Shares of chipmaker Advanced Micro Devices (NASDAQ:AMD) popped and then dropped after the company reported pretty good first-quarter numbers. The results simultaneously confirm that the large year-to-date rally of AMD stock was justified and suggest that further advances by AMD stock in the near-term will be limited.
Generally, AMD’s first quarter numbers were good. Earnings met analysts’ average estimate. Revenue exceeded analysts’ consensus outlook. Against the backdrop of a semiconductor market in free-fall, and following disastrous numbers from rival Intel (NASDAQ:INTC), those results were actually pretty good. Also, the Q2 guidance was in-line with expectations. Again, that’s pretty good, considering that Intel ‘s Q2 guidance came in significantly below the consensus outlook.
All in all, then, AMD’s numbers were pretty good, as they were largely much better than Intel’s recent numbers.
But AMD stock has surged 50% in 2019, and it’s trading at essentially triple the average valuation of all semiconductor stocks. In other words, AMD stock is priced at levels that suggest the company’s numbers will be pretty good. Only great numbers can spark another major rally by AMD stock. Since the numbers weren’t great, the post-earnings rally has faded, and Advanced Micro Devices stock ultimately didn’t get a boost from its Q1 earnings.
AMD stock is poised to win over the long-term, but AMD stock is maxed out as it closes in on $30.
Q1 Earnings Were Good, But Not Good Enough
In the big picture, the long-term bull thesis on AMD stock boils down to two things: market share expansion and margin growth.
Both of those things happened in Q1. Specifically, the company’s sales of graphics processing units (GPU) to data centers more than doubled year-over-year in the quarter, while the sales of Intel’s data center group dropped 6% last quarter. Granted, Intel’s revenue base is much, much larger than AMD’s base. But the massive revenue growth discrepancy does imply that AMD ‘s share of the all-important data center market is significantly expanding.
Further, despite the 23% drop of AMD’s overall revenue in the quarter, its gross margins expanded a healthy five points year-over-year, exceeding 40%. That marks the eighth consecutive quarter of gross margin expansion, and broadly illustrates that even amid widespread semiconductor market weakness, Advanced Micro Devices can leverage its out-sized growth in higher margin markets to drive gross margin expansion.
Overall, then, AMD’s Q1 earnings report checked off the two boxes it needed to check off: market share expansion and margin growth.
But most investors already expected this. After all, AMD stock is up 50% year-to-date, and it does trade at nearly 45-times forward earnings, versus the average forward multiple of 15-16 for semiconductor stocks. As a result, in order to warrant a pop in AMD stock, the company needed to smash both revenue and profit estimates in the quarter, and deliver above-consensus guidance. That didn’t happen. Ultimately, that’s why Advanced Micro Device stock failed to stage a meaningful rally following AMD’s Q1 earnings.
Upside Is Capped at $30
Long term, AMD stock is on a winning trajectory, powered by market share expansion and margin growth. But, in the near term, all of the long-term rallies of Advanced Micro Devices stock seem fully priced into the shares.
The global semiconductor market is supported by healthy, non-cyclical tailwinds in AI and data. Those tailwinds will enable AMD to grow at healthy rates over the next several years.
At the same time, the semiconductor market is pulling back now amid rising supply and falling demand. This correction won’t last forever, but it will weigh on growth over the next several years. Given this dynamic, my math suggests that the global semiconductor market will grow at a 1-2% annualized rate into 2025.
Based on its SEC filings and market numbers from the Semiconductor Industry Association, AMD’s share of the global chip market was roughly 1.4% last year. At its peak about a decade ago, AMD controlled just shy of 3% of the market .
First-quarter numbers imply that AMD’s share of the global chip market will continue to rise over the next few years. AMD’s market share should near 3% by 2025. On top of 1%-2% market growth, that should drive roughly 15% revenue growth over the next several years. At the same time, AMD’s gross margins should ramp towards 45%, and its operating-spending rate should fall back towards 25%.
Based on those numbers, $2.40 of earnings per share seems like a best-case scenario for AMD by fiscal 2025. Based on a forward price-earnings multiple of 20, which is average for growth stocks, that equates to a fiscal 2024 price target for Advanced Micro Devices stock of $48. Discounted back by 10% per year, that results in a reasonable fiscal 2019 price target for AMD stock of roughly $30.
The Bottom Line on AMD Stock
In a best-case scenario, AMD stock is worth about $30 today. More realistically, its EPS will be about $2 in 2025, which would imply a fair value today of around $25 for AMD stock. Not coincidentally, AMD stock currently trades about halfway between those two fair value targets. As a result, AMD stock probably won;t rise much in the near-term. I won’t buy AMD stock until the shares drop below $25.
As of this writing, Luke Lango was long INTC.
