It’s safe to say that next-gen chipmaker stocks have been in favor for the past several months. Both Nvidia Corporation (NASDAQ:NVDA) and Advanced Micro Devices, Inc. (NASDAQ:AMD) have staged spectacular runs since the start of 2016. In that time frame, both AMD stock and NVDA stock are up about 400%.
But this year has introduced some divergence between the performance of the two stocks. NVDA stock, which was stuck in sideways in early 2017, roared higher after the company’s monster Q1 report.
NVDA stock is now up about 50% year-to-date.
AMD stock, though, is up only about 21% year-to-date. Those are great gains, but the stock has been quite volatile. Early 2017 gains were wiped out in May when the company failed to impress with its Q1 report. The stock has since rebounded from that sell-off, but with Q2 earnings due on July 25, investors should be a little concerned that the Q1 sell-off could repeat itself.
All in all, despite its robust growth story, Advanced Micro Devices stock doesn’t attract me at these levels.
Here’s why.
Advanced Micro Devices’ Financial Prospects
There has been a lot of bullishness building around the AMD growth narrative. Following the formal reveal of the EPYC processor, analysts have flown in with bullish notes on AMD stock. Jeffries reiterated its “Buy” rating on the stock, noting that Baidu Inc (ADR) (NASDAQ:BIDU), Microsoft Corporation (NASDAQ:MSFT), Dropbox and Bloomberg all plan to put EPYC in their data center. Wells Fargo reiterated its “Outperform” rating on the stock, noting that EPYC beats Intel Corporation’s (NASDAQ:INTC) Broadwell in both performance and price.
Despite all the fanfare surrounding new products launches and secular market trends, Advanced Micro Devices’ revenues only grew 18% in Q1. I say only because Nvidia saw revenues jump 48% year-over-year in Q1.
In other words, AMD really isn’t a big topline grower, but rather a steady topline grower. Over the next several years, that growth should be somewhere in the high single-digit to low double-digit range, consistent with this year’s projection from management.
The margin expansion story is a really good one. Advanced Micro Devices’ new products carry with them higher margins, and that should be additive to the gross margin line for several years to come. Management thinks they can get gross margins to as high as 40% (versus 34% last quarter). Meanwhile, revenue scale is driving operating expense leverage. Management thinks they can get the opex rate all the way down to 26%.
A 40% gross margin with a 26% opex rate implies a long-term operating margin target of 14%.
Lets say all goes right for AMD stock. The company grows revenues at 10% per year over the next five years and hits 14% operating margins by FY21. That would imply revenues of $6.9 billion. Lets also say that everything below the operating income line goes smoothly as well, and net profit margins grow by as much as operating margins (roughly 1,300 basis points).
Bottom Line on AMD Stock
That gets us to net profit margins of around 10%. On $6.9 billion in revenue, then, we are looking at $690 million in net earnings by FY21.
The current market cap for Advanced Micro Devices is right around $13.5 billion. That means AMD stock is trading around 20-times net income that is five years out … in a best case scenario.
The question, then, becomes what sort of multiple will the market award Advanced Micro Devices in 2021?
I can’t imagine it being much higher than 20 or 25-times, so upside for AMD stock seems limited here.
Advanced Micro Devices is a growth stock, but doesn’t have great value at these levels. The significant amount of volatility in AMD stock over the past six months implies investors can wait for a better price to buy.
As of this writing, Luke Lango had no positions in any of the aforementioned securities.
