Here’s Why You Should Sell the Rally in AMD Stock

AMD stock can't stay up despite much longer

Advanced Micro Devices (NASDAQ:AMD) stock has started to turn the corner recently. After hitting support at the $17 level multiple times, AMD stock has now surged back to the $23 level. That’s still short of last year’s highs at $34, but it’s a big step in the right direction. Unfortunately, the rebound in AMD seems to be based more in sentiment than in fundamental reality.

amd stock Advanced micro devices stock
Source: Shutterstock

For one thing, AMD’s most recent earnings hardly changed the narrative. This is a wait and see story out to late 2019 if not 2020. AMD also moved higher following Nvidia’s (NASDAQ:NVDA) recent upbeat guidance. In the case of Nvidia, however, expectations were so low that it didn’t take much to please investors.

It’s clear that the crypto profits that AMD and Nvidia feasted off in recent quarters aren’t coming back anytime soon. And between a downturn in the semiconductor cycle, trade war concerns, and really lousy demand out of Asia, signs point to a challenging 2019 for AMD.

Make No Mistake: Earnings Were Bad

Remember that AMD stock initially sold off following its most recent earnings report. Though shares quickly reversed and traded higher, the actual results weren’t so good. Cryptocurrency continues to be a major drag on results which offsets strength elsewhere. Even with AMD showing CPU market share gains for the fifth consecutive quarter, it just hasn’t been enough to move the needle. For 2019, AMD’s management still sees only single digit revenue growth.

Keep in mind that AMD’s growth is significantly decelerating. For full-year 2018, AMD grew its revenues by 23%. Despite that, it was only modestly profitable for the year.

It seems unlikely that this year’s softer incremental revenue growth will deliver the bang necessary to make AMD strongly profitable and give it the financial firepower necessary to keep up with Nvidia, Intel (NASDAQ:INTC), and other rivals over the long haul.

Notably, the analyst at JP Morgan gave a rather modest boost to the outlook for AMD stock following this earnings report. JP Morgan’s Harlan Sur raised his price target from just $18 to $20, leaving a neutral rating on the stock. While acknowledging that the company is on track to meet its 2020 objectives, Sur fears competition from Intel among other things will keep AMD from being a buy.

AMD: A Look at the Balance Sheet

Bulls and bears have been arguing over the state of AMD’s finances in recent weeks. On the bear side, AMD skeptics point to a great deal of dilution of AMD stock. On the plus side, that cash is shoring up the company’s debt position. Let’s take a closer look.

It’s important to understand that there are two separate financial instruments at work here. For one, AMD issued a ton of warrants back in 2016 at a low price when the company was struggling.

A major holder of these warrants, WCH, is exercising them. It holds warrants that will become AMD common stock at $5.98 per share. Remarkably, it has 75 million of these. These convert to 75 million shares of stock at less than $6 each. That obviously represents major dilution for AMD, but it does give the company almost $450 million in cash as these warrants become effective.

This will help AMD’s current financial situation to a significant degree. As of its most recent filing, AMD had around $1.2 billion in cash and cash equivalents against $2 billion in short-term obligations. That represents a fair amount of leverage.

There’s also the matter of the convertible debt. The company issued more than $800 million in convertible debt that has periodic windows where that debt can be transformed into stock. Given the run in AMD price, it seems likely that this debt will be converted.

The conversion ratio would reconfigure the debt into just over 100 million shares of AMD stock. That would be worth well over $2 billion at today’s prices, and the debt only yields 2.1% as it is. So it’s logical to convert the debt now. However, analysts have already calculated financials as though this debt had been converted, so there is not nearly the dilutive effect going forward that you might have expected.

All in all, these financial events limit AMD stock’s upside to some degree but substantially improve the company’s balance sheet and cash availability.

AMD Stock Verdict: Expectations Are Too High

Analysts have issued overly rosy guidance for AMD for a little while now. By this point, AMD was supposed to generating strong recurring profits.

Instead, the company is trading at a 74 P/E ratio with people pushing the data for big profits out to next year. If you believe the analysts, AMD stock is now trading at 25x forward earnings. But they’ve been wrong before. Even if they are correct, 25x earnings is hardly that cheap for a semiconductor company.

AMD has done a lot of things right in recent times, and management deserves the credit it is getting. But the stock got ahead of itself. There was little reason for shares to trade north of $30 when earnings are, even if everything goes perfectly, set to come in under a dollar a share over the next year.

Much of AMD’s recent recovery was due to short-term profit sources, such as the crpytocurrency boom. If you’ve looked at Bitcoin prices lately, it should be clear that this revenue isn’t coming back in 2019, if ever.

The analyst firms, JP Morgan excluded, still have relatively favorable outlooks on AMD for 2019. If the company can deliver, the stock may go up a little. But if it misses expectations, you should expect the stock to get hammered. The risk/reward is tilted heavily to the downside, particularly as shares have rallied so sharply in recent weeks.

At the time of this writing, Ian Bezek owned INTC stock. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2019/02/heres-why-you-should-sell-the-rally-in-amd-stock/.

©2019 InvestorPlace Media, LLC