Under $10, It May Be Time to Buy Advanced Micro Devices, Inc. Stock

AMD stock - Under $10, It May Be Time to Buy Advanced Micro Devices, Inc. Stock

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The whole stock market has been under massive pressure recently as trade-war fears have rattled investors. So have fears related to growth in the technology sector. Inflation fears, which spiked in early February, haven’t gone away. All together, the S&P 500 is down about 1.5% so far this year and roughly 8% off its 2018 highs.

But chipmaker Advanced Micro Devices, Inc. (NASDAQ:AMD) has been hit much worse. AMD stock is down 5% this year. Worse yet, it is has fallen 30% off its 2018 highs.

Why the underperformance in AMD stock?

The company is particularly susceptible to tariffs. A lot of AMD’s growth narrative is through big-time data center partnerships with Chinese tech companies. Those partnerships could be pressured by tariffs.

AMD is also particularly susceptible to falling bitcoin prices. As bitcoin prices have fallen, the profitability of cryptocurrency mining has been eroded to a point where people aren’t mining as much as they used to. AMD supplies chips which powers this cryptocurrency mining, so falling demand for crypto mining means falling demand for AMD chips in that market.

Inflation fears are also a headache for AMD stock, which trades at a massive valuation and is all about down-the-road profits. When rates go up, the value of down-the-road profits gets diluted, and companies with tremendous value based in those down-the-road profits get whacked.

Putting it all together, it really isn’t that hard to see why Advanced Micro Devices stock has tripped up from $14 to below $10 over the past several months.

But under $10, AMD stock looks interesting. Here’s why.

Powerful Long-Term Growth Narrative

Despite the aforementioned risks, AMD still has a powerful long-term growth narrative. The risks pulling the stock down over the past several months are near-term in nature. The growth drivers, however, are long-term in nature.

Tariffs? Seems like a bunch of talk and bravado. Treasury Secretary Steve Mnuchin has said that a trade war with China is not the goal, but it could happen. That makes me believe that this chest puffing will persist but won’t materialize into anything serious or long-term. Eventually, the two sides will meet, negotiate, and resolve trade issues.

AMD’s big-time data center partnerships with Baidu Inc (ADR) (NASDAQ:BIDU), Tencent Holding/ADR (OTCMKTS:TCEHY), JD.Com Inc (ADR) (NASDAQ:JD) and Alibaba Group Holding Ltd (NYSE:BABA) shouldn’t be materially affected by tariffs in the long-term.

Falling bitcoin prices? Cryptocurrency mining comprised a very small portion (mid single digit) of AMD’s total revenues last year. Thus, even if bitcoin prices go to zero and cryptocurrency mining dies completely, AMD won’t lose that much business.

Rising rates? They do dilute the present value of AMD stock. But AMD stock has fallen by so much and so quickly that the stock actually looks undervalued, even in a higher-rate environment.

Looking beyond these near-term risks, there is still the powerful AMD growth narrative with 30%-plus revenue growth and exposure to high-growth markets like data center, IoT, VR/AR, AI and next-gen gaming. These drivers are long-term in nature, and as of today, the outlook for growth in each of those markets remains strong.

AMD Stock Is Undervalued Below $10

AMD’s current 30%-plus growth rate will come down significantly over the next several years. But massive data center growth through EPYC should keep growth rates high. Overall, revenues should be able to grow around 15% per year over the next several years.

Margins should continue to zoom higher thanks to the company’s entry into higher-margin businesses. Robust revenue growth should also drive expense leveraging. Long term, management thinks gross margins can get to 40-44%, while the OPEX rate can fall to 26-30%. At the midpoint, that represents operating margins of 14%. AMD should be able to get there in five years.

Roughly 15% revenue growth per year on 14% operating margins implies revenues of $10.7 billion and operating profits of $1.5 billion in five years. Taking out $150 million for interest expense and 10% for taxes, and dividing by presumably a higher diluted shared count of 1.2 billion, that equates to around $1 in earnings per share.

A market-average 16-times forward multiple on that $1 earnings base implies a four-year forward price target of $16. Discounting that back by 10% per year, you arrive at a fair value of about $11.

Bottom Line on AMD Stock

Near-term risks have plunged the stock into undervalued territory. Once these near-term risks ease, the company’s positive long-term growth narrative will come back into focus.

At that point, AMD stock should be able to rally well above $10.

As of this writing, Luke Lango was long AMD, BIDU, JD, and BABA. 

Article printed from InvestorPlace Media, https://investorplace.com/2018/04/under-10-it-may-be-time-to-buy-advanced-micro-devices-stock/.

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