For the second time (at least), patience has paid off when it comes to Advanced Micro Devices, Inc. (NASDAQ:AMD). AMD spent a few years hovering around $2 per share before skyrocketing in 2016. But last year, the rally faded out; by early April, AMD stock had reached a 16-month low.
Those levels certainly proved to be a buying opportunity. Even after a 5%+ pullback Thursday, AMD stock has gained 65%. The question now is whether the rally has more legs.
The recent rally is based on real evidence that AMD is becoming a significant competitor to the likes of Intel Corporation (NASDAQ:INTC) and Nvidia Corporation (NASDAQ:NVDA). And while I get the valuation concerns (in fact I’ve highlighted them in the past) increasingly Advanced Micro Devices looks like it’s capable of growing into that valuation.
Big Wins for AMD
Again, the recent rally in AMD stock doesn’t appear to be based on traders taking long positions or even short covering. The percentage of AMD sold short has come down recently but it’s still near 18%, toward the 20% peak seen over the past decade.
Rather, AMD has posted some nice wins of late. Its 32-core chip, part of the Ryzen Threadripper group, appears well ahead of Intel’s 28-core offering.
And the EPYC processor has gained entrance into servers from Cisco Systems, Inc. (NASDAQ:CSCO) and Hewlett Packard Enterprise Co (NYSE:HPE), while also driving a cloud service from Tencent Holding/ADR (OTCMKTS:TCEHY).
Add to that the first 7nm GPU, and comments from Nvidia that its next-gen GPU’s won’t arrive for “a long time,” and the takeaway seems pretty clear. AMD is becoming a real competitor in CPUs, GPUs, and in datacenter. The promise of that arrival drove much of the 2016 gains. It’s starting to look more and more like that promise will be realized.
Is AMD Stock Too Expensive?
The one key question is valuation. AMD now trades at 26x forward (2019) EPS, and about 20x the company’s 2020 target of $0.75. Expecting more gains requires either that AMD be valued at 25x+ EPS in 2020 (assuming its target is hit) or that it outperforms even management’s expectations.
It’s the latter path that seems more reasonable, and it’s doable. Luke Lango has pointed out that the company’s 14% operating margin target suggests 2022 EPS of $1.10. Discounted back, and assuming an 20x multiple, Lango points out that the model values AMD right now at $15 – almost exactly at Thursday’s close of $14.89.
The point of the recent optimism, however, is that those targets could be raised. AMD’s gross margin has always badly lagged those of Intel and Nvidia, partially due to differences in the companies’ business models. But another major issue has been pricing.
AMD traditionally has had to undercut Intel in CPUs, in particular, given the gap in performance (and branding) between the two companies.
Better pricing will benefit gross margin and allow for higher revenue growth and greater leverage of SG&A. And so it’s possible, if not likely, that if AMD has truly caught up with its rivals, those targets will need to be moved higher. If that’s the case, AMD stock will do the same.
As of this writing, Vince Martin has no positions in any securities mentioned.