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The Big Rally in AMD Stock Isn’t Over, but Watch Out for $30

AMD stock - The Big Rally in AMD Stock Isn’t Over, but Watch Out for $30

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There goes Advanced Micro Devices (NASDAQ:AMD) stock.

AMD stock rallied more than 5% on Monday after the company announced its new graphics card geared towards the hyper-growth and ultra-valuable data-center market. That big rally brings AMD stock’s year-to-date gains to 145%. It also puts AMD stock above $25, a level which the stock has only seen twice before — in  early 2000 and again in late 2005. Both times, AMD stock rallied for another several months, before dropping in a big way.

History may ultimately repeat itself here. But not yet — nor in the same velocity.

This time is slightly different for AMD stock. AMD is running largely without major competition in the server market for the next six to 12 months –until chief rival Intel (NASDAQ:INTC) launches new chips in late 2019. During that stretch, AMD should gain server market share at an accelerated rate, revenue growth should remain robust, margins should trend higher, and AMD stock should bounce.

Eventually, though, Intel will punch back. AMD will also start rubbing elbows more aggressively with Nvidia (NASDAQ:NVDA). At that time, AMD’s competition will beef up. Revenue growth will slow, margins will stop moving higher, and AMD stock will fall flat.

That time isn’t now. Instead, it is a few months down the road. As such, I think the rally in AMD stock will last for the next few months, albeit at a slower pace.

AMD Stock Has Runway for Several Months

The bull thesis on AMD is pretty simple.

The whole semiconductor and chip space is the right space to be in as the world digitizes and modernizes over the next several years. After all, this industry is essentially the fuel for all of tomorrow’s big growth markets — data centers, artificial intelligence, automation, virtualization, smartphones, augmented reality and virtual reality, and so on. Within this industry, AMD plays the part of David with relatively anemic market share. But, David (AMD) has equipped himself with a super-charged sling (new next-gen chips that are better than the competition). As a result, David is suddenly beating up Goliath.

In finance speak, this means that AMD is a small company gaining significant market share in multiple secular growth markets, all of which have big long-term drivers. As long as these market share gains persist, AMD’s numbers will get better, and AMD stock will head higher.

These market share gains should persist for the next several months. During that stretch, AMD should operate in largely open fields. Intel has already announced that it won’t have next-gen chips ready until next year, and the consensus in the market is that AMD will ramp from less than 1% server market share last year to 15-20% by next year.

During this stretch, it is hard to imagine AMD stock dropping. Revenue growth will remain robust. Margins will keep trending higher. Earnings will soar. Sentiment will get more bullish. Plus, there are still a bunch of shorts out there (20% of the float is short), and they will rush to cover as AMD keeps gaining share.

Thus, over the next several months, AMD stock should trend higher.

Multi-Year Outlook Doesn’t Support Prices Above $30

The near-term bull thesis on AMD stock comes with two caveats.

One, even in an “everything goes right” scenario, AMD stock still isn’t worth more than $30 by the end of 2018. Two, no one really knows how the competitive landscape will shake out in late 2019 when Intel punches back.

In an “everything goes right” scenario, AMD continues to top estimates this year and grows revenues to $7 billion. The company continues to steal market share next year, and even in subsequent years, to the tune of 20% revenue growth per year. Gross margins scale up to and above management’s long-term 44% target. The operating expense rate falls to and below management’s long-term 26% target.

Putting all that together, AMD’s bull case scenario is that earnings per share shake out around $2.50 in 2022. Also in a bull case scenario, AMD stock gets a market-average 16X forward multiple at that time, as opposed to the sector-average 13X forward multiple. Thus, the bull case is that AMD stock hits $40 by the end of 2021, or is worth $30 by the end of 2018 — using a 10% discount rate.

Having said all that, there is no guarantee that AMD continues to steal market share and grow margins and earnings past next year. Historically speaking, Intel punching back results in a complete wipe-out of the AMD growth narrative (see 2006). That isn’t to say history will repeat itself here. But, it is to say that Intel punching back does present a huge risk to the long-term growth narrative, and that no one really knows what will happen in late 2019 when the competitive playing field between Intel and AMD evens out.

Because of this, while I think AMD stock has room to run higher in the near-term, I don’t think this rally will last forever.

Bottom Line on AMD Stock

AMD stock is presently characterized by near-term gain, long-term questions. As long as AMD continues to steal share from Intel, AMD stock will head higher. Once Intel punches back in 2019, though, the outlook for AMD stock will become very cloudy.

For now, stick with AMD stock. But, beware that historically speaking, this isn’t a stock you won’t to hold on to forever.

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

Article printed from InvestorPlace Media, https://investorplace.com/2018/08/rally-in-amd-stock-isnt-over-watch-out-30/.

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