AMD's Opportunities And Risks: Why It's Not A Buy Yet

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AMD's Opportunities And Risks: Why It's Not A Buy Yet

Seekingalpha2023-12-05

Advanced Micro Devices reported strong third quarter 2023 results, beating estimates and showing signs of rebound in desktop and notebook sales.The company's introduction of MI300 positions it as a ...

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contributing to AMD's stock price increase.The stock's valuation may not be ideal for investors who are new to the name to buy now.Advanced Micro Devices (NASDAQ: AMD), a fabless semiconductor company, reported third-quarter 2023 results on October 31 after the bell, which excited investors. The company beat analysts' consensus top-line and bottom-line estimates. Additionally, two things in the report made investors optimistic about the stock moving forward: its sales of desktops and notebooks have displayed evidence of rebounding from a downturn, and its introduction of new hardware chips potentially establishes it as a significant competitor to NVIDIA (NVDA) in the Artificial Intelligence (\"AI\") accelerator market.The good news in the earnings report came on top of industry analysts forecasting a semiconductor rebound in 2024. For example, the chip industry trade organization SEMI stated in August this year, \"The global semiconductor industry appears to be nearing the end of a downcycle and is expected to begin to recover in 2024.\" On November 28, World Semiconductor Trade Statistics(WSTS) stated , \"Exceeding the spring projections with slightly better Q2 and Q3 results, WSTS has revised its forecast, anticipating a single-digit contraction in the global semiconductor market of 9.4 percent in 2023. However, this is anticipated to be followed by a robust recovery, with an estimated growth of 13.1 percent in 2024.\" As a result of AMD's earnings report and analysts' optimistic view of the industry, the stock closed November 29 at $123.71, up 26% from its October 31 closing price.Data by YChartsStill, analysts were disappointed by weak guidance due to soft results in the embedded and gaming segments. If you combine AMD's risks, the stock's huge move up in November accompanied by a much higher valuation than it began the month, and a still shaky macroeconomy, there are valid reasons to avoid buying the stock today despite the high potential upside. This article will discuss the company's opportunities and risks and why I rate the stock as a Hold.The company's opportunitiesUp until a decade ago, AMD looked like David against Intel's (INTC) Goliath and had looked like it had little hope of surpassing the then-industry leader in the manufacturing of logic devices. At the end of 2013, Intel had a market cap of $128.91 billion against AMD's market cap of $2.80 billion. What a difference a decade makes. The chart below shows that AMD has finally surpassed Intel's market cap this year.Data by YChartsIt was able to catch up partially due to Intel fumbling the ball over the last decade. Some argue that part of the problem was that Intel had poor leadership over the last decade; it has gone through three CEOs since 2013. Others say the company rested on its laurels and grew fat and lazy. It was slow to adopt newer manufacturing processes like EUV (Extreme ultraviolet) lithography, a way to design smaller chip features and use contemporary design methodologies like chiplets -- small, modular silicon-based semiconductors interconnecting to form a larger, more complex chip. One massive advantage of modular designs is that chip designers can improve them one modular subsystem at a time instead of designing a whole new chip.In contrast, until recently, Intel stuck with manufacturing using a monolithic design for far too long. This design method is the traditional approach of fabricating an entire chip on a single silicon wafer. The disadvantage of the monolithic approach is that all components integrate on a single wafer, which has reached a point where further advancements have become extremely difficult due to physical constraints and the complexity of managing such a large design. For Intel to make further gains using the monolithic approach, involves waiting for smaller node process technology, enabling more transistor integration onto the same chip size. Historically, Intel has transitioned to a new node every two years, slower than chiplet technology can advance capabilities. Intel has also lagged in node process technology, falling behind AMD's foundry partner, Taiwan Semiconductor Company (TSM), in adopting smaller transistor nodes.While Intel jogged in place, AMD raced ahead and introduced its Zen family of products, including the Ryzen processor, in 2017, which helped it gain ground on Intel in the high-performance CPU (Central Processing Unit) market. By 2021, the website TechRadar cited PassMark Software's Performance Test benchmarking tool, showing the company had surpassed Intel in desktop CPU market share for the first time in 15 years up until that point.Additionally, the company introduced the EPYC Server Processors family, also part of the Zen family, in 2017, which helped it make market share gains in the data center. AMD measures