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Advanced Micro Devices (AMD) is a lonely AI stock, down double digits last month. How can a company that makes chips and semiconductors that power artificial intelligence and other digital applications be down double-digits while competitors like NVDA are up more than 50% in the last three months?
Investors price NVDA at more than 40 times its current sales, while AMD has a price-to-sales ratio of 8 times. Is AMD falling behind in the AI race, or is this a temporary bleep in an otherwise rally to the so-called moon?
Let's talk about that!
I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.
This post is part of a series I started a few weeks ago to fundamentally research companies to manage my real-money portfolio. I've already researched Canopy Growth (CGC), Fastly (FSLY), Snap (SNAP) , Shopify (SHOP), Airbnb (ABNB), Unity (U), JD.com (JD), NVIDIA (NVDA) and several others. I'll continue with this series for a few more weeks.
Remember, this content is for education and sharing ideas and not advice to buy or sell any securities.
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The story of AMD and NVDA makes you feel we live in two parallel universes. AMD says it is waiting for the demand environment to improve. NVIDIA says we live in an accelerated demand cycle.
AMD's latest earnings report in May 2023 shows that the company offers a complete line of chips and solutions for AI applications. But revenue was down about 9%. The company lost money compared to several quarters of positive GAAP-based earnings, and worst yet, AMD forecasted a 19% decline in its Q2 revenue.
This earnings release came about at the same time as NVIDIA's roaring earnings report, in which the company announced a revenue forecast of $11B for the second quarter, up from roughly $7B in Q1.
As a side note, I published a fundamental analysis for NVDA a few weeks ago that you can go back to and decide whether NVDA is a buy now. I'll leave a link to the NVDA episode in the show notes.
Today, I dig into AMD's fundamentals and discuss whether the revenue decline and downward forecast are temporary and whether the price drop is an opportunity for us to invest in AMD at a much better price than NVIDIA. This is going to be super interesting!
I'll use our usual 6-part fundamental analysis framework to research AMD:
Can AMD's Revenue Go Back Up?
AMD makes money by designing and selling semiconductor chips that run data centers, PCs, laptops, and gaming consoles or embed them into automobiles and other data processing applications.
Not only AMD designs the chips and sells them, but it also makes software that enables developers to use its products in their devices and applications.
Like NVIDIA, AMD doesn't manufacture its own chips. Taiwan Semiconductor (TSM) is the primary manufacturer of AMD's wafers and works with United Microelectronics Corporation (UMC) and Samsung Electronics Co.
AMD's revenue is relatively equally distributed across gaming, data centers, and embedded systems, and the PCs and laptops segment trail the other three. That's already good news because if we see soft demand in one segment, there are still different segments to compensate for the revenue loss.
So far, so good! But why did the revenue go down? Where is the slowdown coming from, and how is NVIDIA growing exponentially while AMD slows down?
Data Center revenue remained flat, gaming slowed, and PC, laptop, and computer client sales dropped more than 60%. Embedded chips in automobiles, VRs, and other devices soared. Why isn't the data center segment roaring like NVIDIA, and is the drop in PC and Laptop temporary?
The PC & Laptop segment is somewhat understandable. Coming off the surge in demand during the COVID era, the company is now dealing with lower demand and had to cut costs to move its inventory. However, looking at all the new product launches, the company has several high-performing product launches in the segment that should ramp up in the coming quarters.
On the data center side, NVIDIA seems to be the immediate beneficiary of the generative AI infrastructure rush because OpenAI's chatGPT runs on its products and already offers a whole stack of hardware and software for data centers to train and run AI applications. AMD suffered from the global slowdown of investments in data centers by large enterprises and didn't see any benefit from the generative AI heightened demand. Does this mean AMD has lost the market?
As I'm researching AMD today, the company is supposed to have an AI Day presentation in two days on July 13th. While I don't know what AMD will share specifically during the AI day and how the market perceives it, I was able to catch up on Bank of America and JPMorgan Chase analysts' conversations with AMD's leadership team in the last few days and weeks. I got a preview of the company's AI strategy.
As a non-technical investor, it is difficult for many of us to gauge the technical superiority of AMD over its competitors. However, we can deduct its technical capabilities and moat from the information available to us. Here are some of such evidence:
AMD is behind NVIDIA in the AI segment. However, the company isn't a competitor to brush off easily. It has a solid track record of executing its plans and delivering new products based on customers' needs. AMD still has a shot. AI revenue can likely ramp up and accelerate if the management team executes the roadmap it has already planned.
So on the topline side, AMD is expected to ramp up revenue through new product launches. And as the global macro environment recovers and enterprises resume investing in data centers and computation beyond AI, we should see revenue growth to come back to AMD.
AMD's Earnings Loss Isn't A Big Deal
In the last quarter, we saw negative earnings for the first time. Some of the losses are due to lower revenue, but the most significant chunk comes from increasing R&D expenses and the amortization of acquisition-related intangibles. R&D expense increase is an important driver of the future of product releases and not much concern. The amortization of acquisition-related intangibles is also less of a problem. It is a unique way accountants engineer profits and losses. For AMD, it is expensing the costs associated with acquiring Xilinx. This is good news because it means no major cost jump in AMD's operations.
AMD's Cash & Free Cash Flow Power
There are lots of good news here. The company has more than $9B in cash and cash equivalents, against $6B in current liabilities, leaving it with enough cash to continue investing in its products, and better yet, we see AMD generates positive free cash flow indicating its cash position should be growing steadily in the absence of any major new acquisition or expense.
Assuming the management can continue to execute as it has been doing so far, and the market in data center and server sides recover globally and steadily, there aren't major fundamental concerns about AMD.
This brings us to its valuation. The company is priced eight times its sales, which isn't cheap.
Looking at the company's price-to-sales ratio history, eight times isn't the most expensive rate, but it is certainly not historically cheap either. You could have invested in AMD at roughly five times sales only a few months ago and five years ago.
Looking forward, all else equal, to grow revenue by eight times in 10 years, AMD has to increase revenue by 23% per year. The AI chips market is expected to grow more than 40%, while the broader semiconductors market has a much slower growth rate of under 10% per year. Therefore, the 23% per year revenue growth isn't far-fetched and sits between the two markets' growth rates. Moreover, if we look at AMD's revenue growth in the last three years, it has grown above 40% compounded annually, despite the recent slump.
All in all, AMD isn't a cheap stock by any stretch of the imagination, but compared to Nvidia's 40+ Price-to-Sales, and AMD's possibility of growing revenue rapidly, it isn't exuberantly expensive either.
AMD's Fundamental Recap
Let's recap AMD's fundamentals.
Knowing all that, what should we do with AMD? Is it time to buy now?
Is AMD A Buy Now?
Agreeing on the fact that investing is a game of possibilities and betting on probabilities of success, let's discuss two possibilities for where AMD goes from here:
We need more information to decide which scenario is more likely.
To me, this is one of those cases where if you like a company fundamentally and trust the management track record in implementing their plans, you can pick up some shares and add more as you collect evidence on its ability to scale, ramp up and compete in the AI space while not losing market in PC, laptops, enterprise, and gaming segments.
One thing for sure is that the AI revolution is just beginning, and there is a lot of time for chip makers to innovate and grow. 2023 is one of many chances to buy AI chip stocks and win big. This is a multi-year if not decade-long, major technological cycle and most likely full of volatile up and down trends.
See you next time!