Since June 2019, Advanced Micro Devices (NASDAQ:AMD) has been trading in a narrow range. With the announcement of third-quarter 2019 results, it seems that AMD stock is ready to break-out on the upside.
The upside will be supported by visible fundamental developments on the business front. In addition, sustained de-leveraging has helped in improving the company’s credit metrics.
The growth in sales of Ryzen processors is the first reason to be bullish on AMD stock. Ryzen processors based on Taiwan Semiconductor Manufacturing Company (NYSE:TSM) 7nm manufacturing node and AMD’s Zen 2 micro-architecture. Analysts believe that TSM “is more than a year ahead of Intel (NASDAQ:INTC) in implementing new processes.”
This has given an edge to AMD with Intel’s 7nm processor launch not coming before 2021. It is worth noting that seven out of 10 bestsellers on Amazon (NASDAQ:AMZN) in the computer CPU processor belongs to AMD. Not surprising that all these processors are from the Ryzen series.
Another interesting data comes from Mindfactory.de, which is one of the largest German retailers. In the recent past, the sale of AMD processors has skyrocketed as compared to Intel. This provides a ball-park indication of the trend.
The trend is also verified by the company’s 36% year-on-year growth in Computing and Graphics segment revenue. Stellar growth was primarily driven by increased Ryzen client processor sales. In addition, the sale of Ryzen contributed to an improvement in gross margin.
With Zen 3 and Zen 4 in the pipeline, the outlook is interesting for AMD. Further, AMD has an edge over Intel when it comes to pricing. Therefore, the Computing and Graphics segment is positioned to deliver an upside for AMD stock.
EPYC Processor Sales Will Grow
For 3Q19, the Enterprise, Embedded and Semi-Custom segment revenue declined by 27% on a year-on-year basis. For the quarter, lower semi-custom product revenue, partially offset by higher EPYC processor sales.
I believe that EPYC sales will continue to gain traction even as Intel remains a clear market leader in this segment. The second generation AMD EPYC processors have already attracted clients such as Alphabet (NASDAQ:GOOG), Twitter (NYSE:TWTR), IBM (NYSE:IBM) and Dell (NYSE:DELL), among others.
“Intel had a significant portion of the market for a long time,” said John Donovan, executive director of Lenovo’s data center group. “I think they’ll continue to have a significant portion of it. I do think that there are more customers that will look at AMD than have in the past.”
For my part, I believe that over the next 3-5 years, EPYC Processor Sales will boost top-line growth for Advanced Micro Devices.
Improving Credit Metrics
As of Q3 2019, AMD reported cash & equivalents of $1.2 billion. For the same period, the company’s operating and free cash flow were $234 million and $179 million. This implies an annualized free cash flow of $700 to $750 million.
It is worth noting that the company’s total debt was $1.7 billion in Q4 2017 and debt has declined to $1.1 billion in Q3 2019. I expect de-leveraging to continue considering the free cash flow outlook.
In addition, as margins expand, free cash flow visibility will be higher and AMD is well-positioned to report stronger credit metrics in the next 12-24 months.
I believe that positive balance sheet and cash flow developments will also result in an uptrend in AMD stock price.
Final Words on AMD Stock
According to Reuters data, Advanced Micro Devices stock is trading at a forward PE of 56.35. That seems expensive, but AMD stock does have several triggers to keep the markets excited.
Strong growth in the Computing and Graphics segment and gradual market share expansion in the Enterprise, Embedded and Semi-Custom segment are some positives. Gross margin expansion and deleveraging are also upside triggers.
In addition, there is a healthy product pipeline in the next 2 years and that should help in sustaining the reversal in top-line trend for AMD.
Overall, I am bullish and I believe that positive stock momentum will sustain even when valuations are on the expensive side.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