its market share gains in the data center by revenue, not units. During the company's presentation at the UBS Technology Conference, General Manager of NVIDIA's Data Center Group Forrest Norrod said about server market share:At the end of the day, I actually don't really care that much about the unit share. There's some long tail, very low calorie, very low value components out there. We're much more interested from a revenue perspective, revenue share perspective. We're at 30% revenue share today -- as we sit here today and that's more weighted towards cloud than enterprise, but we do see enterprise starting to grow substantially. But our long-term ambition, just to be clear, is to continue to grow our revenue share and we aspire in the fullness of time to be the market leader from a revenue share perspective.Source: UBS 2023 Annual Technology ConferenceAMD's opportunity is more than gaining revenue share against Intel's logic chip franchise; it is also about market share against NVIDIA in the market for AI GPUs (Graphics Processor Units). Like Intel, NVIDIA has been reluctant to adopt chiplets and stuck with the monolithic design, allowing AMD to create a potentially superior chiplet-based GPU named the MI300, which is near its launch date on December 6, 2023. Forrest Norrod also talked about MI300 at the UBS conference. He said:MI300X has a distinct advantage on inference over our competitors' solutions by virtue of its memory bandwidth, as well as memory capacity. You can do a lot more inferencing on each GPU. You can fit more and you can fit larger models and have fewer numbers of GPUs to deliver the same results, which translates into very material TCO [total cost of ownership] advantages. On the training side, though, as well, we're seeing we have a very competitive part. I don't think we've got quite the same level of advantage that we do on inference. But we think MI300X is a very credible training part...Source: UBS 2023 Annual Technology ConferenceWhen Norrod mentions inference in an AI context, he is referring to entering data into a trained machine-learning model so it can make predictions or decisions. Memory bandwidth refers to the maximum data transfer rate between the processor and the memory. Memory capacity refers to the total amount of data the memory can hold. When he talks about having a \"distinct advantage over our competitors' solutions,\" it's primarily a reference to having an advantage over NVIDIA's best solutions. NVIDIA's top AI accelerator, the H200, has a GPU memory bandwidth of 4.8 terabytes per second (TB/s) and a memory capacity of 141 gigabytes (\"GB\"). In contrast, the MI300X has a memory capacity of 193 GB and a bandwidth of 5.2 (TB/s).The MI300 has 12 to 13 chiplets, and it can customize the design of each chiplet to perform different tasks, making it far more flexible than the H200. In contrast, NVIDIA's monolithic manufacturing process builds its entire GPU on a single chip, which can be challenging to scale and customize. It will eventually need to move to chiplet technology to keep up with AMD. The good news for AMD Bulls is that the company is significantly ahead in developing chiplet technology. On the third quarter 2023 earnings call, Chief Executive Officer Lisa Su called for its data center MI300 GPU chip to \"exceed $2 billion in 2024,\" with some analysts thinking that figure is conservative. This stock should be on your watchlist if you believe that generative AI can drive significant growth for its Data Center segment over the next several years.The Client and Data Center segments could be AMD's growth locomotivesOne of the first things to note in AMD's third-quarter earnings report is the improvement of the Client segment, which consists of desktop and notebook personal computer (\"PC\") processors and chipsets. Client revenue was up 46% sequentially and 42% year-over-year to $1.45 billion. Operating profit was $140 million. The last time this segment showed revenue growth and an operating profit was in the second quarter of 2022, when it was the company's largest segment, producing $2.15 billion in revenue and $676 million in operating profit. This turnaround in Client revenue growth and profitability in the third quarter of 2023 signals that the prolonged drought in the personal computer market may soon close. Management gave fourth-quarter guidance for solid double-digit revenue growth in the Client segment. In addition, IDC (International Data Corporation) believes PC shipments will recover next year, which is great news for AMD investors.The next observation is that the Data Center segment revenue, comprised of server processors and AI chips, generated 21% sequential revenue growth. Management attributed the sequential growth to robust sales of its 4th Gen EPYC processors to cloud and enterprise customers. Although year-over-year revenue growth was flat, Chief Financial Officer (\"CFO\") Jean Hu said in the third quarter earnings call that the reason for the lackluster growth was \"a decline in adaptive SoC product sales,\" without identifying why those sales declined. However, those sales dropping off could be anything from an inventory correction in the end market for those devices to the company shifting its