The roller-coaster in Advanced Micro Devices (NASDAQ:AMD) continues. The AMD stock price went from under $15 at the beginning of July to $34 by early September. But a chip sell-off sent AMD into a reversal which is accelerating on Thursday after a disappointing Q3 earnings report.
I was bullish on AMD for much of the run, and I’m not ready to toss the stock just yet. But while the reaction to the Q3 report no doubt has been amplified by the aggressive sell-off in semiconductor stocks of late, investors can’t ignore real concerns here.
This is a disappointing release from a company that until recently was dogged by inconsistent performance. And while the story behind AMD isn’t necessarily broken, even the best-case reading of the quarter suggests that story will take longer to play out than hoped. Even that matters in terms of the AMD stock price long-term.
And in the near term, it certainly looks as if AMD will be at the mercy of sector sentiment for at least a couple of months.
Disappointing Earnings
The headline numbers in AMD’s Q3 report were mixed. Revenue of $1.65 billion rose 4.4% year-over-year, and missed Street estimates by about $50 million, or ~3 points worth of growth. Adjusted EPS of $0.13 came in a penny ahead of the Street.
The problem is that looking closer, the numbers look worse. The narrow profit beat likely came from gross margin, which at 40% was up 390 basis points year-over-year. But about half the increase, per the AMD Q3 conference call, came from IP-related revenue and inventory adjustments, all of which rely in some degree on timing.
The news still is positive in terms of gross margin, which is a key metric here. The rest of the expansion was driven by Ryzen and EPYC, two of the company’s newest processors.
The improvements on both fronts have allowed AMD to take pricing, and better manufacturing likely is helping as well. Still, adjustments aside, it looks like overall profitability was roughly in line with expectations.
As for the sales numbers, the results are somewhat in the eye of the beholder. Mining revenue in the GPU category proved a substantial headwind. Per the call, a high-single-digit portion of Q3 2017 sales came from blockchain.
This year, sales were “negligible.” Outside of bitcoin/blockchain, then, revenue almost certainly rose 10%+ year-over-year. And the inventory built from those rigs (some of which no doubt are being sold already) is having a further impact.
The Story Takes a Hit
That said, it’s how AMD drove its revenue that effects the story here. The graphics business overall disappointed substantially, with CEO Lisa Su estimating the business missed internal expectations by about $100 million.
Ryzen sales made up some of that ground. But that’s not the shift AMD needs to keep the AMD stock price at a high earnings multiple. Trading higher-margin, higher-growth GPU sales for Ryzen sales to the still-stagnant PC market isn’t a good deal. And that colors the revenue performance in the quarter.
So does the outlook from AMD. Q4 revenue guidance of $1.4-$1.5 billion was well below consensus estimates around $1.6 billion. And it suggests, at the midpoint, a year-over-year decline in sales.
Continued pressure from mining is a factor there, admittedly. But even considering that headwind, there’s a clear takeaway from the quarter’s results and the Q4 guidance. The story here is not as quite as attractive as it looked.
The run in the AMD stock price from $2 in 2016 to $30+ this year was based on the improvements across the entire portfolio. The Ryzen line would let AMD become a legitimate competitor to Intel (NASDAQ:INTC), not just an alternative for lower-priced desktops and notebooks.
EPYC gave AMD exposure to the fast-growing datacenter market, where it would again challenge Intel, along with Nvidia (NASDAQ:NVDA). Vega GPUs were a first step in the graphics space.
The story isn’t dead by any means. Datacenter revenue was strong in the quarter. Ryzen is taking market share. 7nm is on the way in Q4, providing another catalyst for share gains.
But the quarter, and more importantly, the guidance suggests that the share gains modeled in by bulls may have been too aggressive. This remains a company still significantly reliant on the PC market. And given that AMD stock still isn’t cheap by any earnings measure, that creates real concern in a chip space under pressure at the moment.
The AMD Stock Price Isn’t Cheap
Back in May 2017, at AMD’s Investor Day, Su projected 2020 earnings of 75 cents per AMD share. The market didn’t like that news, and sold off AMD stock as a result.
AMD hasn’t updated that target since, to the best of my knowledge. But the market has proceeded as if it assumes the figure is too conservative. Street estimates for 2019, heading into Q3, were at $0.69, with many analysts (and investors) seeing that target as coming in a year early.
The key fundamental takeaway here is that the target may have been right, or close, all along. In essence, the market got ahead of the story in moving the AMD stock price to a whopping 40x+ those earnings. Q3 isn’t necessarily a bad quarter, by any means. In fact, expectations aside, it’s actually a good quarter.
Outside of mining, sales grew double-digits. AMD took market share likely across the board (excluding GPU mining sales). Margins expanded in the process, and the new lines are ramping well.
It’s just not good enough given the valuation heading into the quarter, even accounting for the 9%+ decline in trading Wednesday ahead of the release. And with Q4 looking disappointing, it’s hard to see what moves the AMD stock price higher in the near term other than a “buy the dip” move in the chip space more broadly.
The problem there is that there look like better choices should sentiment reverse. NVDA looks attractive here. Equipment manufacturers Lam Research (NASDAQ:LRCX) and Applied Materials (NASDAQ:AMAT) are in line for a quick snapback at the bottom.
In theory, has the sell-off in AMD stock gone too far? Probably. But the gains went too far as well. There is a logic behind Thursday’s sell-off – and a strong likelihood it will take AMD stock some time to get off the mat.
As of this writing, Vince Martin has no positions in any securities mentioned.
