Advanced Micro Devices, Inc. Stock Has Room to Run to $14

Fundamentals support the rally in AMD stock continuing into the $13-14 range

Source: Shutterstock

There were a lot of good earnings report on Wednesday afternoon. For example, Facebook Inc (NASDAQ:FB) silenced its doubters and reported one of its best earnings reports ever against the backdrop of its worst PR incident ever. FB stock jumped 9%. Meanwhile, Chipotle Mexican Grill, Inc. (NASDAQ:CMG) showed that its turnaround under a new CEO is off to a great start. CMG stock soared over 20%.

But one company whose stock seems to have a lot of firepower after Wednesday’s slew of earnings is Advanced Micro Devices, Inc. (NASDAQ:AMD). The chipmaker reported far better-than-expected quarterly numbers on Wednesday afternoon and AMD stock jumped.

Those strong numbers come on the heels of what has been a downdraft in AMD. Shorts piled into the name ahead of the earnings report, thinking that either the cryptocurrency bubble pop would lead to a revenue breakdown or that its new products hadn’t gained strong-enough traction.

Neither of those fears is true. Revenue growth is actually accelerating, while management said that cryptos account for just 10% of revenues. Meanwhile, margins are ramping higher and the long-term growth trajectory looks as rosy as ever.

In other words, the fears that existed in AMD stock prior to the earnings report are now being washed away and replaced by hopes related to the long-term growth narrative. That paves a clear path for Advanced Micro Devices, Inc. stock rebounding back to its fair value, which I peg around $13 to $14.

Here’s a deeper look:

AMD Is Making Big Moves In the Right Markets

Just like Facebook and Chipotle’s earnings reports, AMD’s earnings report silenced all the doubters.

The bull thesis on AMD is that the company is creating competitive technology that will gain market share in a very large and very valuable high-end computing market that has huge growth prospects. The bear thesis on AMD is that the company’s new technology will be crushed by competitors, and that heavy reliance on cryptocurrency mining will derail growth prospects.

The Q1 report showed that the bull thesis is much more reflective of reality than the bear thesis.

Revenue growth in the quarter was 40%. That is better than 34% last quarter and 25% last year. Revenues are also expected to rise 50% next quarter.

Gross margins rose 4 percentage points in the quarter. That is better than the 3 percentage point rise both last quarter and last year.

Clearly, this is an accelerating revenue growth and gross margin expansion narrative. This acceleration is happening despite a cooling off in the crypto markets (which represent only 10% of revenue), so cryptos clearly aren’t the growth driver. Instead, the accelerating revenue growth track is the result of accelerated adoption of the company’s core Ryzen, Radeon and EPYC products.

This is a promising growth narrative. The markets AMD is now attacking (namely, high-performance computing) are huge. And they are high margin. Consequently, revenue growth and margin expansion have long runways ahead.

Advanced Micro Devices Stock Is Worth At Least $13

I maintain that Advanced Micro Devices stock is worth about $13-$14.

Today’s 40%-50% revenue growth rates aren’t sustainable. They are the result of early and big gains in the high-performance computing market. Those gains will continue, but with less magnitude. I reasonably think 15% revenue growth over the next five years is achievable.

Market share gains in high-performance computing will lead to continued robust margin expansion. Operating margins currently hover around 9%. Thus, management’s long-term target of 14% operating margins also seems achievable within five years.

A 15% revenue growth rate over the next five years on top of 14% operating margins implies revenues and operating profits of $10.7 billion and $1.5 billion, respectively. Taking out $150 million for interest expense, 10% for taxes and dividing by a presumably higher share count of 1.2 billion, that equates to about a $1 in earnings per share in 5 years.

A market-average growth multiple of 20-times forward earnings on those $1 earnings implies a four-year forward price target of $20. Discounted back by 10% per year, that equates to a present value in the $13-14 range.

Bottom Line on AMD Stock

Strong first-quarter earnings should propel AMD stock back on an upward path. This uptrend won’t last forever, but fundamentals support a rally to the $13-$14 range. Thus, under $11, Advanced Micro Devices stock still looks like a bargain.

As of this writing, Luke Lango was long FB and AMD.

Article printed from InvestorPlace Media,

©2019 InvestorPlace Media, LLC