sales focus to its new MI300 AI chip, which management expects to boost Data Center results significantly in the future. The good news is that management forecasts the Data Center segment to produce robust double-digit percentage year-over-year revenue growth in the fourth quarter. The odds are that these two AMD segments will be its primary revenue growth drivers over the next year, which should benefit long-term investors in the business.AMD consolidated resultsAlthough the company only produced a meager 4% revenue growth over the previous quarter's revenue, AMD's stock rallied post-earnings as results were better than investors feared. The chart below shows that revenue growth may have bounced off a bottom.Data by YChartsThe good news is that the company called for total year-over-year revenue growth of 9% in the fourth quarter and 5% sequentially to $6.1 billion, plus or minus $300 million. With the Client and Data Center segment looking healthier, 2024 increasingly looks like a rebound year.Next, let's look at GAAP (Generally Accepted Accounting Principles) Gross Margins. Before 2017, AMD produced CPUs on the lower end of the market, while Intel dominated the high-performance CPU market. Intel could command higher gross margins by charging a premium for its higher-end chips and brand. When AMD introduced its Ryzen chips in 2017, it began challenging Intel's dominance in the high-end CPU market. Consequently, as AMD gained a foothold in the high-end chip market, its gross margins started to rise, and as Intel made a series of missteps, its Gross Margins came down, as shown in the chart below.Data by YChartsLet's switch to looking at non-GAAP Gross Margins. AMD management prefers using non-GAAP metrics in its guidance as it provides a more accurate picture of the company's underlying financial performance. For instance, its acquisition of Xilinx in February 2022 introduced one-time costs that make today's GAAP Gross Margin comparisons to 2022 GAAP numbers challenging to analyze.Management reported a non-GAAP Gross Margin of 51%, up approximately 100 basis points over the previous year. CFO Hu attributes the gross margin rise to stronger Client segment revenue and product mix. Translation: the company sold higher-margin products in the third quarter of 2023 compared to the same period in 2022. Management also guided non-GAAP gross margins for the fourth quarter of 2023 to reach 51.5%. An upward trend in gross margins over time could indicate that the company is becoming more efficient in its operations and can command higher product prices. Ideally, we want to see this number continue to rise over time, as it would be one factor to look at for an indication that it is becoming more competitive with Intel and NVIDIA in high-end CPUs and GPUs.AMD Third Quarter 2023 PresentationAnother area that investors should pay attention to is Operating Expenses. The highly competitive nature of the chip manufacturing industry could pressure AMD to increase its operating expenses. It must invest heavily in research and development (R&D) to keep up with technological advancements. Additionally, the company must spend money on sales and marketing to promote products like MI300, EPYC Server Processors, and Ryzen chips. CFO Hu attributed the company's 12% non-GAAP operating expense growth over the previous year's comparable quarter to \"higher R&D investment to support our significant AI growth opportunity.\" One future that investors should consider is the possibility that AMD may need to increase operating expenses as a percentage of revenue to remain competitive in AI chips. In that case, less money could drop to the bottom line, causing earnings growth to underperform expectations.AMD Third Quarter 2023 PresentationLast, it has an excellent balance sheet. The company's cash and short-term investments came in at $5.8 billion, with $2.5 billion in long-term debt at the end of the third quarter. It has a debt-to-equity ratio of 0.05, indicating a low level of debt compared to equity. Free cash flow rebounded to $297 million.Data by YChartsAMD doesn't have a dividend. Still, it repurchased 4.8 million shares for $511 million and has $5.8 billion in remaining share repurchase authorization.Short-term risksOne short-term risk of investing in AMD today is that the business is not firing on all cylinders. Although the Data Center and Client segment look poised for a strong rebound, the Gaming and Embedded segment may drag on overall results for the foreseeable future.AMD Third Quarter 2023 Earnings PresentationGaming revenue was down 8% over the previous year's comparable revenue to $1.5 billion. CFO Hu attributed the Gaming segment decline to gaming consoles being in the fourth year of the gaming cycle. Typically, each gaming cycle lasts five years, with sales of new consoles starting to decline in the fourth year as consumers wait for manufacturers to release the next generation. Rumors suggest that Microsoft (MSFT) may release a new Xbox controller in 2024, and Sony's (SONY) PlayStation may release an upgraded PS5 gaming console in late 2024 or early 2025. So, this segment could bounce back in the latter half of next year. Microsoft uses Xbox Series X GPU in its console, and Sony usesOberon