Advanced Micro Devices (NASDAQ:AMD) is coming off a fourth-quarter earnings beat in which the company reported $1.1 billion in revenue. AMD stock bounced 16% to above the $12 level as a result, continuing a red-hot streak of nearly 500% returns in just 52 weeks.
This was a sub-$2 stock just a year ago amid fears about competition and potential bankruptcy.
AMD is a leading maker of graphics cards, including Radeon for consumers and FirePro for workstations. The company operates in two segments: Computing and Graphics, which makes desktop and notebook processors and professional graphics; and Enterprise, Embedded and Semi-Custom, producing server chips, embedded processors for the Internet of Things and chips for gaming consoles.
Since taking the helm two years ago, Advanced Micro Devices CEO Lisa Su — an MIT-educated electrical engineer who has authored over 40 technical papers — has presided over a remarkable recovery. Now, AMD, having played second fiddle to Intel Corporation (NASDAQ:INTC) for decades, is making a play for the PC and server markets, Intel’s bread and butter. AMD’s Ryzen CPU will challenge Intel’s Core i5 and i7 chips.
AMD is moving up the value chain amid a falling PC market, going from low-end to high-end PC processors.
Even if prospects for Advanced Micro Devices’ business are good, though, investors have to deal with a few issues. AMD hasn’t posted an operating profit since the third quarter of 2014, holds a great deal of debt and yet trades at a stratospheric valuation.
Amid these high expectations and gains worthy of bubble talk, is AMD stock still a buy? Here are two problems that should have the bulls taking a second look.
AMD Has a Not-Great Balance Sheet
Despite many chipmakers such as AMD going “fabless” and outsourcing the fabrication of their chips to contract manufacturers such as Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM), the industry remains capital-intensive.
Advanced Micro Devices escaped bankruptcy last year. It took advantage of low interest rates and improved investor confidence to restructure its debt in September 2016. AMD issued $600 million in shares and $450 million in convertible senior notes. This enabled AMD to pay off $676 million in debt due in 2020. So instead of $600 million in AMD debt maturing in 2019, only $196 million will mature that year.
Still, AMD is highly leveraged by several measures. With $1.435 billion in long-term debt and $416 million in shareholder equity as of Dec. 31, 2016, AMD’s long-term debt-to-equity ratio stands at 3.44. That figure is much lower for Intel, at 0.38, and Nvidia Corporation (NASDAQ:NVDA), at 0.37, indicating less leverage. Likewise, AMD’s debt-to-capital ratio of 0.775 stands above 0.27 for both INTC and NVDA.
Intel and Nvidia also are better able to service debt. For the year ended December 31, 2016, AMD generated only $90 million in operating cash flow, with $2.9 billion in total liabilities, a ratio of 0.031.
NVDA earned $1.462 billion in operating cash flow for the four quarters ended October 30, 2016, with $4.24 billion in total liabilities, a ratio of 0.34.
Intel showed an even healthier balance sheet, with $19.09 billion in operating cash flow for $48 billion in total liabilities, a ratio of 0.396.
AMD Stock Is Much More Expensive
Nvidia and Intel are profitable and have a better track record of generating operating cash flow. They earned positive operating cash flow in the four most recent quarters, while AMD’s operating cash flow went negative for two quarters.
Still, AMD stock trades at a huge premium to both.
AMD trades at a whopping 25.66 times book, versus 11.5 for Nvidia (which itself is high), and 2.61 for Intel. It’s not difficult to justify a higher price than Intel given AMD’s growth prospects, but for comparison’s sake, know that while Wall Street sees Advanced Micro Devices growing revenues roughly 10% this year and next, NVDA should be sitting at roughly 37% annual sales growth after it reports Q4 earnings, with analysts expecting that to slow to “only” 16% next year.
It’s difficult to fight the momentum, but you might just want to in AMD stock. At this point, anyone tussling with Advanced Micro Devices is playing with overpriced fire.
From a valuation standpoint, INTC actually looks like the best buy, simply because the market expects less from it than from AMD and NVDA. Also, Intel leads in the production of microprocessors, and this matters in the semiconductor industry, since often only the market leaders can turn a profit, while laggards destroy value.
AMD made some mistakes in the past, switching back and forth between ARM and x86 architectures, and never was quite able to catch up to Intel. The stock looks promising, but dislodging Intel and showing a steady track record of profits will not be easy in this industry.
As of this writing, Lucas Hahn did not hold a position in any of the aforementioned securities.