see what we can get for earnings in order to attach our multiple and get a price target.
What Can AMD Earn This Year And Next?
Let's verbally go through some of the important line items in the model and then put it in a spreadsheet.
Revenues
We know revenues are likely going to ramp (go higher). We can't know by how much but we can do some guessing.
The company guided to 18% revenue growth for Q1 2017 year-over-year. Last quarter revenues grew by 15%. Q1 '17 though has a major launch occurring in March.
Let's assume 18% is right even though we'd hope they are trying to be conservative given they want their new launch to look good to Wall Street and clients. Missing quarters does not impress either group so we hope they are somewhat conservative.
Now for the ramp. Q2 and Q3 are historically seasonally stronger quarters that see sequential growth (Q2 versus Q1, Q3 versus Q2) accelerate. Last year, revenues grew 23% and 28% in Q2 and Q3 sequentially. This year could be even bigger because of what seems to be a bigger launch schedule.
Revenue growth should pick up in Q1 because of the Ryzen launch and accelerate in Q2 and Q3. We aren't so afraid to put faster numbers in Q2 and Q3 because sequential growth was strong last year in Q2 and Q3. This year has the ability to be bigger. (Results for this denoted in Green on the earnings model below)
Gross Margins
The company has been talking about their newer products having higher margins than their older products. As these new products launch, gross margins should rise.
Margins are expected to pick up. By how much and how quickly we can't know. However, Q4 picked up and Q2 can also pick up as AMD starts selling more of their higher-end products. (Denoted in Blue on the earnings model below.)
Operating Expenditures
The company said, during last quarter’s earnings call, they will be managing costs closely. They plan to invest some, but expenses should grow more slowly than revenues. Expenses have been flat year-over-year so far, which gives us a lot of confidence this will enable good earnings leverage.
AMD targeted $360M in OpEx for Q1 during their last call, so we modeled that growth rate through the year. (Denoted in Yellow on the earnings model below.)
You can decide these factors on your own of course, but this is an example of how we come to an earnings number.
Let's model it.
When we run the numbers using what we believe to be fair assumptions, our earnings start to beat the Street's estimates. The company did not guide for earnings or most line-items through 2017. We did our own math based on this year’s launch and last year’s numbers.
Looking at last year's performance and understanding this year's ramp, our earnings beat the Street by 26 cents for 2017.
Would the Street be happy with 26 cents of upside? We think they would be.
But Can We Get A Valuation To Own AMD?
The stock has gone from $2 to $13. Let’s try to answer our original question, “How in the world can I buy this thing.”
That takes us to the final step, valuation. Let's use a 35x PE to our 31-cents for 2017. What do we get? $11. That’s not so enticing but we’re definitely not shorting AMD.
Obviously the Street is looking out a little further than just 2017 though, so it's fair to run the same exercise on next year's numbers. In 2018, using similar assumptions for revenues and gross margins moving up, we can get closer to $1.00 in earnings. 35 x $1.00 is $35. Now we’re talking.
Naturally, there are many risks since these catalysts have yet to happen. That’s why we consider both this year and next year, average them together and come up with a $23 target. Which in our view would be great.
That $23 allows us to assume there should be some momentum in the stock if our numbers for this year prove closer than the Street's. That $23 also allows investors to start looking out to next year if AMD manages to have a good Q1 and Q2. If that happens, investors will quickly swivel to do that same simple math we just did and will reach $.31 and next year’s $1.
Conclusion
AMD has a lot to prove given this just-begun launch schedule. That said, AMD now has a much better chance of winning back share with the new CEO’s higher-end focus. In our view, AMD has an exciting story starting now, catching up to major players in price and performance. This story has risk attached, of course. The stock has already run, but when working through the numbers based on their upcoming launch schedule we see additional upside. There are huge swaths of market share to win. We think AMD is positioned for success.
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