graphics.AMD also reported that increased Radeon GPU sales offset some cyclical gaming console decline. Radeon-branded GPUs are the second most popular GPU for desktops and laptops, especially gaming computers. So, with the bounce back in PCs, it makes sense that Radeon sales would also increase. Additionally, AMD has recently released its newest Radeon series, Radeon RX 7000, in December 2022, and some users may be upgrading. The biggest issue that Radeon has is that although it is the second most popular GPU, it is a distant second with a 16.19% market share behind NVIDIA's 75.12%, according to Steam's monthly hardware survey. It may be less competitive in GPUs for PCs than in other areas of its business. Overall, management forecasts that fourth-quarter year-over-year Gaming segment revenue will continue declining due to the console cycle. Investors shouldn't expect any bounce back in this segment in the next several quartersEmbedded segment revenue, which primarily encompasses hardware that goes into IoT and Edge computing solutions, was down 5% from the previous year's comparable quarter to $1.24 billion. CFO Lu confirmed that inventory correction on the earnings call when she said, \"Embedded segment revenue declined 15% [sequentially], primarily due to inventory correction at customers in several end markets.\" Management forecasts that the Embedded segment's fourth-quarter revenue will decline due to weak IoT and Edge Computing demand.Long-term risksOver the longer term, Intel and NVIDIA remain fierce competitors and are not staying idle while AMD attempts to take market share. Intel hired Pat Gelsinger as CEO on February 15, 2021, to get the company back on track. Only a month later, he introduced IDM (integrated device manufacturing) 2.0, the company's new multi-pronged plan to regain leadership in the semiconductor industry. Additionally, the company introduced its first chips using EUV and chiplet technology, which include the Meteor Lake PC processors due to launch on December 14, 2023, and Granite Rapids server chips, with a planned 2024 release. If you invest in the company, monitor whether AMD can hold off a now revitalized Intel.NVIDIA might be an even tougher nut to crack as competition in GPUs and AI accelerators takes place with software as much as it does hardware. NVIDIA has a substantial first-mover advantage with its CUDA (Compute Unified Device Architecture) computing platform, invented in 2006 to help developers build GPU-accelerated applications. The CUDA platform has achieved wide adoption among developers, and some believe it gives NVIDIA a powerful moat around its GPU business. AMD created ROCm (Radeon Open Compute platform) around 2016, a competing open-source computing platform. However, it is debatable whether the ROCm platform provides an attractive alternative to CUDA and whether it can eliminate NVIDIA's software edge. AMD might never catch up. Rumors also suggest that NVIDIA is working on a next-gen AI chip based on chiplet technology named Blackwell with a planned 2024 release. No one should be surprised when NVIDIA releases this next-gen chip if its capabilities surpass MI300, so the time AMD has a superior AI chip may be fleeting.AMD also has more competition than simply Intel and NVIDIA. Some of its biggest competitors are some of its potential customers. For instance, it competes with Alphabet's (GOOGL) (GOOG) (\"TPU\") Tensor Processing Unit and Amazon's (AMZN) Trainium and Inferentia chips for AI chips in each company's respective cloud units. Microsoft (MSFT) and Meta (META) have also jumped into the fray with their own AI chip manufacturing plans. So, the company faces considerable competition in all the markets it competes in, and it faces high uncertainty about whether it can meet its own or analysts' revenue and earnings projections.Should you buy it?Analysts' consensus average earnings-per-share (\"EPS\") ratio for AMD in 2023 and 2024 is $2.65 and $3.71, respectively. Its closing price on December 1, 2023, was $121.39. Therefore, its one-year forward price-to-earnings (P/E) ratio equals 32.71x. The company's earnings growth rate for 2024 equals 2024 EPS - 2023 EPS/2023 EPS or 3.71 -2.65/2.65 = 0.40 or 40%. Ideally, a company's P/E ratio is approximately equal to its EPS growth rate. Suppose you value AMD at a one-year forward P/E ratio of 40x; the stock price would equal 40x 3.71 (2024 consensus EPS), which equals a stock price of $148.40 in fiscal 2024 or 22% above December 1's closing price. Because of macroeconomic and competitive uncertainty, I value AMD at a forward P/E ratio of 35x or a stock price of $129.85 or about 7% above the December 1 closing price.In my opinion, there needs to be more than a potential return of 7% by 2024 for new investors to jump into the stock currently. There may be a better value to buy AMD over the next year. However, AMD can potentially outperform analysts' EPS expectations in 2024 if global economic growth rebounds stronger than economists forecast and the Gaming and Embedded segment returns to growth earlier than expected. If you already own the stock and believe AMD has long-term potential upside in AI, hold on to your shares. 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