I’ll be honest: I never understood the optimism toward Advanced Micro Devices, Inc. (NASDAQ:AMD) stock. While AMD stock languished in the $2 range for much of the past few years, I thought the bullishness toward the stock was simply too optimistic.
Advanced Micro Devices was a distant second to Intel Corporation (NASDAQ:INTC) in CPUs. It lagged behind Nvidia Corporation (NASDAQ:NVDA) in gaming. Its balance sheet wasn’t exactly spectacular, and AMD consistently lost money and burned cash.
Obviously, I missed the huge run in AMD stock, which has gained almost 700% from early 2016 lows. At the risk of joining the party too late, I think there could be more upside, even after a modest breather in those gains over the past few weeks.
Advanced Micro Devices has some risk at current levels, to be sure. But there remain a number of catalysts that can continue the run.
The Ryzen CPU Can Push AMD Stock Higher
AMD’s Ryzen chips already have driven some of the optimism toward shares of late — but they might have more to contribute. Jefferies recently upgraded AMD stock based in large part on the competitive boost from the new chips. In fact, the firm said revenue could potentially double in a best-case scenario.
The rollout of Ryzen 7 has hit an early speed bump, with the CPU leading computers to lock up. But Advanced Micro Devices appears to have a fix and issues aside, reviews seem positive. Ryzen 5 will be launched soon, to likely be followed by lower-cost desktop CPUs and laptop and server chips later this year.
And Ryzen’s impact goes beyond its sales and profit contributions. It positions AMD as once again a worthy competitor to Intel, not just a second source of supply for lower-cost, lower-performance processors that drive lower-end desktops and notebooks.
And its early reviews bode well for Vega, which AMD hopes will allow to target Nvidia in gaming the way Ryzen has improved its competitive position in CPUs.
The Numbers Still Work
It is worth pointing out that AMD still isn’t profitable, and still isn’t really growing – yet. Advanced Micro Devices lost almost $500 million in 2016. Revenue did increase 9% year-over-year … but sales remain 20%-plus below 2014 levels.
But higher-priced Ryzen chips can reverse substantial pressure on gross margin: AMD’s gross profit dollars declined a stunning 46% between 2014 and 2016, with both lower sales and lower margins. Cost-cutting has brought down marketing and G&A spend, and Advanced Micro Devices still has room for improvement on that front.
Meanwhile, the balance sheet has improved, with both debt and interest expense declining of late and likely again in 2017. There’s a substantial amount of earnings leverage to be unlocked over the next few years. Higher pricing will improve gross margins; those incremental dollars will fall to operating income at a high rate due to a fixed-cost model. Cost-cutting should keep opex increases in check. Add in lower interest expense, and AMD’s recent losses can reverse quickly.
Analysts expect an 8-cent profit in 2017 and 30 cents in 2018. A reinvigorated Advanced Micro Devices could beat those estimates … which would drive AMD stock higher still.
An Acquisition Isn’t Out of the Question
It’s a bit too simple to argue that AMD is the next target simply because there’s been consolidation in the semiconductor space of late.
M&A activity has been heavy, to be sure. Intel is acquiring Mobileye NV (NYSE:MBLY) for $15.5 billion. Qualcomm, Inc. (NASDAQ:QCOM) is in the process of buying NXP Semiconductors NV (NASDAQ:NXPI) for $39 billion. And Softbank Group Corp (OTCMKTS:SFTBY) — better known as the majority owner of Sprint Corp (NYSE:S) — completed its $32 billion buyout of ARM Holdings last year.
Semiconductor industry M&A spend totaled over $200 billion in 2015 and 2016, which naturally raises speculation that AMD might be the next takeover target. But a deal might be difficult.
The x86 cross-licensing deal with Intel gives AMD’s larger rival essentially a veto on any deal. A buyout of AMD stock by Intel itself likely would raise antitrust concerns. Foreign buyers likely would fall a CFIUS (Committee on Foreign Investment in the United States) review at this point; the possibility of the Trump administration allowing a Chinese buyer of a U.S. computer chip manufacturer seems extremely low.
That’s not to say AMD couldn’t be acquired — and certainly the takeover rumors that have surrounded the company for as long as anyone can remember might resurface. Micron Technology, Inc. (NASDAQ:MU) might make some sense, and past speculation even has mentioned potential suitors like Oracle Corporation (NYSE:ORCL) and Microsoft Corporation (NASDAQ:MSFT).
At the moment, however, Advanced Micro Devices doesn’t seem like a likely takeover target — and that’s just fine. AMD stock has more than enough going for it on its own. It’s tempting to say after a 600% run that the easy money has been made.
But while I’m not predicting another 600% gain for AMD stock by 2019, I do believe there’s further upside ahead.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.